Transcript The Why’s and How’s of Pension Reform by Estelle James

The Why’s and How’s of Pension
Reform
by
Estelle James
World Bank Institute
1
Populations are Aging
• By 2030 the proportion of the world’s
population that is > 60 will nearly double,
from 9% to 16%
• China’s old population will jump from 9%
to 22%
• More than 25% of the world’s old people
will live in China
• How to care for the old as family system
breaks down (small size, urban migration)
2
Percentage of the Population Over 60 Years Old,
by Region, 1990 and 2030
1990
OECD countries
2030
Transitional Socialist Economies
China
Latin America and the Caribbean
Asia (excluding China)
North Africa and the Middle East
Subsaharan Africa
WORLD
0
10
20
30
Percentage of population over 60
3
When Populations Age, Public
Pension Spending Increases
• Many industrialized countries now spend
more than 10% of the GDP on pensions
• China spends only 2% but will spend over
10% in 30 years if it follows the same
policies
• This will interfere with ability to spend on
health, education, other public goods
4
Relationship Between Percentage of the Population
over 60 Years Old and Public Pension Spending
Pension spending as
percentage of GDP
16
Austria
Italy
Poland
Luxembourg
12
Greece
France
Sweden
Uruguay
U.K.
8
Panama
U.S.
Costa Rica
4
Israel
Japan
Australia
China
0
Jamaica
5
10
15
Percentage of population over 60 years old
20
5
Public health spending also
increases as populations age
• I will talk mainly about pensions, but health
spending and health systems for aging
populations is something you should think
about too
6
Public Health and Pension Spending
versus Population Aging
Spending as a percentage of GDP
Austria
20
Czechoslovakia
Sweden
Poland
15
U.K.
New Zealand
Iceland
Canada
Switzerland
Spending on health and pension
10
Brazil
Trinidad &
Tobago
5
Japan
Australia
Cyprus
Spending on health
China
Jamaica
Swaziland
Zambia
S. Korea
Indonesia
0
0
5
10
15
20
Percentage of population over 60 years old
25
7
With such large sums involved, social
security affects the entire economy
•
•
•
•
It influences:
Peoples’ incentive to work
Employers’ willingness to hire labor
Labor allocation between formal and
informal sectors
• Level of national saving and its allocation
• Financial market development
• Therefore, the quantity and productivity
of labor and capital and size of GNP
8
I will talk about:
• Why countries have been reforming
• Commonalities and differences in reforms
• How China’s reforms compare with others
• The difficulties China faces in financing its
transition to a partially funded system, and
what steps might facilitate success
9
In most industrial countries,
traditional systems were PAYG DB
• No funds were accumulated
• Benefits paid according to formula that
depended on wages and years of work, but
not closely linked to contributions
• China also used this system
• New systems try to add fully funded defined
contribution component--mixed systems
10
Problems with PAYG DB
Systems
• Not sustainable--contribution rate will have to
rise or benefits fall drastically in future
• Inequitable--doesn’t redistribute to low-earners.
Big gainers are first generations
• Not good for the economy
–
–
–
–
–
leads to high payroll tax as populations age
may discourage employment
doesn’t mobilize long term saving
doesn’t help develop financial markets
DB often rewards early retirement and evasion
• Political risk: Promises may not be kept in
11
future because of high costs
Is this relevant to China?
• Contribution rates already too high, especially in
declining regions--makes them decline faster
• Unemployment, so high payroll taxes not good;
early retirement is not a good remedy--raises tax,
discourages employment
• Growing evasion and informal sector
• Many municipalities find it hard to pay
• Private saving high but MPK also high
• China needs financial market development
12
Therefore, many countries have
decided to reform
• By making their systems partially funded
and DC, while maintaining a smaller
targeted PAYG DB social safety net
• Examples--OECD countries (Australia, UK,
Denmark, Switzerland); transitional
economies (Hungary, Poland, Kazakhstan),
Latin America (Chile, Mexico, Argentina,
Bolivia, Uruguay, etc.)
• China also wants to reform but is finding it
13
difficult to finance the transition
Reformed multi-pillar systems
• Pillar I: social safety net, publicly managed, tax
financed
• Pillar II: individual accounts, fully funded DC,
privately managed
• Pillar III: voluntary saving
• China has also decided to reform along these lines14
The Pillars of Old Age Income Security
Objectives
Redistribution
plus
Co-insurance
Savings
plus
Co-insurance
Savings
plus
Co-insurance
Form
Flat or
Means-tested
or
Minimum
pension
guarantee
Personal
savings plan
or
Occupational
plan
Personal
savings plan
or
Occupational
plan
Financing Tax financed
Regulated
Fully funded
Fully funded
Mandatory
Mandatory
publiclyprivatelymanaged pillar managed pillar
Voluntary
pillar
15
Number of Contributors to a Mandatory Private Plan, 1982-2000
80
Ho n g Ko n g
70
Hu n g a ry
E l S a lv a d o r
Ka z a kh s ta n
P o la n d
B o liv ia
Arg e n tin a Me x ic o
60
In millions
50
Un ite d Kin g d o m
40
30
Au s tra lia
Co lo m b ia
De n m a rk
P e ru
Uru g u a y
S witz e rla n d
Ne th e rla n d s
20
Ch ile
10
0
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
16
Individual Accounts
Why DC?
• Links benefits to contributions
• Discourages & immunizes system to
evasion and early retirement
• Avoids hidden redistributions
• Individual accounts in China will be DC
17
Why funded?
• Avoids:
– Benefit promises that are too high
– Tax increases as populations age
– Intergenerational transfers
• Builds savings committed for long term
• China wants this but so far funds haven’t
accumulated--are paid out to pensioners
18
Why competitively managed?
• To get best return on savings, highest productivity of
capital
• To diversify investments (public, private, internat’l)
• To develop financial markets
• Empirical evidence shows private competitive
management earns higher return than public
management--portfolios are diversified, economic
rather than political criteria determine investments
• New plans in Latin America, Hong Kong use private
competitive management. Singapore uses central
management--returns are low
• Controversial in China
19
Difference between annual compounded real publicly-managed pension fund
returns and bank deposit rates in 20 countries (from worst to best)
Ave rage
-1.8%
Uganda
Zam bia
V e ne zue la
Egypt
Ecuador
Sri Lank a
Guate m a la
Ke nya
Cos ta Rica
Jam aica
Canada
Singapore
Morocco
India
M ala ys ia
US
Sw e de n
Philippine s
Kore a
Japan
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
gros s re t urns m inus bank de pos it r ate
20
Difference between real annual compounded publicly-managed
pension fund returns and real income per capita growth in selected countries
-8 .4 %
A ve r a g e
Peru
Ug a n d a
Z a m b ia
V e n e z u e la
Eg y p t
T a n z a n ia
Ecu a d o r
C o s t a R ic a
G u a t e m a la
Ke n y a
Sin g a p o r e
Sri Lan k a
J am a ic a
Kor e a
Jap an
I n d ia
Can ada
M a la y s ia
Sw e de n
US
M oro cco
P h i li p p i n e s
-5 0 %
-4 0 %
-3 0 %
-2 0 %
-1 0 %
0%
10 %
g r o s s r e tu r n s m in u s in co m e p e r cap ita
Source: IMF International Finance Statistics; Authors’ calculations.
21
Average private schemes
Average public schemes
Switzerland (70-90)
Japan (70-87)
United States (70-90)
Canada (75-89)
Denmark (70-88)
Hong Kong (83-96)
Netherlands (70-90)
Japan (84-93)
Switzerland (84-96)
Denmark (84-96)
Australia (87-94)
United Kingdom (70-90)
Spain (84-93)
Netherlands (84-96)
Ireland (84-96)
Chile (81-96)
Belgium (84-96)
United States (84-96)
Sweden (84-93)
United Kingdom (84-96)
-10% -8% -6% -4% -2%
0%
2%
4%
6%
8%
10%
Gross returns minus income per capita growth
22
Alternative models for
competitive management
• Latin American model (Chile, Mexico, Hungary)
– Individual workers choose investment manager
– Portfolio restrictions and guarantees
– High administrative, marketing costs
• OECD Model (Australia, Switzerland, Hong Kong)
– Employer and/or union representatives choose
investment manager for group
– Fewer restrictions and guarantees
– Lower costs--economies of scale & expertise
– But principle-agent problems--may not serve best
interest of workers
23
3. Using the institutional market to
give workers choice while keeping
costs low:
• Bolivia--
– Limited entry: right to operate auctioned off to
two companies using international competitive
bidding process--much lower fees
• Sweden-– Open entry for fund management but public
agency negotiates fees centrally
– Centralized collections and records
• Competitive bidding may cut costs but must
avoid collusion, corruption.Useful in China24?
Results of multi-pillar systems
• Too new in most countries to assess impact
• Some OECD countries have had quasimandatory funded pillar for 10-20 years--has
deepened capital market, longer term
investments, better corporate governance
• Chile has had new system for 20 years-average real rate of return 10%, financial
markets developed, total factor productivity
increased 1% per year due to pension reform
25
How have countries financed the
transition--and how can China?
• Key issue:If country can’t finance transition
to partially funded scheme, will remain
PAYG with long term debt, even if has
individual accounts--they will be notional
• Transition financing gap arises because, to
fund individual accounts, part of
contribution is diverted, so other money
must be found to pay old pension debt
26
Methods to pay pension debt
1.Downsize old system--raise retirement age,
reduce benefits (gradual, difficult, necessary).
This only has small impact on IPD
2.Keep part of new system PAYG-- modest
PAYG first pillar in new system; old workers
stay in old PAYG system; so part of
contribution flows into PAYG system
3.Use general government revenues or other
assets to cover pension liabilities--budget or
social security surplus, privatization assets 27
Methods to Pay Old Debt (2)
4.Raise taxes--payroll tax often too at beginning
5.Borrow: convert implicit into explicit debt and
pay off gradually. Debt can eventually be paid
off via PAYG surplus or tax
Advantage--spreads burden over generations so
helps avoid political opposition, equitable
Disadvantage--doesn’t enhance national saving
until debt is paid off.
28
What is happening in
China?
• Attempt to shift from PAYG to multi-pillar
system, but difficulty in financing transition
29
1997 State Council Document 26 and
2000 Document 42:
Multi-Pillar system in China
• Pillar I: Basic benefit = 20% average wage
• Pillar II: Individual account with 8%
contribution from workers. Funds invested
in state bonds. Annual annuity =
accumulation/10
• 20% payroll contribution from enterprise
goes into pooled fund to finance basic
benefit + transition--not enough in short run
so transition obligations also covered by 30
municipalities, provinces, central govt.
Problems with this plan
• No firm plan to cover transition costs so full
28-29% contribution (or more) is often used
• Thus most individual accounts are not
funded--they remain largely notional, don’t
avoid PAYG problems, costs will rise
• No diversification, investments won’t earn
highest rate of return or MPK
• Conversion to annuities not actuarially fair-– accumulation won’t cover promised outlays
– formula won’t discourage early retirement
• No work incentives in basic benefit
31
• Problems augmented by fragmented system
Possible sources for financing
transition in China
• SOE assets or other proceeds
• Borrow in short run, repay from surplus in
long run (basic benefit will only require
contribution rate of 10-12%, so surplus in
long run if funded individual accounts
generate high revenues from investments)
• Fragmentation complicates transition--who
owns the assets and who is responsible for
32
paying the pension debt?
Special Problem in China-Fragmentation
• Remnant of cultural revolution: was SOE
responsibility, not pooled at municipal
level--great differences in dependency rates
• Pension debt in China is low (<70% GDP)
for country as a whole but IPD is unevenly
distributed; > 100% in some municipalities.
• High payroll tax accelerates decline in
depressed areas. They can’t fund accounts
while paying benefits
33
Fragmentation (Cont’d)
• Problem when CR varies across localities;
but provincial or national pooling is needed
to have same CR when support rate varies
• Should rich areas be pooled with poor areas,
to pay pension debt? Difficult--winners and
losers.
• What is responsibility of national,
provincial and municipal governments?
Ambiguous.
34
Strong funded pillar helps
reduce financing gap
• Diversification into private sector would raise
returns and productivity--high MPK in China
• International diversification would reduce risk
• If individual accounts earn high rate of return,
they will yield high replacement rate so PAYG
can give less compensation to middlemen for
past service, smaller transition gap
• Also, could make smaller contribution to
individual account, more money for transition
– if CR = 8% and r = 2%, RR only 15%,
– but if r = 5%, RR 40%
35
Conclusion--key questions for
China
• Who owns the assets and who is responsible
for the debt?
• How can high investment return be earned to
achieve high replacement rate?
• What reshaping is needed to encourage
continued work, later retirement?
• China is now struggling to implement a multipillar system with partial funding, as other
countries are doing. Never easy but always
36
possible.