Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized and Prosperous Aging and Prosperous Growth for Saving Poland Europe and Central Asia Region Asia andCentral Europe ReductionPoverty andEconomicManagement Unit June 2014 Report No 88624-PL POLAND SAVING FOR GROWTH AND PROSPEROUS AGING Country Economic Memorandum Poverty Reduction and Economic Management Unit Europe and Central Asia Region June 2014 Document of the World Bank CURRENCY AND EQUIVALENT UNITS Exchange Rote as of June 2, 2014 Currency Unit Polish Zloty US$1 3,0413PLN Government Fiscal Year January 1 - December 31 ABBREVIATIONS AND ACRONYMS AR Adequacy Ratios HCE Health Care Expenditure CEE Central and Eastern Europe HCS Health Care System CESEE Central, Eastern and Southeastern Europe IKE Individual Pension Accounts CF Cash Flow IKZE Individual Pension Security Accounts CS Corporate Saving KRUS Farmers’ Social Security Fund DB Defi ned Benefi t LCR Liquidity Coverage Ratio DC Defi ned Contribution LTC Long-term Care DSGE Dynamic Stochastic General Equilibrium MFI Monetary and Financial Institutions EET Exempt-exempt-taxed MoF Ministry of Finance EU European Union MTO Medium-Term Objective FDC Financial Defi ned Contribution NBP National Bank of Poland FDI Foreign Direct Investment NDC Notional Defi ned Contribution FSAP Financial Sector Assessment Program NFL Net Foreign Liabilities GDP Gross Domestic Product NFZ National Health Fund Vice President: Laura Tuck, ECAVP Country Director: Mamta Murthi, ECCU5 Acting Sector Director: Roumeen Islam, ECSPE Sector Manager: Satu Kahkonen, ECSPE Task Team Leader: Emilia Skrok, ECSPE CONTENTS Executive summary V Chapter 1 Introduction 1 Chapter 2 Why Does National Saving Matter for the Polish Economy? 5 Chapter 3 Mobilizing Private Savings: Where Households and Companies Fit in 29 Chapter 4 Mobilizing Saving – the Role of the Public Sector 65 Chapter 5 Savings and the Financial System 97 Chapter 6 The Economic Effects of the Main Determinants of Saving in Poland Quantified 119 Chapter 7 Conclusions and Policy Recommendations 127 Annex 1 Model Linking Saving and Growth in Poland 136 Annex 2 Households Ssaving: Definitions, Data and Estimation’s Techniques 141 Annex 3 The Literature on Determinants of Saving 145 Annex 4 Household Savings Regression for the Czech Republic Based on Quarterly data 150 Annex 5 Household Income, Consumption, and Savings Measured in the Microdata 151 Annex 6 Saving Rates and Age by Income Level – Quartliles 152 Annex 7 Estimation of Age and Cohort Effects on Savings 153 Annex 8 Rough Calculation of Savings Necessary to Guarantee Current Replacement Rates 155 Annex 9 Re-weighting Methodology and Results 156 Annex 10 Poverty Rates in the Re-weighted Samples 159 Annex 11 Corporate Sector Regressions 161 Annex 12 Government Saving Definitions. 165 Annex 13 Saving and Financial Stability 166 Annex 14 Annuities 168 Annex 15 Summary Table of Interventions to Encourage Household Saving 172 Annex 16 Description of the DSGE model MEMO 176 Annex 17 Literature review on empirical elasticities of labor force participation by age groups 178 References 179 ACKNOWLEDGEMENTS This study was prepared by a core team comprising Emilia Skrok, Paulina Hołda and Mark Allen, with support from Leszek Kąsek, Ewa Korczyc, Ana María Oviedo, Marcin Piątkowki, Magdalena Anna Rola-Janicka and Nistha Sinha. Special thanks are due to Agnieszka Boratyńska and Aleksandra Ignaczak for their excellent research assistance. The team is greatly indebted to the principal authors of valuable background papers, prepared for the Study, namely Maciej Bukowski, Jan Gąska, Constantino Hevia, Janusz Jabłonowski, Aleksandra Kolasa, Barbara Liberda, Christoph Müller, Michał Myck, Aleksander Łaszek and Wiktor Wojciechowski. The authors are grateful for invaluable comments provided by peer reviewers: Maurizio Bussolo (Lead Economist, ECACE), Franziska Ohnsorge (Lead Economist, DECPG), Brian R. Pinto (former Senior Advisor, PRMPI) and Kaspar Richter (former Lead Economist, ECSP3). The World Bank team is sincerely grateful to senior officials from the Ministry of Finance and the National Bank of Poland for their comments and suggestions during preparation of the report. In particular, we would like to thank to Sławomir Dudek and Dawid Pachucki (Ministry of Finance, Financial Policy, Analyses and Statistics Department) and Tomasz Chmielewski (National Bank of Poland, Economic Institute, Bureau of Macroprudential Policy). Special thanks also go to Satu Kahkonen, Sector Manager, and Yvonne Tsikata, former Sector Director of the World Bank, who provided continuous support, guidance, and technical advice during this work. Finally, the team wishes to thank Mamta Murthi, Country Director for Central Europe and the Baltic Countries, as well as Xavier Devictor, Country Manager for Poland and the Baltic Countries, for their valuable advice and guidance. EXECUTI VE SUMMARY Executive Summary Why does Poland need to save more? 1. Although its economic growth over the last two decades has been impressive, serious challenges to Poland’s growth prospects are appearing on the horizon. Since 1995 growth has averaged about 4 percent a year, led by growth in total factor productivity (TFP) and capital deepening. The speed of convergence to the average income in the European Union (EU) has been impressive, with income per capita increasing from less than 42 percent of the EU151 average in 2000 to 60 percent in 2012. However, much of the catching-up process relied on exuberant domestic demand, which outpaced the supply potential of the economy. Consumption averaged 80 percent of GDP for 2004–08, and the contribution of investment was particularly powerful in the years immediately after EU accession, when public investment was boosted by EU transfers. The slackening of Poland’s economic performance after the financial crisis reflects the vulnerabilities of the growth model Poland adopted: strong domestic consumption fuelled by borrowing, high reliance on the EU15 for export markets and capital inflows, and national saving that is inadequate to fund investment. These factors have instead become the source of risks in light of the long-term challenges facing the Polish economy in coming decades: probable slower growth in productivity, the economic and social implications of population aging, and less supportive global financial conditions undermining further capital deepening. 2. Sustaining strong productivity growth will not be easy. Poland’s high growth rates after the economic transition reflected to a large extent a rapid rise in TFP as its productivity caught up with that of other countries at similar levels of GDP per capita. Economic liberalization, the privatization of state-owned enterprises, and opening up to international trade and capital flows resulted in sustained productivity growth as resources were reallocated toward more productive sectors and firms. The transition-related catching-up process in the countries of Central and Eastern Europe (CEE), however, seems to be coming to an end (EBRD, 2013). Productivity growth is now mainly driven by efficiency gains within individual firms, and productivity patterns increasingly resemble those of advanced market economies. While they have largely closed the gap with similar countries, Poland and other CEE economies are likely to grow more slowly in the future, mainly for two reasons: the slowing of structural reform since the mid-2000s, and the effects of the financial crisis. Sustaining robust TFP growth in Poland, even at only slightly above the long-term global projection of 1.5 percent, will be challenging. 3. Strong headwinds are to be expected also from demographic trends: Poland has one of the most rapidly aging populations in the EU. Given its profound economic, social, and cultural implications, population aging is currently becoming one of the world’s most significant challenges. It is particularly pronounced for Poland, where life expectancy at birth has increased in Poland by about six years for both men and women since the early 1990s. Meanwhile, in the early 1990s fertility rates in Poland fell below the simple replacement rate of 2.1, and have been trending downward (apart from a short-lived upturn during the 2004–09 boom), hitting 1.3 by 2012—one of the fastest demographic transitions on record. As a result, Poland’s old-age dependency ratio (population aged 65 and more as a percentage of the population aged 20-64) is expected to increase from 20.9 percent in 2010 to 58 percent in 2050 and 70.7 percent in 2060 (European Commission, 2012). Meanwhile, the share of the working-age population, which was 71.3 percent of the total population in 2010, is projected to sink to 53.4 percent by 2060. The magnitude and pace of these changes will have serious implications for both the economy and society. It is likely that aging will affect the supply of labor and reduce both private and public saving, repressing investment and capital accumulation. 4. Foreign financing to support capital deepening may also be harder to attract, given tighter global financial conditions and regulatory action since the financial crisis. The crisis has changed global financial markets, particularly by changing the perception of credit risk in highly leveraged institutions, which caused capital to suddenly dry up at the peak of the crisis. This in turn increased the refinancing risk for both private and public entities. In Europe this change contributed to the Eurozone crisis,