The IIASA Social Security Reform Project Multiregional Economic-Demographic Growth Model: Policy Background and Algebraic Structure

The model presented here is a neoclassical two-factor multiregional economic-demographic growth model. It is designed to assess the impacts of different demographic futures, labor-market scenarios, combinations of accumulation-based and transfer-based pension systems, and international portfolio allocations decisions on a range variables which play an important role in the population aging and social security reform debates. Among these are: the overall rate of economic growth; the relative incomes of retirees and workers; financial inflows into and out of the public and private pension systems and their implication for capital formation; and international capital flows. The model tracks income and outlay of households by single-year age groups, as well as intergenerational transfers of resources via bequests. Households accumulate assets during working years and then dissave in retirement, in addition to which, intergenerational transfers between the working and the retired populations are mediated through the PAYG public pension system. Capital may be installed either at home or abroad. In this paper, the policy background is briefly summarized and the algebraic structure of the model is elaborated. Other Interim Reports in this series describe the simulation and robustness characteristics of the model and present the results of model applications

Global Change, Catastrophic Risks and Sustained Economic Growth: Model-based Analysis

This paper analyzes the effects of catastrophes on two types of regions referred to as developed and developing. Economic development of regions is measured in terms of gross domestic product (GDP) per capita and incomes are considered to be the main factor driving demand for ex-ante catastrophe management arrangements. We show that the same magnitude shocks affect regions differently. While a developed country has sufficient resources to cope with catastrophes, the developing may stagnate or even collapse without appropriate catastrophe mitigation measures or external aid that is needed only until sustained growth takes off. The analysis relies on a stochastic multiregional growth model that embeds mechanisms enabling the design of robust strategies ensuring sustained performance of regions under catastrophes at any time that they may occur. Resilience of regions is estimated with respect to the abundance of internal and external resources, e.g., capital labor and catastrophe fund, to adequately confront the shock and to maintain regional growth on a "satisfactory" level

Globalization, Social Security, and International Transfers

In this paper, we quantify the impact of globalization (i.e., integration of global capital markets) on intergenerational transfers mediated through Pay As You Go (PAYG) public pension systems in more developed countries (MDCs), as well as impacts on the intergenerational distribution of income and wealth. Our basic finding is that, while globalization is likely to erode the pension income of older persons, it will enhance their wealth, leaving their overall spending power little changed. The working age population, which earns lower wages, is an unambiguous loser from the globalization process, at least to the extent that we limit ourselves to a neoclassical analysis of the phenomenon. The main impact of globalization is unlikely, however, to be captured by economy-wide averages such as those presented in this paper. This is the redistribution from lifetime non-savers, especially the poor, who depend on labor income while young and wage-based intergenerational transfers when old, to lifetime savers, who are able to take advantage of improved capital returns. While we concentrate on MDCs in this paper, we make the point that economic impacts of globalization in less developed countries (LDCs) are opposite in sign and greater in relative magnitude. The latter is the case because reallocation of capital gives rise to a greater proportional change in the capital-output ratio in LDCs than in MDCs

A Social Security Forecasting and Simulation Model

This paper presents and validates a multiregional neoclassical economic- demographic growth model developed by the IIASA Social Security Reform Project. This model is intended to study linkages between population age distribution, the macroeconomy, the nature of pension arrangements, the intergenerational distribution of income and wealth, and international capital flows. In this paper, we concentrate on the model in single-region form, showing that: (i) reasonable exogenous assumptions give rise to a reasonable long-run model solution; (ii) when exogenous assumptions or model parameters are changed, the model performs sensibly on a baseline-vs.-alternative basis; and (iii) model projection results are reasonably robust to selection of demographic scenario and exogenous assumptions regarding household saving and labor supply; they are sensitive, however, to the selection of the parameters of the core production function

Two stage model of ecological and economic decisions

Imperfection of ecological and economic decisions should be corrected by certain programs of public-private partnership. It is important to suggest and substantiate incentives for participation in such programs. The two-stage approach for making strategic and adaptive ecological and economic decisions is proposed

Induced Discounting and Risk Management

The goal of this paper is to specify and summarize assumptions and proofs for new approaches to discounting proposed inour catastrophic risk management studies. The main issue is concerned with justification of investments, which may turn into benefits over long and uncertain time horizon. For example, how can we justify mitigation efforts for expected 300-year flood that can occur also next year. The discounting is supposed to impose time preferences to resolve this issue, but this view may be dramatically misleading. We show that any discounted infinite horizon sum of values can be equivalently replaced by undiscounted sum of the same values with random finite time horizon. The expected duration of this stopping time horizon for standard discount rates obtained from capital markets does not exceed a few decades and therefore such rates may significantly underestimate the net benefits of long-term decisions. The alternative undiscounted random stopping time criterion allows to induce social stopping time discounting focusing on arrival times of potential extreme events rather then horizons of market interests. In general, induced discount rates are conditional on the degree of social commitment to mitigate risk. Random extreme events affect these rates, which alter the optimal mitigation efforts that, in turn, change events This endogeneity of the induced discounting restricts exact evaluations necessary for using traditional deterministic methods and it calls for stochastic optimisation methods. The paper provides insights in the nature of discounting that are critically important for developing robust long-term risk management strategies

Discounting and catastrophic risk management

The risk management of complex coupled human-environmental systems essentially relies on discounting future losses and gains to their present values. These evaluations are used to justify catastrophic risks management decisions which may turn into benefits over long and uncertain time horizons. The misperception of proper discounting rates critically affects evaluations and may be rather misleading. Catastrophes are not properly treated within conventional economic theory. The lack of proper evaluations dramatically contributes to increasing the vulnerability of our society to human-made and natural disasters. Underestimation of rare low probability - high consequences potentially catastrophic scenarios (events) have led to the growth of buildings and industrial land and sizable value accumulation in flood (and other disaster) prone areas without paying proper attention to flood mitigations. A challenge is that an extreme event, say a once-in-300-year flood which occurs on average only once in 300 years, may have never occurred before in a given region. Therefore, purely adaptive policies relying on historical observations provide no awareness of the risk although, a 300-year flood may occur next year. For example, floods in Austria, Germany and the Czech Republic in 2002 were classified as 1000-, 500-, 250-, and 100-year events. Chernobyl nuclear disaster was evaluated as 106-year event. Yet common practice is to ignore these types of events as improbable events during a human lifetime. This paper analyzes the implications of potentially catastrophic events on the choice of discounting for long-term catastrophic risk management. It is shown that arbitrary discounting can be linked to "stopping time" events, which define the discount-related random horizon ("end of the world") of valuations. In other words, any discounting compares potential gains and losses only within a finite random discount-related stopping time horizon. The expected duration of this horizon for standard discount rates obtained from capital markets does not exceed a few decades and, as such, these rates cannot properly evaluate impacts of 1000-, 500-, 250-, 100- year catastrophes. The paper demonstrates that the correct discounting can be induced by the concept of stopping time, i.e. by explicit modelling of arrival time scenarios of potential catastrophes. In general, catastrophic events affect the induced discount rates, which alter the optimal mitigation efforts that, in turn, change events. The paper shows that stopping-time related discounting calls for the use of stochastic optimisation methods. Combined with explicit spatio-temporal catastrophe modelling, this induces the discounting which allows to properly focus risk management solutions on arrival times of potential catastrophic events rather then horizons of capital markets