A risky strategy: Reflections on the World Bank Report Averting the old age crisis

A risky strategy: Reflections on the World Bank Report Averting the old age crisis
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  PENSION REFORM A risky strategy: Reflections on the World Bank Report Avertina the old aae crisis Roger Beattie and Warren McGillivray IntcHnatlml Labour o Rw and Intematlonal Socbl Sticurlty AswclaHon This article is critical assessment of report on pensions recently published by the World Bank. It takes issue with the report’s assertion that public pension systems have failed both socially and economically, demonstrating that many of the shortcomings identified by the World Bank apply with equal or greaterforce to private systems. It argues that the strategy outlined in the report, involving the replacement of social insurance by mandato y avings schemes, would involve an unacceptably high degree of risk for workers and pensioners, that it would make old-age protection more costly, and that the transition would impose hea burden on the current generation of workers. The article concludes that more ejicient and less disruptive approach to the provision of retirement pension would be to focus efforts on measures to rectify design deficiencies and inequities in existing schemes. e World Bank recently released a T” ajor Policy Research Report entitled Averting the old age crisis: Policies to protect the old and promote growth.’ The report rep- resents a considerable research effort and contains a wealth of information and stat- istics on public and private pension schemes. It is without doubt an important analysis of alternative policies for the pro- vision of social security pensions. To those who are familiar with the activities of the Bank in Latin America and elsewhere, the policy proposals set out in ths report will not be new. However, the fact that they have now been made public and are being vigorously promoted is significant.* What has hitherto been presented here and there to national governments is now authorita- tively set forth. The report is a valuable contribution to thinking on pensions issues, which should now be the subject of informed debate, particularly in view of the economic assumptions and the social philosophy that it embraces. The policy message which the report seeks to convey is that public pension VOl. 48.3-4195 International Social securlly Review  A risky strategy: Reflections on the World Bank Report Averting fhe oldage crisis schemes should be restricted to paying modest flat-rate benefits, while the bulk of mandatory retirement pension provision should be entrusted to private commercial pension funds. The public scheme may be means-tested or universal in character, al- though the greater cost of the latter solu- tion is duly underlined. The report strongly recommends that earnings- related benefits be provided through mandatory savings schemes of the defined contribution type, i.e. where benefits de- pend on the accumulation of contributions at a specified rate, and there is no guaran- tee as to the amount of the benefits that will ultimately be received. To the extent that the report has a model to put forward, it is the pension system which now exists in Chile, where it was decided in 1980 to replace the existing social insurance pen- sion schemes by a privately administered mandatory savings system, with the State providing a very low social assistance benefit to old people on a means-tested basis. Also referred to approvingly in the report is the Australian system, where so cial security provides flat-rate means- tested pensions. Central to the Bank s strategy are two assumptions. The first is that a fully funded pension system will increase ag- gregate savings and lead to increased pro- ductive investment and economic growth. The second is that a privately rI'IaMged pension system will, thanks to the virtues of competition and independence from political interference, be more efficient than a public system. The report s analysis of existing pension systems In its analysis, the Bank's report seeks first and foremost to demonstrate that public pension systems have failed both socially and economically. It argues inter alia that public systems often fail to protect benefits against inflation, that they encourage early retirement, that they pay higher benefits to the rich than to the poor, that they have over-generous benefit formulae and that they often have high administrative costs. In particular, it is alleged that people covered by the public schemes are exposed to a high degree of "political risk, as the defined benefits provided by public schemes are frequently redefined down- wards. However, the report ignores the fact that many of the criticisms levelled at pub- lic schemes have been seen to apply just as forcibly, and in some cases even more so, to private schemes. Furthermore, there are many examples of public pension systems, particularly in industrialized countries, which have been effective in eliminating or greatly reducing poverty among the el- derly, in providing workers with an ade- quate degree of income replacement in old age, in adjusting benefits in line with earn- ings or prices, and in operating very effi- ciently indeed, with administrative costs far lower than those of any privately man- aged scheme. Effects of public pension schemes on the economy The report claims that public pension schemes "have major effects on labour and its productivity, on capital accumulation and its allocation, on the ability of govem- ments to finance public goods and services -and therefore on the growth of the econ- omy" (p. 120). As regards the labour market, Atkin- son, in a recent and authoritative review of social security and work incentives? has lnlemalknal sodel Secwny Review Vd. 48.3-4/95  A risky strategy: Reflections on the World Bank Report Averling the old age crisis concluded that there are relatively few situations in which a disincentive effect has been clearly established and that a number of the adverse effects which have been identified are relatively small. He also points out that social security may have positive effects on economic perfor- mance: the existence of social insurance benefits may bring people into the formal labour force in order to qu hfy for future benefits, and the safeguards that are inher- ent in such schemes may encourage people to make riskier career choices. The report recognizes that in indus- trialized countries, where the supply of la- bour is relatively inelastic, workers in practice bear not only their own share of social security contributions but also the employers’ share in the form of lower wages. In this case, output is not reduced by the imposition of contributions. Such a result is not of course guaranteed in all cir- cumstances. If the supply of labour is elas- tic and if there is little competition in pro- duct markets, then employers’ contribu- tions may be passed on to consumers. In certain conditions, employers may be un- able to pass on the cost of payroll taxes to workers or consumers. Then, says the re- port, “the result is likely to be unemploy- ment, as is occurring in Eastern Europe today” (p. 122 . In fact it has not been es- tablished that employers in eastern Europe are unable to pass on the cost of payroll taxes: indeed, the exceptionally low share of wages in national income in these coun- tries suggests that they succeed in doing 50.4 What is more, to suggest that unem- ployment in eastern Europe is attributable to employers’ social security contributions is to forget the other developments which have taken place in that region in the past few years. The report alleges that public pension schemes are responsible for the large-scale decline in the supply of experienced workers that has taken place through early retirement. ts Issue Brief Table 8.1 shows an average decline of 20.9 per cent in la- bour force pakticipation rates in OECD countries for males age 55 to 64 over the period 1986-90 compared with 1960-66. Given the restructuring, downsizing and re-engineering which have occurred in many of these countries, whether a social security pension is inducing early retire- ment or facilitating involuntary withdra- wal from the labour force is a moot point? Two contrary examples suggest that public social security schemes are not the root cause of the large-scale decline in the supply of experienced workers that has taken place through early retirement. During the 1980s in Sweden, where there were generous social policy mechan- isms to facilitate early retirement, a far higher proportion of people in the 60-64 age group continued to work than in France, Germany or the Netherlands the explanation being the vastly different situation and policies as regards unem- ployment. In the United States, where the social se- curity system has been restrictive with re- spect to early retirement, there has been a large decline in the labour force participa- tion of older workers; many have received early retirement pensions from private (rather than public) schemes, but a num- ber have had no replacement income until age 62, when reduced social security benefits become payable, emphasizing again the importance of unemployment as a “push factor. When it comes to the impact of public pension plans on savings and the capital market, the report recognizes (p. 126 that empirical studies of ths issue in indus- ilOl.48.3-4B5 lnt~thmal ocial searrily Review  A risky strategy: Reflections on the World Bank Report Averting the old ege crisis trialized countries have come to very dif ferent conclusions and that any negative effect in developing countries is likely to have been small. It is alleged that public pension schemes are often not affordable, which presumably implies that they impose an excessive burden on the economy. The re- port often refers to “affordability” or “sus- tainability” as if these were objective scien- tific concepts. On page 107, figure 4.1 indi- cates public pension spending and the per- centage of population over age 60: a) for the United Kingdom over time from 1910 to 1990, and b) for a cross-section of 92 countries circa 1990. This is said to show that many developing countries today spend more on pensions than indus- trialized countries did at a similar state of development. (One might cavil at the choice of the United Kingdom to represent “industrial countries”, as its public pen- sions are among the lowest in the OECD.) The implication is that developing coun- tries are spending more than they can af- ford. Does this mean that, because the United Kingdom used to allow many of its elderly to live in poverty, other countries in more enlightened tim s cannot do bet- ter? Is it justifiable to correlate pension spending and the percentage of the popu- lation over 60 and conclude that countries above the regression curve are spending too much? Is it not conceivable that differ- ent countries will have different priorities and different values? There is no economic law that prevents societies from deciding to allocate more resources to old-age se- curity and less to some other expenditure. To try to establish that public pension schemes are unsustainable, the report in- cludes estimates of the implicit public pen- sion debt ll that is owed to retirees and workers who have accumulated social se- curity pension entitlements. It is reported that in OECD countries this debt ranges from 100 per cent to over 200 per cent of GDP nd that current payroll tax rates are not nearly large enough to pay off ths debt. ”How”, asks the report on page 140, ”did these countries get into so much trouble?” If the debt suddenly had to be paid off, hey would indeed be in trouble, but there is absolutely no reason why such a liquidation should be necessary. Coun- tries will find themselves in real trouble only if their governments decide, as the re- port suggests, to terminate their pay-as- you-go schemes. “Political risks” of public schemes The report points out that in recent years many governments have made cuts of one kind or another in their public pension schemes. These may fairly be regarded as ”political risks”, but do they amount to a “repudiation of previous arrangements” or to a major change in the “rules of the game“? Concerning some of the examples cited on pages 112-113, the following ob- servations may be made: Increases in retirement age have been made in Germany, Sweden, the United Kingdom and the United States, but in all cases these are being phased in very grad- ually, over periods of up to 30 or 40 years, with little or no impact on current entitle- ments. 0 The United States reduced benefits for higher-income retirees by making 50 per cent of the pension taxable in 1984 and raising the taxable share to 85 per cent in 1994, but more than 80 per cent of benefi- ciary families are totally unaffected by either of these measures Japan’s defined benefits were made less generous in 1986. There was a substantial htematlona/ cdal SeaKny Review Vd. 48,3-4/95  A risky slraiegy: Reflections on the World Bank Report Averting the old age crisis reduction in the accrual rate in the em- ployees’ pension scheme from 1 per cent to 0.75 per cent, but it did not apply at all to current pensioners or to anyone aged 60 or more in 1986. The measure was applied fully only in the case of workers under 40 at the time of the reform, with transitional arrangements over a 20-year period de- signed to apply it only gradually to those in the 40-60 age group. In 1992 Iceland shifted from a universal flat-rate benefit to a means-tested benefit and thousands of pensioners had their benefits reduced or eliminated. The rules of the scheme were indeed changed in Iceland, without any transi- tional measures for existing pensioners or those close to retirement. It is significant that, unlike the other examples cited above, the benefit in Iceland is non-con- tributory. Acquired entitlements under such a scheme do not enjoy the kind of protection that is normal under social in- surance. Yet it is precisely tax-financed flat-rate or means-tested benefits which the World Bank report recommends as the model for public schemes. Many would argue that measures that have been taken by social insurance schemes in recent years, such as gradual increases in pension age, are signs that public schemes are able to adapt to chang- ing circumstances. While these measures may be viewed as political risks, they may equally be seen as ways to ensure the long- term stability, solvency and survival of the schemes. In the light of the criticism of the politi- cal risk of public schemes, it is ironic that governments are urged in the report to re- form public schemes so as to reduce claims which workers and pensioners have on the system n order that these schemes may then be shut down at a lower cost to the State (p. 264). The cynicism of ths rec- ommendation may gravely undermine the efforts of reformers to persuade the popu- lation to accept measures such as an in- crease in the pension age as a way of safe- guarding and improving existing public schemes. Capacity to cope with demographic trends The report devotes sigruficant attention to demographic trends, which policy makers have long recognized will affect pension systems in all regions of the world over the next few decades.’ In the case of pay-as-you-go schemes, it is clear that demographic ageing necessi- tates either an increase in contribution rates or a cut in benefits (the preferred method being gradually to increase the pension age). The Bank claims that funded pension schemes are able to withstand the forthcoming demographic transition. This is a facile point of view. For, whether the pension system is funded or pay-as-you-go, demographic ageing will, other things being equal, mean higher dependency rates: more pen- sioners will be consuming the output of fewer workers. In one system, redistribu- tion to pensioners is through social se- curity schemes, whereas in the other it is through profits and the mechanism of the capital market. It is not at all clear that, for a given level of benefits, the burden on the active popu- lation will be any less under one system than under the other. Public schemes, on the other hand, have the clear advantage over private schemes that the extent to which they are funded may be varied over time. Thus, for example, reserves may be accumulated during a period when the demographic VOl. 48 -4/95 lntemstional soci l Securify Review
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