Comments on Working Longer: Comprehensiveness, Timeliness and Gradualness of Reforms

Working longer is an essential ingredient of the adaptation of our societies to the challenges posed by increased longevity. Working longer as a response to living longer trends is both feasible and optimal. This is because to a large extent the increase in longevity has also implied a postponement, over the life cycle, of many health impediments. Moreover, preventing those defects over the life cycle is potentially much more fruitful than reacting to them through early retirement policies or the provision of disability allowances.
So, increasing the time span of the working life — vis-à-vis the increase in the overall life span — allows as to increase the resources available during retirement. The alternatives to this would be rather pauperistic, as one would have to either reduce the yearly income flows during a (lengthened) retirement period or put aside a larger amount of yearly resources during the working life. The nature of the pension system — a pay-as-you-go system financed by ad hoc labour income taxes or a system based upon the financial returns upon invested funds, a defined contribution system or a benefit defined system — does not change the intrinsic logic of what has just been said. So, whatever the details of the pension system, engineering a working longer response is a key ingredient of any sensible policy response to the demographic trends of the forthcoming decades.
While a quite natural and obvious response — actually working longer would tend to be the response, vis-à-vis a scenario of enhanced longevity, which would be selected by a hypothetical Robinson Crusoe making his life plans knowing from the outset that his life expectancy is longer than that of his predecessors — accomplishing such a working longer response is not so easy in the real world. To a large extent this is due to the need to engineer comprehensive, timely and yet gradual changes over many social and economic dimensions. The presence of traditional and institutionally determined rules and habits may lead to difficulties as changing those rules may not be easy — as many individuals will have made their own life plans on the basis of those rules. So, adapting the rules to a changing world, one in which a longer life may be enjoyed, is a difficult task, as rules needs to be well enshrined, in order to ease people’s lives and plans, and flexible enough in order to take account of the evolving circumstances.
As just said the changes need to be comprehensive as many different aspects of our lives have to be considered. The rules concerning retirement decisions, and those relevant to the amount of the pension incomes enjoyable when retired, are not the only relevant aspects. In the following I will briefly touch upon them but also on the broader changes needed in the functioning of the labour market in order to prevent the elderly, while physically able to work (and here there may also be the need to take preventive steps in order to avoid a deterioration of the health conditions over the life cycle), from being at a disadvantage vis-à-vis their younger competitors in the labour market. The changes need to be timely, as in many cases preventive steps have to be taken: besides health conditions, the life long learning area is another example in which — because of the learning begets learning principle — only timely interventions may allow elderly workers to remain competitive in the labour market. Finally the changes need to be gradual as abrupt changes would not allow people to make their own decisions and adaptations. In what follows I will briefly touch upon some broad areas. I do not have the time to provide for a complete picture. So what is said here is not to be interpreted as an overall policy package plan. My intention is to touch upon some controversial issues widely discussed over recent years. The choice is partly due to what I know best. To some extent the intention is also to provide a vivid example of the comprehensiveness, timeliness and gradualness just advocated.
A first relevant area is that concerning the retirement rules, and the link between them and the rules governing the pension amounts granted by the first pillar pension schemes. As said, it would be incorrect to assume that either the retirement rules or the rules governing pension amounts (or both) are the only relevant factors which still induce people to retire too early. Nonetheless they surely matter a great deal (and here Italy is a good example, as it is clear that most of the increase in the average age at retirement experienced over the last decade is linked to the postponement of the minimum retirement age thresholds gradually imposed for the seniority pensions). The double challenge here is to allow for some flexibility in the retirement decision to be made by the individual while insuring that, over time, the decisions are responsive to the increased longevity trends. In principle, the 1995 reform provided for such a compromise, with its provision of an age window within which retirement was flexibly possible, the pension’s amount being positively tied to the postponement of actual retirement. The challenge would appear to be to fully adopt those principles envisaging a gradual and continuous over time raising of that age window. So one would keep the advantages of the presence of such an age window, adapting it to evolving demographic trends. Informing the individuals far enough in advance of such a raise would allow them (and firms as well) to adapt their behaviour in the labour as well as in the financial market. Unfortunately, the 1995 reform had postponed those principles too far into the future. indeed, while the 57-65 boundaries envisaged for that window were possibly reasonable values given the mid 1990s demographic picture, they are much less so given the demographic picture, expected for the forthcoming decades. Furthermore, the subsequent policy interventions made in 2004 and in 2007 were quite confused and to a large extent contradicted the age window principles.
All too often the flexible retirement principles — and the age window discussed above in line with which individuals may decide to postpone retirement so accumulating further pensions rights — have been assumed to imply an absence of redistribution in the pension first pillar schemes. On the other hand, such an absence of redistribution may often imply that workers accumulating too few pensions rights — because of their low skills and their reduced employment and earning chances — risk ending up with inadequate pensions. The risk envisaged by many observers is that, in the future, too many retired people may become poor (in absolute or at least in relative terms), or that massive transfers will have to be arranged, ex-post jeopardizing the financial stability of the system as political pressure would mobilize additional resources (the financial stability now forecast for the system in the future decades is actually based upon a politically unpalatable reduction in the average pension amount). To a large extent the way-out of these risks is again in engineering an extension of the working life along the lines advocated above. An additional reflection is that there is no reason at all to rule out the possibility of some redistribution even in a notionally defined contribution system (such as the one introduced in Italy by the 1995 reform and later on, and more coherently, by Sweden and other countries). Actually, in those systems the insertion of some redistributive components — provided they are framed in such a way that, on average, the link between future pensions’ rights and longevity (and macroeconomic) trends is maintained — might take account of the fact that low income individuals have on average a higher mortality risk.
A third remark concerning the first pillar pension scheme is that its transformation along the lines described above — towards a notional defined contribution nature with a moving over time retirement age window — would suggest the dismantling of the historic links between disability and old-age schemes. Such a separation — already made in countries like Sweden — does not imply that an ‘activation’ approach — so as to foster the labour market participation of disabled people — has to be neglected. Quite on the contrary, there is a risk that people impeded from retiring may be pushed towards the use of disability benefits (and countries like Sweden are a vivid example). The solution however is in fostering the correct labour market behaviour.
Activating elderly workers, after they may have been disenfranchised in the labour market, is however not enough. A preventive approach is often necessary, with respect to health conditions as well as to human capital and skills. A broader reflection on labour market functioning is needed.
A big issue concerns the link between the working longer approach and labour market flexibility. Quite often firms fear the working longer principle because of the presence of seniority pay regimes and because of the two tier labour market reforms of the last two decades, reforms which have eased the entrance into the labour market of low paid, flexible (and often temporarily engaged) youths. Here there is the need to adapt both workers’ and firms’ habits. A two tier market actually risks being the worst labour market environment for the elderly unemployed as firms may tend to prefer hiring youths while older people may find it extremely difficult to find new job opportunities once they have been dismissed. Over-protecting older workers from dismissals would risk exacerbating such a segmentation.
While working longer may not mean having a longer career in the same firm — actually many forces seem to operate in the opposite direction — firms will have to realize that elderly workers are increasingly a resource. Demography works in this direction as in the next decade there will be abundance of elderly people and lack of young recruits. Organizational changes need to be implemented. Health and human capital accumulation policies need to be implemented in a timely fashion. Again, pension rules and labour market functioning interact since having pensions rights linked to the whole working life contributions may help in this process, avoiding segmentation and non-linearity risks.

Paolo Sestito: Banca d’Italia, Economic Research Area, Department for Economic Structural Analysis. The opinions expressed here are those of the author alone and do not necessarily reflect those of the institution to which he belongs.

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