Can the introduction of a public old-age assistance scheme make a society better off? Economic theory is ambiguous on this question. One the one hand, public old-age assistance prevents poverty through redistributive transfers and thus increases income equality. One the other hand, these income transfers also potentially reduce employment among the elderly, resulting in lower economic efficiency.
New research to be presented at the annual congress of the European Economic Association in 2020 provides evidence that the introduction of public pensions in the UK made society better off. The reform, implemented in 1909, increased social welfare because the equality gain easily outweighed the efficiency loss.
The study by Matthias Giesecke and Philipp Jäger documents that in contrast to previous beliefs, the new pension in the UK indeed lowered employment among the elderly. Using census data including everyone who was alive in England and Wales at the time, the authors find that 6.0% of people immediately retired when they reached the newly created retirement age of 70.
The efficiency loss was nonetheless limited. Almost 60% of people above the age of 70 received a pension. Compared to the high pension coverage, the reduction in work activity was relatively small. The authors also show that the tax increase needed to pay for the pension created only very modest inefficiencies.
The equality gain, however, was tremendous. Income inequality was high and social security spending very limited at the time. Income transfers from taxpayers to elderly people therefore substantially increased income equality. Under the standard assumption that societies value equality, the new pension was clearly welfare-enhancing.
The analysis demonstrates that the introduction of an old-age assistance system can significantly improve social welfare. This finding is especially relevant for developing countries without universal coverage by old-age assistance (e.g. in sub-Saharan Africa), many of which are also characterised by high income inequality and limited public welfare spending.
More generally, the study shows that the welfare effect of pension reforms crucially depends on the distributional implications of the reform. So far, most of the existing research has mainly focused on the efficiency loss of old-age assistance.
‘Pension Incentives and Labor Supply: Evidence from the Introduction of Universal Old-Age Assistance in the UK’
Contact
Philipp Jäger
RWI - Leibniz Institute for Economic Research