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The Challenge of Pension Reform in Advanced and Emerging Market Economies.

The Challenge of Pension Reform in Advanced and Emerging Market Economies by Benedict Clements, David Caody, Frank Eich, Sanjeev Gupta, Alvar Kangur, Baoping Shang, and Mauricio Soto, Washington, DC: International Monetary Fund, 2012.

This ambitious and well-done publication examines public pension plans and related matters in 53 countries: 27 advanced economies and 26 emerging market economies. The emerging market economies include 10 emerging European economies (including Turkey) and 16 other emerging economies. The report consists of 38 pages of text organized in eight chapters and five appendices, as well as numerous exhibits and tables.

Chapter 1 provides an overview of the book; Chapter 2 is an overview of the current pension landscape, explaining that public pension systems vary widely between advanced and emerging economies and between emerging European and other emerging market economies. They also differ within these groups. Most public pension systems are financed on a pay-as-you-go basis. They are based on a social contract to use current tax revenues to provide for the elderly. Canada and the United States have the only partially prefunded systems. Most private pension plans are prefunded, albeit seldom fully so.

Chapter 3 entitled "Historical Trends in Public Pension Expenditures" focuses on the two major demographic developments of recent decades: a widespread increase in the old-age dependency ratio (population aged 65 and over divided by population aged 16 to 64) and a widespread decline in fertility rates (births per-woman). In the advanced economies fertility rates have declined from over three births per woman in the 1950s to about two births today. The result is a decline in the number of active participants (workers) to beneficiaries (retirees) and hence a massive increase in projected retirement expenditure and national indebtedness.

Chapter 4 deals with pension reform measures over the last 10 years. In the advanced economies these consist mainly of parametric reforms to existing systems, such as extending the statutory retirement age to reflect increasing life expectancies, reducing eligibility and adjusting benefit formulas by reducing accrual rates, tightening eligibility rules and altering indexing rules. In European emerging economies there was a trend toward mandating private pension plans and most of them did not fare well during the recent recession. Other emerging economies exhibited a variety of reforms.

Chapter 5 examines the outlook for public pension spending for the next several decades. Population aging will continue and even accelerate through 2030 for both advanced and emerging economies. In advanced economies, the old-age dependency ratio is expected to double between 2010 and 2050. The trick will be to control public pension spending in a "graying" world. The authors identify a number of risks associated with their projections. They include overoptimistic macroeconomic assumptions, over estimating fertility rates and reform reversal due to political pressures.

Chapter 6 identifies a number of considerations that should underlie public pension reform including contributing to fiscal consolidation, addressing equity issues and supporting economic growth. Fiscal consolidation is a policy of reducing government deficits and accumulated debt ratios (debt divided by GDP). Equity in this context involves the redistribution of income within and across generations from high to low earners. A number of countries have adopted a flat public pension benefit for all elderly. Others use a progressive benefit formula. The authors report that increasing the statutory retirement age can contribute to economic growth by increasing the labor supply. Interestingly, the labor force participation rate of older men declined significantly between 1950 and 2000, due mainly to the increased availability of pension and disability plans.

Chapter 7 investigates public pension reform options. It suggests that relatively modest additional reforms could stabilize pension spending over the next 20 years. The advanced economies face a double challenge: high national debt and aging populations due to increased life expectancy and reduced fertility. This will translate into higher pension (and health care) costs. Their alternatives boil down to curtailing eligibility by gradually increasing the statutory retirement age, discouraging early retirement, and restricting alternate pathways to retirement such as disability retirement. Advanced economies with a low "tax wedge" may use additional taxation to increase revenue. Of course, in many countries that would be met with strong opposition from many quarters.

The public pension systems of the emerging market economies of Europe are similar to those in the advanced economies. The parametric reforms recommended include increasing the retirement age in line with increased life expectancy, equalizing the retirement age between men and women where a differential exists, and tightening eligibility rules. It is also recommended that pensions be indexed to price inflation rather than to wage growth.

The authors urge other (non-European) emerging market economies to increase their public pension coverage. Such plans are often limited to civil servants and to employees of the organized sector of the economy. The coverage gap is especially large in Asia, less in Latin America, and lesser still in the Middle-East and Africa (Egypt and South Africa). The authors contend that increasing pension coverage and eligibility would increase consumer spending, which would serve as a catalyst for economic growth. Countries with very low pension coverage are advised to consider "social pensions" with a flat rate to alleviate elder poverty.

This assessment ignores the negative effect of the increased taxation needed to pay for the additional benefits. It also ignores competing demands for those resources. Should a poor country invest its marginal resources in retirement benefits for the elderly or in health services and education for the young? The assessment also misses the competitive advantage that some emerging economies enjoy by not being encumbered with large retirement benefit obligations.

Chapter 8 is a summary of the other chapters. The economies vary in terms of their fiscal situations (budgetary deficits and accumulated debt) and the parametric features of their public pension systems. The appropriate mix of additional reforms will be situational. The chapter includes a major table that summarizes the issues and reform options by country.

The five appendices explain the methodologies employed, sources referenced and provide a wealth of information that amplifies the text discussion and its numerous charts and exhibits. The tables are a treasure. In the social sciences, we understand things largely by comparing them to other things through longitudinal or cross sectional analysis. Benchmarking is a variant of cross-sectional analysis. To do this, we need comparable data. The IMF report is replete with graphs and tables that provide perspective to readers familiar with their own national public pension system(s).

However, American readers familiar with Social Security may wonder at the lack of attention to 75-year projections, trust fund exhaustion dates, "trust fund ratios" (assets divided by current year expenditures), which give the number of years that scheduled benefits can be paid from current assets, "funded ratios" (assets divided by liabilities), which measures percent funded, and the like. Such metrics would be meaningless to most readers from other countries. Only Canada and the United States prefund their national pension systems. Many Americans fret that Social Security is less than fully funded, not knowing that the so-called assets held by the Treasury Department have long-since been spent and that there is no real money there. The U.S. Social Security unfunded liability problem is in reality a national fiscal problem. It is quite similar to the national pension problems of other countries that operate on a pay-as-you-go basis.

In the United States, Social Security is only one of the sources of retirement income, albeit an extremely important one for those at the lower end of the lifetime earnings distribution. For those in the middle and upper segments of the distribution Social Security is complemented by an array of defined-benefit and defined-contribution pension arrangements. There are also a number of tax-favored retirement saving plans available [e.g. 401(k), 403(b), 457(b), Keogh, SEP, plans, plus an assortment of Individual Retirement Accounts] that allow and encourage many to supplement their Social Security benefits. No doubt such arrangements exist in other countries, especially in other advanced market economies. The IMF may want to consider such programs in future studies.

It is unfair to fault a publication for not doing what the author(s) had no intention of doing. Clements, et. al. did what they said they were going to do and did it well. This paper was an ambitious project that was well executed and I learned a lot from it.


Professor of Management, Emeritus

California State University, East Bay
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Author:Kilgour, John G.
Publication:American Economist
Date:Sep 22, 2013
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