The fall of the Berlin Wall and the collapse of the Soviet Union marked the beginning of a dramatic economic transformation in Eastern Europe and Central Asia. In those tumultuous years, international donors, including Bretton-Woods institutions based in Washington, found they had significant new roles.
For the World Bank, public pensions was not a subject of much concern before then, but the new regions of focus posed distinct challenges. Demographically older than other parts of the globe, they also relied more heavily on public pensions as a central element of social policy.
From a fiscal viewpoint, public pensions are often the most difficult budget item to contain, as is seen by the fact that in many countries it had risen to more than 10% of gross domestic product. A new approach to pensions was clearly needed and the research department was tasked with producing a flagship report. The result was the Bank’s first major research volume on global pension policy entitled
. Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth
The 415-page book included a chapter on emerging Eastern Europe and the former Soviet Union, but its scope went far beyond to review the global experience with public pensions. This included examining evidence on how different systems affected labor and capital markets, savings and ultimately growth. Most of all, the report questioned the most prevalent approach, namely payroll financed social insurance that had its origins in Bismarck’s Germany.
Averting pointed out that most defined benefit schemes had serious financial sustainability problems and unintended redistribution issues between and across generations. It also highlighted the potential of schemes to distort the economy, especially as payroll taxes were forced to rise as schemes matured. And it argued that prefunding pensions could, under certain circumstances, help the system cope with aging populations and contribute to economic growth.
In the twenty intervening years, debate between those who argue for prefunding and for private management of funds and those who advocate a dominant public, pay-as-you-go scheme was often intense, but the major academic questions remain largely unresolved. While dozens of countries have reformed their systems and some of these reforms were influenced directly or indirectly by
Averting, most countries have maintained the traditional model. Other countries, most notably Argentina and Hungary, have even completely reversed their reforms and shut down their private, funded schemes. So, the story continues to unfold.
20 YEARS LATER
The team that produced
Averting attempted to find international patterns of pension provision using the limited data available in 1994. A two-year effort resulted in a set of indicators that, for the first time, allowed a comparison across a wide range of countries. Two indicators were especially important – spending and coverage.
The share of GDP that a country spends on public pensions was found, not surprisingly, to closely correlate to the share of the population over age 60 (see Figure 1) with fiscal pressures likely to increase given expected aging patterns. Indeed, countries like Mongolia, Brazil and Ukraine now spend as much or even more than they would have been expected to based on the relationship found in the early 1990s.
Importantly however, countries that implemented major reforms, like Italy, Japan and Sweden, are now found well below the line from the early 1990s. This suggests reforms can be effectively undertaken. In fact, the most recent data suggests that the fitted line has shifted downwards. But the crucial question in 1994 was whether or not countries would make adjustments in time to avoid financial crisis.
Twenty years after the release of Averting, adjustments are taking place, especially among countries with older populations. In 2013, Edward Whitehouse and colleagues at the OECD documented the ‘parametric’ reforms that have been undertaken in OECD countries. They found that in 18 out of 22 countries where future pensions were modelled, lifetime benefits will be reduced by an average of more than one-fifth.
Japan, the country with the highest share of its population over age 60 in the world, is a prime example. It implemented changes to retirement incentives that have increased the effective retirement age and kept the labor force participation rates of the elderly among the highest in the developed world. In addition, it reduced benefits and introduced an automatic stabilizing mechanism.
Finally, on the revenue side, Japan shifted financing so that a larger share of the pension bill now depends on earmarked consumption taxes. Since the publication of
Averting, the share of its population over aged 60 increased 56% while spending as a share of GDP has only increased by 53%, much less than implied by the relationship observed in 1994.
The second key indicator was share of the working age population (or labor force) contributing to a pension scheme in a particular year. Figure 2 (solid line) shows the close correlation that the
Averting team found when comparing income per capita with coverage. Recent data shows that this relationship is still strong (dotted line). After 20 years, bringing workers into a payroll-tax financed pension mandate is, if anything, more difficult at any given level of income per capita. THE FORGOTTEN MESSAGE
The often polemical discussion that followed
Averting focused on funding and the role of private provision. Largely ignored, however, was the key recommendation to address the twin goals of pension policy – redistribution and savings – with different instruments.
The examples cited in 1994 were Australia and the Netherlands. Today, they would include New Zealand, with its new
KiwiSaver scheme, and Chile, where the 2008 Bachelet reform introduced the Pension Solidaria. These provide non-contributory or social pension schemes financed by general revenues, so addressing redistributive goals, while contributions into individual accounts address the savings goal.
Averting went further, suggesting that low income countries should focus on addressing poverty in old age and only look at savings after creating an enabling environment. Recognizing that many countries had already installed the traditional schemes, Averting suggested keeping the existing contributory public scheme “small and flat” and to provide income support to the “old poor who are not covered by contributory plans.”
The appropriate instrument or program to address old age poverty varies across countries depending on resources and other social assistance programs that can be harnessed.
Averting could have devoted more space to details of how to structure a redistributive element in the pension system. More could have been said about issues such as the incentive effects of redistributive programs on savings schemes, the relationship between other cash transfer programs and social pensions and, of course, the long run cost of different design choices.
The World Bank and other institutions are addressing this with publications like
, a review of social pensions in Latin America, the Asian Development Bank’s publication, Beyond Pensions or the Inter-American Development Bank’s What is the Role of Social Pensions in Asia , all published within the last few years. Better Jobs, Better Pensions
The common message emerging across this literature was already delivered in 1994 and is the forgotten message of
Averting the Old Age Crisis – use the right tool for the right job.