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ABSTRACT
Ageing workforces due to low fertility rates and higher life expectancies challenge modern industrialized economies. In order to secure economic welfare and to balance public budgets, governments worldwide implement reforms to increase the retirement age. The trend towards a higher retirement age confronts defense sectors that for centuries have been in search of an age structure characterized by ‘youth and vigor’. In this article, we study the economic gains to society when the special retirement age for military personnel in the Norwegian Armed Forces is increased. Combining the literatures on pension, personnel, and military economics, we identify mechanisms crucial to the outcome of a special retirement age reform. Monte Carlo simulation is applied to illustrate the potential impact on the economic net gains of uncertain variables. We find that an increase in the retirement age provides substantial net benefits to society, even under fairly negative assumptions about the consequences for retention, motivation and efforts, and the value of elderly personnel in the Norwegian Armed Forces.
Acknowledgments
We would like to thank Wrenn Yennie Lindgren, Steinar Strøm, Kari R. Strand and Sverre Kvalvik for generous amounts of support, comments, and critical perspectives to the paper. We would also like to thank Joachim Reitan and Hallvard Gisnås for providing the underlying demographic data. Per Bilet provided help in programming the Monte Carlo simulation. Thanks to Vidar Christiansen for discussions on marginal cost of taxation. Finally, but not least, Simen Pedersen provided helpful comments to an early version of a subset of this paper.
Disclosure statement
The Norwegian Ministry of Defense (MOD) funds our research program, and is (obviously) eager to understand the financial and economic effects of alternative increases in the special retirement age. MOD commented on the reports that this paper builds upon. The comments concerned understanding the underlying assumptions and details of the defense sector in Norway. To be clear, once assigned the task of investigating the effects, we have designed and executed the research independent of the MOD. We, therefore, emphasize that the results presented in this paper stem from unbiased and academically independent research.
Notes
1. We define retirement age concepts as follows: actual retirement age is the age an individual retires from work; statutory retirement age is the age private and public sector employers have the right to retire their employees (but not necessarily enforced to do so); special retirement age is similar to statutory retirement age, but enforces the employer to retire its employees; pension age is the age an individual can at earliest retire with pension benefits.
2. The Ministry of Defence (MOD) has four defense agencies under its command: The Armed Forces, The Norwegian Defence Estates Agency, The Norwegian Defence Material Agency, and The Norwegian Defence Research Establishment; military personnel (with special retirement age) are employed in these institutions, including the MOD.
3. In this paper, we define ‘older’ as persons between 60 and 69 years old, and ‘young’ as those between 20 and 59 years old.
4. There is indeed substantial information asymmetry between the employer and employee about efforts and productivity in the defense sector (Hanson Citation2016; Citation2019; Førsund Citation2017).
5. By ‘prestige’ we mean status that is freely deferred by others based on achievement (see Henrich and Gil-White Citation2001).
6. This assumption is based on competitive wage theory, i.e. a theory that states that firms pay the competitive wage in the labor market; deviation from this wage is irrational for either the firm or the employee.
7. Other prominent theories on the relationship between productivity and wages are ‘efficiency wages’ (Krueger and Summers Citation1988) and ‘fairness wages’ (Akerlof and Yellen Citation1988; Citation1990), but these do not offer specific predictions about the relationship between older employees’ wages and productivity. ‘Matching’ (Jovanovic Citation1979) could potentially explain older people’s relatively high wages (because they have had more time to find a good job match than younger people), but nearly all military employees have matched with the Armed Forces early in their careers and can therefore not explain the relationship between wages and productivity (except that those who have stayed may be more skilled and prefer the Armed Forces more than those who left the organization).
8. Seniority wage refers to wage that stems from staying in the same company over time, in addition to the wage increases from gaining general experience and skills in the labor market.
9. See more information about the general pension system in Appendix A.
10. This means that there is a clear link between contributions and pension benefits (Lindbeck and Persson Citation2003).
11. Equal to the discounted value of take-up age, discounted at a real annual rate of interest of 2%.
12. Military personnel serving for at least 28 years at the age of 57 can choose to retire with full special retirement pension.
13. Personnel hired prior to 1 January 2006, remain in the Legacy System. Personnel hired between 1 January 2006, and 31 December 2017, had the option of enrolling into the new system (until 31 December 2018). Personnel joining after 1 January 2018 are automatically enrolled in the Blended Retirement System.
16. For conceptual definitions, see e.g. Chetty et al. (Citation2011).
17. For more details on the MCF, see Appendix B.
18. Dagsvik, Strøm, and Locatelli (Citation2019) calculate the MCF based on a labor model, where labor supply depends on the taxation system. They estimate the MCF in Norway to be 15%.
19. The mortality rate in the model is 0.
20. https://www.nav.no/546063/mottakere-av-uf%C3%B8retrygd-som-andel-av-befolkningen.etter-kj%C3%B8nn-og-alder.pr.31.12.2009-2018.
21. Data on male use of disability benefits are derived from the Norwegian Labour and Welfare Administration.
22. The economic literature has shown that unemployment leads to higher propensity to end their work career on disabled benefits in Norway (Rege, Telle, and Votruba Citation2009).
23. This estimate stems from the knowledge that military special retirees on average exhibit 50% work supply (described below) and that 10% of male early retirees in the private sector have withdrawn completely from the formal labor market. We thus estimate 20% of the workforce in the private and defense sector to retire early and continue working on average 50% of the available time.
24. The model is the second generation of its kind (PEMOD 2.0) at FFI. The first generation is applied in (Lindgren and Hanson Citation2018; Citation2019a; Citation2019b; Citation2019c; Hanson and Lindgren Citation2019; Lindgren, Hanson, and Strand Citation2019). Compared to the first-generation model, PEMOD 2.0 is upgraded with more detailed pension calculations and is able to calculate stochastic variables. The model is developed in Excel 2016, with use of SQL coding.
25. The scope of the study is limited to individuals up to 70 years of age. Any additional labor supply from individuals above 70 years will have positive effects beyond the results presented in this article.
26. The size of the public sector is held constant in all alternatives. Thus, the net increase in labor supply in the civil sector is all channeled into the private sector. It is irrelevant whether the personnel otherwise recruited to the Armed Forces are employed in the private or public sector (by pushing others into the private sector), as long as the net increase in labor supply is demanded by the private sector and the relative prices and wages are unaffected.
27. Pension is considered an expense the year that pension rights are earned, not when they are paid out. We also consider future tax payments on pensions as paid the year the pension right is earned. Thus, employees earn their rights and pay their pension taxes when they are active in the labor market.
28. The pension contributions from the National Insurance Scheme are based on total wage, while the public service pension is based on base wage.
29. See Prendergast (Citation2015) for arguments on professionalism and (the lack of) financial incentives in the public sector.
30. The normal rate is 14.1%, but zero in the northernmost parts of Norway, where the Armed Forces have several military bases. We assume an average employers’ contribution of 10% for the Armed Forces.
31. Appendix C provides further details about the assumptions on the variables in the Monte Carlo simulation. Appendix D provides more results on the Monte Carlo simulations, while appendix E tests the reliability of the estimates.
32. This holds only under the assumption that personnel contribute with social value equal to their wages. If higher retention means that personnel on average quits before the Armed Forces are able to fully exploit their competence and skills, the results will differ.
33. Read more about this reform in the two empirical studies mentioned in the literature review that exploits this new program to estimate the effects on the labor supply (Hernæs, Sollie, and Steinar Citation2000; Vestad Citation2013).
35. Employees earn pension allowance from NIS at the rate of 18.1% of gross wage (including overtime and additional payments). Annual NIS earnings are limited to a maximum of 7.1 G (83 300 USD). Employees in the public sector receive an additional 5.7% (up to 7.1 G) and 23.8% for earnings between 7.1 and 12 G (140 800 USD) through the public service pension system. Public employers deduct 2% of the gross earnings (prior to taxes) as payment into the public service pension system. A.F.P. is valued to 4.21% of base gross income.
36. The Samuelson rule states that the optimal level of provision of public goods is when the marginal cost equals the marginal benefit.
37. Moreover, this CBA concerns the labor supply effect of a potential reform, and in this sense, we do respond to the Kaplow critique (Citation1996; Citation2006).
38. https://www.nav.no/no/Person/Pensjon/Alderspensjon/Uttak%2C+regulering+og+levealdersjustering/
levealdersjustering-av-alderspensjon.