Aging, informality and public finances in Poland and Slovakia: A general equilibrium approach, background paper for the ECA Old-Age Insurance World Bank report ; Final Report ; Study on behalf of The World Bank

Abstract: This document is the final report for a background paper for the ECA Old-Age Insurance report, using a General Equilibrium approach to analyze aging and pension reforms in two countries from the Europe and Central Asia region, Poland and Slovakia. Compared to the second interim report, this document adds analysis for some additional reforms, sensitivity analysis and policy implications. Low fertility and increases in life expectancy lead to aging of the population. As the number of young active households is growing less rapidly (or even shrinking) than old households prone to retirement, the financing of pension systems is a challenge when these systems are based on the pay-as-you-go scheme. All developed countries rely to some extent on pay-as-you-go schemes. The basic challenge of pension financing created by population aging is common to many developed countries . The challenge confronted by countries in the ECA region may however be larger, for several reasons. In particular, high participation in informal markets decreases government revenue, adding to immediate pension financing difficulties. Using an expanded overlapping generations model with endogenous retirement decisions with formal and informal sectors, simulation predicts that aging would increase social security deficits by more than 5% of GDP by 2100. Among the various reforms considered, cuts in pension benefits are the most successful at containing the deficits if the sole goal of reforms is financial sustainability. Increases in retirement age may be preferable if additional goals are considered. Targeting a decrease in informality alone may not help to decrease the deficit in the long run because gains in revenues are offset by the increase in pension payments.;