Exercises: Sustainability of the welfare state

Explain how the Spanish pay-as-you-go pension system works: who pays today's pensions, and who will pay yours? How does it differ from a fully funded individual pension scheme?

Define the dependency ratio (the ratio between elderly people and the working-age population) and explain what happens to the pension system when the population ages.

The figure shows the population pyramid of an imaginary highly aged country, with the population of each age group (in millions of inhabitants), males on the left and females on the right.

1. a) Describe the shape of the pyramid: what do its narrow base and wide top indicate?
2. b) Explain what problem this structure poses for pensions in twenty years' time.

What are social security contributions and who pays them (one part by the employer and one by the worker, deducted from the payslip)? Explain what that money funds and why it appears as one more deduction on the payslip alongside income tax.

Life expectancy in Spain is over $83$ years and keeps rising. Explain how that affects the pension system: if retirement is around $65$, how many years is the pension collected on average and what does that mean for the system's accounts?

What is the birth rate and how does it relate to pensions twenty-five years from now? Explain the chain: fewer babies today, fewer contributors tomorrow, the same or more pensioners.

What is the "pension piggy bank" (the Social Security reserve fund)? Explain what it was created for (saving in surplus years for deficit years) and what happens when it runs out: where does the missing money come from then?

What is early retirement? Explain the dilemma it poses for the system (fewer years contributing and more years drawing a pension) and why it usually carries penalties on the pension. In which cases can it be fair (hard jobs, long contribution careers)?

In a country, there are two contributors for every pensioner, and the average pension is $1.200\ \text{€}$ per month.

1. a) Calculate how much each contributor should pay per month solely for pensions (excluding healthcare and other expenses).
2. b) What happens to that amount if the ratio drops to $1,5$ contributors per pensioner? Recalculate and comment.

Analyse the effect of immigration on the sustainability of pensions: average age of arrivals, contributions they make, and why many economists consider it part of the demographic solution.

Present three options to ensure future pensions (raising the retirement age, increasing contributions, encouraging complementary private pension plans) and analyse one social advantage and one disadvantage of each.

In a country, the average pension is $1.300\ \text{€}$ a month and there are $3$ contributors for every pensioner.

1. a) Calculate how much each contributor must pay per month just to cover pensions.
2. b) If the ratio falls to $2$ contributors per pensioner, recalculate the necessary contribution and comment on what the result shows about the demographic pressure on the system.

Fictitious data: in the year $2000$ there were $4$ working-age people for every person over $65$; today there are $2,5$; in $2050$, $1,7$ are forecast.

1. a) Interpret the evolution: what is happening to the population pyramid?
2. b) Beyond pensions, name two economic consequences of ageing (health spending, long-term care, less dynamism) and explain them briefly.

More and more elderly people need daily care, and today it is provided mainly by relatives, mostly women.

1. a) What opportunity cost does that family model have for the carer (employment, social security contributions, health)?
2. b) Compare two solutions (public long-term care services, well-regulated professional care employment): what do they cost, what jobs do they create and how are they financed? Which do you find more sustainable?

Private pension plans allow people to save for retirement with tax advantages.

1. a) Explain what they are and how they differ from the public pay-as-you-go system.
2. b) Reason why they are not a complete solution for low incomes (what saving capacity do they have? who do the tax advantages "pay off" most for?).
3. c) What role can they play as a complement to the public system? Propose how to encourage them fairly.

In most rich countries, the birth rate is well below the generational replacement rate.

1. a) Set out four possible causes (expensive housing, unstable employment, difficulty balancing work and family, cultural changes and life projects) and develop two of them briefly.
2. b) Analyse, using cost-benefit criteria, a policy to support the birth rate (cheques per child, public nurseries, long parental leave): what it costs, what evidence there is that it works and over what timescale.

A valley is losing its young people: $300$ residents remain with an average age of $58$ years, the local medical surgery reduces its opening hours, and the shop barely survives.

1. a) Analyse the valley's demographic and economic spiral: what feeds it and what sequential effects it triggers.
2. b) Propose two measures to reverse it and assess their realistic feasibility.

A televised debate concludes with the following statement: "The pay-as-you-go public pension system is a Ponzi scheme doomed to bankruptcy; the fairest and safest approach is for each worker to save in their own private fully funded pension plan in financial markets."

1. a) Imagine that the economy enters a ten-year cycle of high inflation ($6,5\ \%$ annually) and stock market crashes due to international financial crises. Compare and predict how this economic situation would affect a retiree under individual funding versus one under a public pay-as-you-go system. Justify what risks each system bears in the face of inflation and market fluctuations.
2. b) Analyze distributive equity: what lack of protection would workers with persistently precarious wages or with career interruptions due to unpaid family care face in a purely fully funded system? Justify why the pay-as-you-go system mitigates these individual risks.
3. c) Design a mixed proposal (multi-pillar system) that combines pay-as-you-go and funding, justifying what weight you would give to each pillar to balance intergenerational solidarity and financial returns.

Design a "generational pact" for pensions.

1. a) Combine at least three measures (demographic, labour, fiscal, savings) and explain what each generation gives up and gains.
2. b) Which indicators would you monitor to determine if the pact is working in ten years' time?

A fictitious country has $10$ million pensioners with an average pension of $1.200\ \text{€}$ a month, and the average contribution earmarked for pensions per worker is $400\ \text{€}$ a month.

1. a) Calculate how many contributing workers are needed per pensioner to balance just the pensions.
2. b) If the real ratio is $2,3$ workers per pensioner, quantify the system's monthly shortfall and rank the levers for closing it (raising contributions, holding back the real pension, using general taxes, delaying retirement), assessing the social cost of each one.

A labor reform proposes replacing the traditional severance pay system with the "Austrian backpack" model: each month the company deposits $1,5\ \%$ of the worker's gross salary into a portable individual account managed by an investment fund, which the employee can access if dismissed or keep as a supplement to their retirement pension.

1. a) Analyze and compare two profiles: Sara, a $24$-year-old worker with high turnover and temporary jobs in the service sector, and Roberto, a $53$-year-old employee with $25$ years of permanent tenure in an industrial company planning a collective dismissal. Who wins and who loses in terms of protection and severance pay compared to the current system? Justify your analysis.
2. b) From the macroeconomic perspective of firms and employment, justify whether this model would incentivize permanent hiring or make dismissals cheaper by facilitating turnover, explaining the economic mechanisms involved.
3. c) Analyze the "transition cost" problem: if employer contributions to the backpack are diverted from current Social Security contributions to finance individual funded accounts, predict what immediate impact this creates on the deficit of the pay-as-you-go system and what fiscal dilemma the State must face.

To delay the effective exit from the labor market in light of increasing life expectancy, a proposal has been made to make "active retirement" more flexible, allowing people over $65$ years old to collect $100\ \%$ of their public pension while continuing to work full-time or part-time at a market wage.

1. a) Analyze the contradictory effects on the labor market: in what type of professions or sectors does this measure enable the transfer of accumulated experience without harming employment, and in which ones could it act as a barrier to entry or a bottleneck for the hiring and promotion of young people? Justify your answer.
2. b) Evaluate the distributive impact and the impact on public finances: which socioeconomic worker profile is more likely to take advantage of this measure (an executive or a tradesperson in a physically demanding job)? Justify whether the measure reduces or widens inequality among pensioners and whether its net revenue effect is positive or negative.
3. c) Design a regulatory framework for active retirement that maximizes savings for Social Security and avoids hindering youth hiring. Establish at least three specific requirements (percentage of pension collected, type of working hours, subsidies or conditions for companies) and justify each one.

If pensions rise every year with the CPI but young people's wages do not, the gap between generations opens up.

1. a) Explain, with a simple numerical example of your own invention, how both incomes evolve over ten years and what "intergenerational equity" means here.
2. b) Propose a rule for updating pensions that protects their purchasing power without breaking equity between generations (a mixed index of prices and sustainability) and defend it against pure CPI-linked revaluation.

Two opposing economic views debate the sustainability of the pay-as-you-go pension system in Spain in the face of the massive retirement of the "baby boom" generation:

• Position A: "Sustainability is a matter of labor demographics. Only by increasing net inflows of young migrant population (around $300.000$ people per year) will we maintain the ratio of contributors to pensioners."

• Position B: "Demographics does not solve the root of the problem. The key is productivity growth: by investing in R&D and digitalization, higher real wages will allow pensions to be funded with fewer workers."

1. a) Identify the temporal and structural limits of Position A: predict what will happen to the population pyramid and the system's expenditures $30$ years from now if action is only taken on demographic volume without raising the qualification or wages of new contributors.
2. b) Examine the difficulties and contradictions of Position B: if the increase in productivity is concentrated in capital-intensive and automated sectors (with few wage earners and high corporate profits), explain why payroll contributions might not grow at the same pace as GDP and what reform in pension financing would be required.
3. c) In a scenario where the old-age dependency ratio will increase over the next two decades, design a comprehensive strategy combining labor, productive, and fiscal measures, justifying how it distributes the effort between expanding the contributor base and alternative sources of revenue.