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Financial Economics


Implications of Recent Income Distribution Trends on National Pension Reform Discussions

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  • Author YUN. Heesuk
  • Date 2016/11/15
  • Series No. KDI FOCUS No. 76, eng.
  • Language English
SUMMARY □ The maturing of the National Pension scheme has helped improve income distribution recently, but its effect has been limited due to a large coverage gap in the system. Against this backdrop, the focus in pension reform discussions needs to be reset toward enhancing enrollment instead of heightening the replacement ratio.

- ① Growth and distribution in a virtuous cycle after economic development in the 1960s; ② deteriorating distribution after the early 1990s; and ③ signs of improvement in distribution thanks to redistribution in recent years.

- Overall, the poverty rate of respective population groups is declining, and the increase in the senior population is largely to blame for the heightening poverty rate.

- The recent reduction in poverty is owing to the maturing of the National Pension.

- Public pension benefits 76% of the povertyescaping households in the redistribution process.

- The main channel for redistribution through tax expenditures is through public pension payments

- The higher public pension’s income replacement ratio rise, the more households with no earned income appear. As a result, market income inequality would worsen and redistribution will seemingly function strongly.

- Fixation to income replacement ratio in pension reform discussions originated from certain myths: ① Korea’s income replacement ratio is low, and ② that is mainly responsible for the old-age poverty.

- Households with public pension are 44.6% likely to escape poverty through redistribution, but those without show only a 9.8% likelihood.

- The presence of a coverage gap in its pension system is the main reason of Korea having difficulty in reinforcing a redistribution function.
KDI VOD Report
The market income-based poverty rate is increasing while the disposable income-based, i.e. the final income which reflects government tax and expenditure, poverty rate is decreasing.

This implies that through the government’s redistribution measures, which include public pension, social benefits, public transfer and basic old-age pensions, the poverty rate is decreasing.

An examination of the income composition of households who have escaped poverty through the government’s redistribution efforts reveals that the contribution of public pension, including the national pension, was the most significant. The proportion leaped 8%p, from 60% in 2006 to 68% in 2015, hinting at a gradual increase in the size of contribution as time passes.

In 2015, 74.3% of households who escaped poverty were public pension recipients while only 28.1% of recipients remained in poverty despite the government’s redistribution efforts.

Similar observations were made for senior households.
Of those escaping poverty, 80.6% were public pension recipients, while only 36.8% of recipients were still in poverty despite the redistribution.

The fact that public pension has such a significant impact on poverty is
tied to the rapidly increasing share of senior households among the

That is, as the increase in the senior population drives up the poverty
rate, public pension, which has a big impact on the income of the
senior population, has become a key contributing factor.

Therefore, we can assume that considering the progress in population aging, the role of public pension for the senior population will become increasingly important in easing poverty.

An international comparison was conducted to examine how universal the critical role of public pension was on income redistribution.
The results show that the government’s income redistribution is mainly driven by expenditure than income, and that this expenditure-driven redistribution is being actualized through public pension.
Data on Finland, Italy, the Netherlands and Denmark also reveal that public pension significantly contributes to total income redistribution.

Then, what implications do these findings have for the reform direction of the National Pension Scheme?

The most important implication is finding the focal point in the improvement of the National Pension Scheme.

In the past, discussions for national pension reform were fixated on the income replacement ratio due to a misunderstanding that a low ratio is the main cause of senior poverty.

The misunderstanding was based on three myths:
First, the income replacement ratio of the national pension was fixed at a low level.
Second, increasing the ratio was the best way to reduce senior poverty.
And third, increasing the ratio would not have any major side effects on the national economy.

However, a examination rebutted these myths.
The income replacement ratio of Korea’s National Pension Scheme is approximately 50%, higher than the OECD average of 41.3%.
Furthermore, unlike advanced countries, the nominal income replacement ratio is not interlinked with the actual pension amount, as such there is a high possibility that increasing the ratio will not contribute much to easing senior poverty.

Not only that, there may be negative effects for economic growth.
That is, if an increase in the ratio is not supported by a sufficient increase in the insurance premium, it would significantly damage the financial soundness of the national pension.
The resulting problems in the pension’s substantiality could have a huge impact on the government''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''s fiscal condition, labor market and long-term economic growth.

In this context, what is urgently needed is to enhance the enrollment rate of public pension, in other words to reduce the pension coverage gap.

For instance, of poor households in terms of market income, those with public pensions are 44.6% likely to escape poverty through redistribution while those without show only a 9.8% likelihood.
This means that reducing the pension coverage gap could result in effective poverty reduction.

In conclusion, the national pension reform for old-age income security should focus on reducing the pension coverage gap rather than emphasizing the replacement ratio so that the benefit of public pension could be enjoyed by more senior citizens.
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