Diamond Barr 2010

Reforming Pensions: Lessons from Economic Theory and Some Policy Directions [with
Comment]
Author(s): NICHOLAS BARR, PETER DIAMOND and Eduardo Engel
Source: Economa, Vol. 11, No. 1 (Fall 2010), pp. 1-23
Published by: Brookings Institution Press
Stable URL: http://www.jstor.org/stable/25800053 .
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NICHOLAS BARR
PETER DIAMOND
Reforming
Pensions: Lessons from Economic
Theory
and Some
Policy
Directions
Pension
systems
have
wide-ranging
and
important
effects.
They
influ
ence the
living
standards of older
people
and hence the welfare of both
older
people
and their children.
They
can also affect national economic
performance through potential
effects on the labor
supply
and
saving.
The
design
of
pensions
therefore matters. In
discussing
the
topic,
this
paper
draws
on two of our earlier works.1 It starts
by setting
out some central lessons from
economic
theory.
The second section derives some
policy implications
of
particular
relevance to Latin America. The
policy chapters
in our two earlier
books focus
particularly
on two countries in which we have worked:
China,
which is
important
because of its
size,
and
Chile,
which is
important
because
its 1981 reforms were
widely adopted
in Latin America and elsewhere and
which has become an
exemplar
in the
pension
debate. Box 1 defines
some of
the relevant terms. The final section concludes.
Key
Lessons from Economic
Theory
Economic
theory
offers a series of conclusions that should frame
policy
design.
Some of
them,
though apparently
obvious,
are
frequently forgotten;
others can be counterintuitive. We focus
on five sets of lessons:
pension
sys
tems have
multiple objectives;
different
pension systems
share risks differ
ently,
both across
people
and over
time;
there is no
single
best
pension system;
pensions
should be
analyzed
in a second-best
context,
that
is,
taking
account
of market
imperfections
and other
distortions;
and
a move to
funding may
or
may
not be the
right policy.
Ban is with the London School of
Economics;
Diamond is with the Massachusetts Institute
of
Technology.
1. Barr and Diamond
(2008, 2010).
1
2
ECONOMIA,
Fall 2010
BOX 1.
Terminology
Defined-benefit
(DB)
pensions
are
systems
in which the
pension
benefit is determined as a function of the worker's
history
of covered
earnings.
The formula
may
be based on the worker's final
wage
and
length
of service or on
wages
over a
longer period
(for example,
a full
career).
A DB
system may
be
fully
or
partially
funded,
or it
may
be unfunded. In a
pure
DB
arrangement,
insofar as the
degree
of
funding
is
maintained,
the
sponsor's
contributions are
adjusted
to meet
anticipated
obligations;
thus,
the risk of
varying
rates of return to
pension
assets falls on the
sponsor.
Defined-contribution
(DC) pensions
are
systems
in which the benefit is determined
by
the value of assets accumulated
toward a
person's pension.
Benefits
may
be taken as a
lump
sum,
as a series of
withdrawals,
or
through
an
annuity.
The
expected
discounted value of benefits is thus
equal
to the value of assets
(in
technical
terms,
the benefits are determined
actuarially).1
A
pure
DC
plan adjusts obligations
to match available
funds,
so that the individual bears the
portfolio
risk.
Fully
funded
pensions pay
all benefits from accumulated funds. See also
partially
funded
pensions.
A
noncontributory pension
is based on
age
and
years
of residence.
Notional defined-contribution
(NDC)
pensions
are financed on a
pay-as-you-go
or
partially
funded
basis,
with a
person's
pension bearing
a
quasi-actuarial relationship
to his or her lifetime
pension
contributions.
Partially
funded
pensions pay
benefits both from accumulated assets and from current contributions.
Pay-as-you-go
(PA YG)
pensions
are
paid
out of current revenue
(usually by
the
state,
from tax
revenue)
rather than out
of accumulated funds.
Partially
funded
pensions
are often referred to as PAY6.
A
provident
fund
pays
a defined-contribution
pension
based on the
performance
of a
single,
central fund rather than on
the
performance
of individual accounts.
1. The discounted value
depends
on the relevant interest rate and load factors.
Pension
Systems
Have
Multiple Objectives
For the individual or
family,
the
major objectives
of
pensions
are
consump
tion
smoothing (redistribution
from one's
young
self to one's older
self)
and
insurance. Governments have additional
objectives, including poverty
relief
and redistribution.
Any analysis
of
pension
reform needs to take account of
the full
range
of
objectives alongside
other
policy goals,
such as economic
efficiency
and
output growth.
Different Pension
Systems
Share Risks
Differently
Separate
from their redistributive
effects,
different
pension systems
share
risks
differently.
Pension
systems
are
subject
to
multiple
sources of
risk,
and
they
have different
underlying philosophies
of who should bear those
risks. This section looks at four
types
of
pension,
with a
focus on
how
they
distribute risk.
We start with two
polar
extremes of
fully
funded
systems: pure
funded
defined-contribution
(DC)
plans
and
pure
funded
mandatory
defined-benefit
(DB)
plans.2
In the case of the former?also known as funded individual
accounts?individual workers set aside a
given
fraction of their
earnings
to
2. See the
glossary
in box 1 for a brief definition of these terms.
Nicholas Barr and Peter Diamond 3
buy private
financial
assets,
which are
accumulated until retirement. At that
point,
the retirees can either
purchase
an
annuity
or take a series of with
drawals from the accumulation. Fluctuations in the cumulative return on
assets
during working
life affect the individual account holder
by affecting
the amount available to finance retirement. If the worker
buys
an
annuity,
he
or she will have faced the risk in the
pricing
of
annuities,
reflecting
both mor
tality projections
and asset returns from this
point
forward. Once the
annuity
is
purchased,
however,
further fluctuations in asset returns and the
develop
ment of
mortality compared
to the
projections
used in
pricing
the
annuity
are
borne
by
the insurance
company,
unless
annuity
benefits are indexed for asset
returns
(a
variable
annuity)
or for
mortality
realizations. As the insurance
company adapts
to the realizations of returns and
mortality,
it
may
in turn
adjust
the
price
of its
policies,
the
compensation
it
pays
its
workers,
and the
returns to its shareholders
(if
it is not a mutual
company).
If the retiree does
not
buy
an
annuity,
he or she faces
mortality
and return risks. That
is,
the risks
of different outcomes
up
to retirement fall on the individual
retiree,
since
benefits
adjust
to what is in a worker's individual account at the time of retire
ment. Annuitization shifts risks after retirement to
insurers,
but the retiree
still faces the risk of the
pricing
of annuities at the start of retirement.
In the case of
pure
funded
mandatory
defined-benefit
(DB) plans,
individ
ual workers receive retirement benefits based
on a formula
relating
benefits
to their
earnings history.
Thus,
both asset return and cohort
mortality
risks are
managed through adjustments
in contributions and are therefore borne
by
the
workers
during
their
working
lives. That
is,
in order to sustain full
funding
for the
provision
of future benefits
as set out in the benefit
formula,
contribu
tions need to be
adjusted
as returns
vary
and
mortality projections change.
Since
a
single
fund is available for all benefits and
changes
in contribution
rates are
normally
uniform across
workers,
there is a collective dimension in
that the need at
any
time
depends
on the full
array
of workers who share in
the need for
aggregate
contributions. A
plan
does not have to be
fully
funded
at all times?fluctuations in the
degree
of
funding
are a device for
shifting
risks
intertemporally
and, therefore,
across workers born in different
years.
The fund
may purchase
annuities,
shifting
risks to insurance
companies.
A
plan may
have
a
sponsor
who absorbs the
risk,
such
as a
corporate employer
or the
government relying
on taxes in addition to contributions. The former
shifts risks to current and future workers at the
firm, shareholders,
and
possi
bly
customers,
if the
company responds
to a
pension
deficit
by raising
its
prices.
If the
government
is the
sponsor,
the risks are shifted to current and
future
taxpayers.
4
ECONOMIA,
Fall 2010
Thus,
one
element in the distinction between DB and DC
plans
is the
focus on
adjusting
contributions or
adjusting
benefits. In
practice,
corpora
tions and
governments commonly adjust
both,
so that
plans
are not
typically
pure, although
the
labeling
can affect the
legislative
outcome. A second ele
ment is the collective
aspect
of
having
a
single
fund rather than individual
accounts. This
opens up opportunities
for risk
sharing
within the DB con
text,
although governments
could redistribute
across individual DC accounts
and
may
provide
insurance on
the rate of
return,
financed from outside the
pension system.
A central fund has lower administrative costs and avoids
poor decisionmaking by
workers,
although
it is at risk of
poor
investment
decisions
by
the fund
managers. However,
a
central fund
forgoes
the
oppor
tunity
to have different
degrees
of asset return risk for workers with different
levels of risk aversion.
Corporate pensions
should remain close to
fully
funded since
corpora
tions can
fail,
leaving
the workers with less than
planned
or
leaving
it to the
government
to insure the workers. While
occasionally governments go
bank
rupt
as
well,
this risk is not
significant
in countries with sound economies
and effective
governments.
Governments can therefore have
systems
that are
less than
fully
funded,
but still well
designed.
The extreme version has no
funding?something
that is not standard
practice
since most
systems
main
tain
a
buffer fund for short-run
fluctuations,
and
government plans
sometimes
provide significant funding.
A third
option
is a
pay-as-you-go (PAYG)
defined-benefit
system
financed
by
social
security
contributions. In this
arrangement,
there are no
assets,
so the rate-of-return risk is of
no
significance.
Instead,
the risk to the
plan's
income comes from fluctuations in the
earnings
of covered
workers,
given
the contribution rate. Since there is no
opportunity
for
surpluses
and
deficits,
the risks are shared
among
current workers
through changes
in contributions. If the fund can run
surpluses (partial funding)
or deficits
(borrowing against
future contributions or
using previous surpluses),
the
risks can be shared with future workers or eased
by
the
presence
of accu
mulated
past
contributions.
Any
accumulation,
whether
positive
or
negative,
involves risk in rates of return. There is also the risk of the evolution of mor
tality
rates: if
people
live
longer,
the cost of
paying
a
given
level of benefits
will increase.
A final
option
involves
systems
financed at least in
part by general
tax rev
enues. For
example,
in a
(referred
to as a
citizen's
pension),
the risks are
shared
by
all
taxpayers
and are thus
spread
across
gen
erations
(since
future taxes as well as current taxes can
change
as debt
varies).
In
practice, plans
are not
pure,
and countries
frequently adjust
both con
tributions and
benefits,
thus
sharing
risks between workers and
pensioners.
A
central
question
for
policymakers
is how risks should be
shared,
a
question
with both
efficiency
and
equity implications.
As with
redistribution,
different
answers are
possible,
but it is a
major
error to
ignore
the
question.
There is No
Single
Best Pension
System
Policymakers
face
a series of constraints in
pursuing
the
multiple objectives
mentioned
above,
including
fiscal
capacity (stronger
fiscal
capacity
makes
it easier for the
system
to find additional revenues for a
pension system);
institutional
capacity (stronger
institutional
capacity
makes feasible a wider
range
of
design options);
the
empirical
value of behavioral
parameters (such
as the
responsiveness
of labor
supply
to the
design
of the
pension system
and
the effect of
pensions
on
private saving);
and the
shape
of the
pretransfer
income distribution
(a
heavier lower tail increases the need for
poverty
relief).
The reason
why
there is no
single
best
system
is
simple: policymakers
at
different times and in different
places
attach different relative
weights
to the
various
objectives;
and the
pattern
of
constraints,
including political
and his
torical
constraints,
will differ across countries. If
objectives
and constraints
differ,
the
optimum
will
generally
differ,
as well.
Pensions Should Be
Analyzed
in a Second-Best Context
The assessment of the
optimal pension system
should be made in a second
best context.3
Simple theory
assumes that individuals make
optimal
choices
and that labor
markets,
savings
institutions,
and insurance markets exist and
function
ideally.
Those
assumptions
do not
apply
to
pension systems
because
workers and
pensioners
face information
problems,
behavioral
problems,
missing
markets
(for
example,
the lack of
private
instruments to
provide
indexation),
and broader factors such as the
inescapable
existence of distor
tionary
taxation.
Framing
the
argument
in second-best terms starts from the
multiple objec
tives of
pension systems.
Thus,
policy
has to
optimize (not
minimize
or max
imize)
across a
range
of
objectives,
which cannot all be achieved
fully
at the
same time.
Policy
has to seek the best balance between
consumption
smooth
ing, poverty
relief,
and
insurance,
and this balance will
depend
in each
society
3. For a fuller
discussion,
see Barr and Diamond
(2008,
section 4.2 and box
9.6).
6
ECONOMIA,
Fall 2010
on the
weights given
to those and other
objectives
and to the different con
straints that societies face.
A Move to
Funding May
or
May
Not Be the
Right Policy
In
assessing
whether,
and to what
extent,
a move to funded
pensions might
increase
welfare,
policymakers
need to ask two sets of
questions.4
First,
is a
move toward
funding
welfare
improving?
For
example,
does it increase out
put,
either
by increasing savings
in a
country
that is short of
saving,
or
by
strengthening capital
markets,
thereby improving
the
efficiency
with which
savings
are channeled into
productive
investment? Does it have desirable
intergenerational
redistributive effects?
Second,
even if a move toward fund
ing
is in
principle
welfare
improving,
is such a move feasible? Does the coun
try
in
question
have the economic conditions and institutional
capacity
necessary
to
implement
schemes that are safe and
administratively cheap?
The answers to these
questions
will
vary
over time and across countries.
First,
an increase in
saving may
not be the
right objective, particularly
in a
country
where the
saving
rate is
already high (for
example,
China). Second,
a move to
funding may
or
may
not increase
saving.
For
example,
fund
ing through
the issue of new
government
bonds will not do so.
Similarly,
increased
mandatory pension saving may
be
largely
offset
by
declines in
voluntary private saving
or
by
increases in
government borrowing, perhaps
to
help
finance the transition costs of a move to a
regime
with more
funding.
Third,
formal
capital
markets
may
or
may
not allocate funds to investment
more
effectively
than informal
capital
markets. Gains in the effectiveness
of
capital
markets will
depend
on
effective administration and on
political sup
port
for
improved regulation.
Thus,
funding may
increase national
saving
or
expand explicit public
debt,
or
both;
and it
may
improve
the
operation
of
cap
ital markets. Either is
possible;
neither is inevitable. The economic case for
funding
has to be
analyzed
in each
country.
In addition to the
potential
effects on
output,
a move to
funding
has inter
generational
effects. If
funding
is to raise
output growth
in the
future,
it must
increase
saving today.
But for
saving
to
increase,
there must be a decline in
consumption, by government
or
by today's
workers or
by today's
retirees.
Thus,
a move to
funding generally imposes
a
burden on
today's generations
to the benefit of future
generations,
an outcome that
may
or
may
not be
good
policy.
More
generally, introducing
a new PAYG
system
allows the
early
4. For a
fuller
discussion,
(2008,
section
6.3).
cohorts to receive
larger pensions
than if the new
system
were
fully
funded.
Consequently,
any
choice between
PAYG,
partial funding,
and full
funding
is also and
necessarily
a choice about the
intergenerational
distribution of
income and of risks. Even if
funding
does increase
output,
the
change
cannot
be
presented
as an
unambiguous improvement.
The answers to these
questions
shed
light
on whether a move to
funding
might
be
optimal.
A
separate
issue is whether it is feasible. Funded
pensions
make
significant political
demands
on
government
and
require significant
institutional
capacity
in both the
public
and
private
sectors. The
litany
of
funded schemes that have failed
completely
or that have not lived
up
to the
promises
that were made for them attests to the
importance
of these
opera
tional
issues,
as well as to the
dangers
of
basing policy
on untested and
per
haps excessively optimistic predictions.
Policy Implications
In
discussing policy
direction in the context of Latin
America,
it is
helpful
to start with
consumption smoothing.
This discussion establishes the con
text for
examining poverty
relief
generally
and the 2008 reforms in Chile in
particular.
Consumption Smoothing
It is
a mistake to conflate the
separate concepts
of individual accounts
and
funding.
Individual accounts can be
fully
funded
(such
as the Chilean
DC
scheme),
partially
funded,
or PAYG
(for example,
a notional defined
contribution scheme with no reserves
beyond
a buffer fund to cover a few
months of
payments).
The discussion below looks first at notional defined
contribution
(NDC)
pensions
and then at reform
options
for funded indi
vidual accounts.
ndc pensions. A recent innovation
internationally, pure
NDC
systems
mimic funded individual
accounts,
but on a
largely
or
wholly pay-as-you-go
basis. In the
simplest
such
scheme,
each worker
pays
a contribution of a fixed
percentage
of his or her
earnings,
which is credited to a notional individual
account,
while the workers' contributions this
year largely
or
wholly pay
this
year's pensions.
The
government keeps
a record of individual
contributions,
each
year attributing
a notional interest rate to each worker's accumulation.
When the worker
retires,
his or her notional accumulation is converted into
8
ECONOMIA,
Fall 2010
an
annuity.
In a
pure
NDC
system,
benefits are
strictly
related to the size of a
person's
notional accumulation.5 The
system
can also
incorporate
redistribu
tion,
such as minimum benefits
or
pension
credits for
caring
activities,
and
the scheme
can
incorporate partial funding.
NDC schemes have
a
range
of
potential advantages.
The
system
is sim
ple
from the
point
of view of the
worker,
and the fact that it is administered
centrally keeps
administrative costs low. Risk is
kept
low,
since
an unfunded
NDC
pension system
is not affected
by capital
market
volatility,
the main
source of risk to funded individual accounts. An NDC
system
does not
require
the institutional
capacity
to
manage
funded schemes. In
addition,
saving may
be the
wrong policy,
or
people
may
not want to save.
Finally,
NDC can be
partially
funded and can be the basis for a future move to full
funding,
so the
approach
may provide
a
starting point
if financial market tur
bulence continues.
As discussed
earlier,
solid
analytics
should
underpin
the choice between
NDC and funded accounts. The choice should be
economic,
not
primarily
political.
funded individual accounts. If
policymakers
want a
system
with
funded individual
accounts,
there
are different
ways
to
implement
the
policy.
In the best-known
arrangement,
workers have
significant
individual choice
over their
pension provider,
as in Chile and Sweden. Choice is
generally
assumed to be
welfare-enhancing. Simple
economics
argue
that
policy
should
allow
people
to choose their own
pension provider
in a
competitive
market.
Such
choice,
it is
argued,
benefits the individual in the
same
way
as choice
and
competition
for
clothes, cars, restaurants,
and MP3
players.
That view
needs to be
tempered by
two sets of
factors,
however:
impediments
to
good
choice
by
individuals;
and the fact that choice has costs.
The model of the well-informed consumer does not hold in
many
areas of
social
policy,
as demonstrated
by
the economics of information. In the con
text of
pensions,
there is
ample
evidence of
poor
information.
Many
do not
understand basic
concepts
in finance:
Orszag
and
Stiglitz quote
the chairman
of the U.S. Securities and
Exchange
Commission as
stating
that over 50
per
cent of Americans do not know the difference between a stock and a
bond.6
5. The
system
is
quasi-actuarial
in that the interest rate attributed to a worker's notional
accumulation is not the market return to financial
assets,
but an interest rate determined
by
the relevant
pensions legislation?for example,
the
growth
in the total
wage
bill of covered
workers each
year.
6.
OrszagandStiglitz(2001,p. 37).
Most
people
with an individual account do not understand the need to shift
from
equities
to bonds as
they age,
and
virtually nobody
realizes the
signifi
cance of administrative
charges
for
pensions.
As
noted,
choice has
costs,
and
in the case of individual accounts those costs are
significant:
over a full
career,
an annual
management charge
of 1
percent
of the individual's
accu
mulation reduces the accumulation
(and
hence the
pension) by
20
percent.7
Recent lessons from behavioral economics also
yield powerful
lessons,
explaining
such
phenomena
as
procrastination (people delay saving,
do not
save,
or do not save
enough),
inertia
(people stay
where
they
are),
and immo
bilization
(whereby
conflicts and confusion lead
people
to behave
passively,
like a deer in the
headlights).8
These bodies of
theory suggest
that the benefits of wide choice
are
likely
to be
very limited,
and for most
people likely
to be
outweighed by
the costs
of choice.9 These considerations
suggest
a series of
guidelines
for the
design
of individual accounts:
?Use automatic
enrollment;
?Keep
choices
simple
(for
most
people, highly
constrained choice is a
deliberate and
welfare-enhancing
feature of
good pension design,
although
one of the
options
could be to allow individual
choice);
?Design
a
good
default
option
for
people
who make no
choice;
and
?Decouple
fund administration from fund
management,
with account
administration centralized and fund
management organized
on a whole
sale,
competitive
basis.
The U.S. Thrift
Savings
Plan for federal civil servants
complies
with these
criteria.10 The
plan
offers
participants
a
very
limited choice of
portfolios.
Ini
tially
there were three:
a stock market index
fund,
a fund
holding
bonds
issued
by private
firms,
and a fund
holding government
bonds. In 2007 work
ers could choose from six
funds,
including
a
life-cycle option
(that is,
an
option
in which
a
person's portfolio
shifts
automatically
from
mainly equi
ties to
mainly
bonds
as he or she
ages).
A
government agency keeps
central
ized records of individual
portfolios.
Fund
management
is on a
wholesale
basis. Investment in
private
sector assets is handled
by private
financial
firms,
which bid for the
opportunity
and which
manage
the same
portfolios
in the
voluntary private
market,
providing
insulation from
political
interference.
7. See Barr and Diamond
(2008,
Box
9.4).
8. For a fuller
discussion,
(2008,
Box
9.6).
9. For a fuller
discussion,
(2008,
section
9.3).
10. For more
information,
see the U.S. Thrift
Savings
Plan website
(www.tsp.gov).
10
ECONOMIA,
Fall 2010
This
plan
thus
(a)
simplifies
choice for
workers,
respecting
information
constraints, (b)
includes automatic
enrollment, (c)
has a default
option,
and
(d) keeps
administrative costs
astonishingly
low,
at as little as 6 basis
points
annually,
or 60 cents
per $1,000
of account balance.
By
the end of
2009,
the
program
had
grown
to include 3.2 million active
participants
and 4.3 million
total accounts and held assets of
$244
billion. The United
Kingdom
is intro
ducing
a
similar
arrangement.11
Poverty
Relief
Pure DC individual accounts
provide consumption smoothing,
but
they
do not
provide adequate poverty
relief for workers with limited lifetime contribu
tions,
typically
as a result of low
earnings, fragmented
careers,
or a work his
tory substantially
in the informal sector. In this
regard,
the
post-1981 system
in
Chile,
which is based
heavily
on individual
accounts,
offers three
primary
lessons:
first,
mandatory
funded individual accounts can be
part
of a
good
reform,
but such a reform is not
easy
and
depends
on
complementary
reforms;
second,
private supply
and
competition
alone are not sufficient to
keep
down
transactions costs or
charges;
and,
finally,
unless
accompanied by
a robust
sys
tem of
poverty
relief,
individual accounts do not constitute
a
pension system,
but
only part
of a
pension system.12
To
explain
the
shape
of Chile's 2008
reforms,
it is
necessary
to consider
the
changes
in the economic and social environment within which social
pol
icy operates.
The
contributory principle
assumed that workers had
long,
sta
ble
employment,
so that
coverage
would
grow. History
has not sustained this
supposition.
To
explain why,
consider the
way
the world has
changed
over
the
past sixty years.
Social
policy
in 1950
was based on a series of
assump
tions: the world was made
up
of
independent
nation
states;
employment
was
generally
full time and
long
term;
international
mobility
was
limited;
the sta
ble nuclear
family
with a male breadwinner and a
female
caregiver
was the
norm;
and
skills,
once
acquired,
were
lifelong.
While these
assumptions
were
not
entirely
true even
then,
they
held well
enough
to be a realistic basis for
social
policy.
The world
today
is
very
different. There is
increasing
international com
petition.
The nature of work is
changing,
with more fluid labor markets.
11. See the website of the U.K. National
Employment Savings
Trust
(www.nestpensions.
org.uk).
12. Barr and Diamond
(2008, p. 238).
International
mobility
is also
increasing,
and it is
likely
to continue to do so.
The nature of the
family
is
changing,
with more
fluid
family
structures and
rising
labor-market
participation by
women.
Finally,
the half-life of skills
has declined.
Given this new
environment,
the
key
drivers of
change
when
considering
pension design
are more diverse
patterns
of
work,
which create
problems
in
terms of
coverage
for
contributory
benefits tied to
employment,
and increas
ingly
fluid
family
structures,
which make it difficult to base women's benefits
on
their husbands' contributions.
Those circumstances create a case for a
noncontributory
basic
pension,
that
is,
a
pension
financed from
general
taxation and awarded at a flat rate to
any
one who meets an
age
and residence test. The Chilean Presidential
Advisory
Council on
Pension Reform
put
the
point succinctly:
"The
prevailing image
at
the time of the
pension
reform
[in
Chile in
1981],
of a workforce
composed
mainly
of male heads of
household,
with
permanent jobs, contributing
contin
uously throughout
their active
lives,
has become less and less
representative
of the real situation of the
country
and will become even
less
so in the future.
This means
that the
system designed
at that
point
in time is also
gradually
los
ing
its
ability
to
respond
to the needs of the
population
as a whole."13 For these
reasons,
Chile introduced
a
noncontributory pension (the
Pension Bdsica Sol
idaria)
in
2008,
initially
for
pensioners
in the
poorest
40
percent
of the
popu
lation and
rising
to 60
percent
when
fully phased
in.
The case for a
non-contributory pension
is that it
strengthens poverty
relief
in terms of
coverage, adequacy,
and
gender
balance;
improves
incentives rel
ative to income-tested
poverty
relief;
provides good targeting
(in
that
age
is a
useful indicator of
poverty);
and can assist international labor
mobility.
The
obvious
question
is how to
pay
for such a benefit. Three instruments can match
expenditures
with
budgetary
constraints: the size of the
pension,
the
age
at
which it is first
paid,
and the
option
of an affluence
test,
which
keeps
benefits
from the best-off
segment
of the
population.
The Chilean mechanism for con
trolling
beneficiaries was mentioned above. In
Canada,
95
percent
of older
people get
the full flat-rate
benefit,
and
only
2
percent
are
entirely
screened
out. In the
Netherlands,
the benefit is awarded
only
on the basis of
age
and res
idence,
with no test of income or assets. Box 2 summarizes the international
experience
with this
type
of
pension.
13. Presidential
Advisory
Council on Pension Reform
(2006).
BOX 2.
NoncontributoryPensions
A number of countries have
implemented
a
noncontributory pension system.2 High-income
countries with this
arrangement
include
Australia, Canada,
the
Netherlands,
and New Zealand. For middle-income
countries,
the
introduced in Chile in 2008 is discussed in the text. South Africa also has a
noncontributory
pension, namely,
the State Old
Age
Grant. The case is
interesting
in that it reaches not
only
urban
pensioners,
but also the
rural
elderly.
The
pension,
which is
paid
to men at
age
65 and women at
60,
is financed from
general
revenue with no
contribution conditions. The benefit is around half of
average
household income and is thus
high
relative to the
very
low
incomes of most nonwhites in South
Africa,
but low relative to the incomes of the better off.
Originally
introduced as
poverty
relief for whites
during
the
1930s,
the
plan
was
gradually expanded
to cover all race
groups.
Research
suggests
that it is
highly
effective both in terms of social
policy
and in the
way
the
plan
is
implemented:
"The South African social
pension
is an
example
of a transfer
plan
where
eligibility
is determined
by age.
In
spite
of the
simplicity
of the
targeting
indicator,
the
pension
is effective in
reaching
the
poorest
households and those with children_The South African
authorities have overcome the difficulties of
making
cash transfers to even remote rural areas and of
checking eligibility
among
even illiterate
pensioners."3
In most urban
areas,
people
receive the
pension through
bank accounts or
post
offices.
In rural
areas,
government
has outsourced
delivery
to the
private
sector,
organized
at the
provincial
level. At its
best,
the
system
is effective and innovative. In some
areas, vehicles fitted with cash
dispensers go
to
designated places
at
preordained
times. Pensioners enter their identification number
(or
fingerprint),
and their
pension
is
paid
out.
Notionally,
there is a
government
official on hand to
provide help,
but this
facility
is
patchy.
A number of low-income countries also have
noncontributory pensions (sometimes
called social
pensions), including
Bolivia, Botswana, Namibia,
and
Nepal.
Total
spending
is
typically
small in these cases
(below
1
percent
of GDP in
Botswana, Namibia,
and
Nepal),
and the benefit is also
generally
small.4
Pensions of this sort have the
great potential advantage
of
extending coverage
to
people
with limited contributions
records,
especially
women and workers in the informal sector. In
assessing
their
desirability
and
feasibility
in a
particular
country, policymakers
need to consider a
range
of factors:
?How well could the
pension
be
targeted?
The cost effectiveness of a
noncontributory
universal
pension depends
on
the
accuracy
of
age
as a
targeting
device. In
principle,
the more
poor people
a
country
has,
the
greater
the
importance
of
poverty
relief and the
better-targeted
a
will be. The extent to which
age
alone is a
good
indicator,
however,
will
vary
from
country
to
country, depending,
for
example,
on the extent to which old
people
live alone or as
part
of an extended
family.
?Is administrative
capacity
sufficient? Even a
simple pension
has administrative
requirements.
The
government
must
be able to establish
people's ages
and to
guard against multiple
claims
by
one
person
and claims
by
relatives on behalf of a
pensioner
who has died.
?Is the cost of
delivery
low
enough
relative to the size of
pension being
considered?
Finally,
where a
government
has the
necessary implementation capacity, policymakers
have a
range
of
options
for
containing
costs.
First,
the level of the
pension
can be
kept
low. For
example,
it is
only
10
percent
of GDP
per capita
in
Botswana and
Nepal.
Second,
the
age
at which the
pension
is first
paid
can be set
high.
In
Nepal, only
1.1
percent
of the
population
is older than the
qualifying age. Finally,
if administrative
capacity permits,
a further
option
is to
pay
a smaller
pension
at first
(for
example,
to
pensioners aged sixty-five
to
seventy-five)
and a
larger
one thereafter
(to
those
seventy
five and
over).
2. For further discussion of
noncontributory pensions,
see Willmore
(2007).
3. Case and Deaton
(1998, p. 1359).
4. Willmore
(2007,
table
2).
Conclusion
In
considering
the
implications
of economic
theory
for the
design
of
pension
systems,
a number of conclusions stand out.
First,
the
analysis
should con
sider the
pension system
as a whole. Pension
design
affects the labor
market,
economic
growth,
the distribution of
risk,
and the distribution of
income,
including
effects
by gender
and
generation. Analysis
should consider the
entire
pension system.
There is no
efficiency gain
from
designing
one
part
of
the
system (such
as individual
accounts)
without distortions if distortions are
then
placed
elsewhere to
accomplish
other
objectives.
Hence,
there can be
no
gain
from
an actuarial second-tier
pension given
the need for a
poverty-relief
element in the first tier. What is relevant for
analysis
is the combined effect
of the
system
as a whole.
Consequently, analysts
must
simultaneously
con
sider the
parts
of the
pension system
that
provide poverty
relief and those
whose
primary
focus is the
pursuit
of other
objectives.
Second,
the economic crisis has
provided
some
strategic
lessons.
Perhaps
the
key
lesson for
pensions
is the
importance
in
any
reform of
explicitly
ask
ing
how risk should be shared. With
pure
funded individual
accounts,
all
of the risk falls on the
worker,
and modifications
frequently
leave the
worker
bearing
a
large
fraction of the risk.
Many (including
us)
regard
this concentration of risk as undesirable. One
way
of
sharing
risk more
widely
is to buttress individual accounts with a tax-financed noncontribu
tory pension.
Third,
there are
many choices,
which widen as a
country's
economic and
administrative
capacity grows.
To
illustrate,
we
briefly
describe
pension sys
tem
options
for a middle-income
developing country
and for an advanced
country.
A middle-income
developing country
has two main
options
for its first-tier
pension:
a
noncontributory
tax-financed
pension
(see
box
1),
with
or without
an affluence test
(examples
include
Australia,
the
Netherlands,
New
Zealand,
South
Africa,
and
Chile);
or a
simple contributory
PAYG
pension,
such as a
flat-rate
pension
based on number of
years
of contributions
(such
as the basic
state
pension
in the United
Kingdom).
For the second
tier,
the
options
include a
publicly organized earnings
related defined-benefit
pension,
or
possibly
a notional defined-contribution
pension;
or a
provident
fund defined-contribution
pension (Malaysia, Singa
pore),
in which the
design
of
any
tax concessions should consider the extent
to which tax benefits
are
regressive.
If the first tier includes a
contributory
pension,
the second-tier mechanisms can be
separate
from it
or
integrated.
14
ECONOMIA,
Fall 2010
The third tier
comprises voluntary
pensions
at the
level of the firm or the
individual;
any
tax benefits should be
designed
to avoid
excessive
regressivity.
In an advanced
country,
the
options
for the first-tier
pension
are either a
contributory pension
aimed at
poverty
relief,
with a
large
array
of
possible
designs (many
countries
use this
type
of
system, including
the United
King
dom);
or a
noncontributory
tax-financed
pension,
with
an affluence test
(for
example,
Australia and South
Africa)
or without
(for example,
the Nether
lands and New
Zealand).
There
are several
options
for the second tier: a
publicly organized
defined
benefit
pension,
which
may
be
integrated
with the first-tier
contributory
pension
(the
United
States)
or
operated separately (France, Germany,
and
Sweden);
a notional defined-contribution
pension system (Sweden);
an
administratively cheap savings plan
with access to annuities
(for example,
the Thrift
Savings
Plan in the United
States); mandatory occupational
funded
defined-benefit
pensions
(this
is the de facto
system
in the
Netherlands);
or
funded defined-contribution
pensions
(Chile, Sweden),
possibly including
an
anti-poverty
element
(Mexico).14
As in the case of the
developing country,
the third tier
comprises
volun
tary
pensions
at the level of the firm or the
individual;
any
tax benefits should be
designed
to avoid excessive
regressivity.
Finally,
for an effective
pension system,
two
things
matters above all:
effective
government
and
output growth.
These factors
are
simple
to
identify
but difficult to achieve. An effective
government
will
manage
a PAYG
sys
tem
responsibly,
and it will create the macroeconomic and
regulatory stability
within which funded schemes can flourish. In
contrast,
ineffective
govern
ments are
prone
to make
irresponsible
PAYG
promises
and to
pursue policies
leading
to macroeconomic
instability.
Robust
output growth, by relaxing
resource
constraints,
makes it easier to realize the
plans
of both workers and
pensioners.
14. The
system
in the Netherlands is now
moving
more toward a defined-contribution
arrangement.
Comment
Eduardo
Engel:
This
paper provides
a masterful
primer
on the economics of
pensions.1
Barr and Diamond also cover the
shortcomings
of
arguments
for
privatizing pensions
in Latin
America,
as well as
problems
that were not
envisioned at the time of reform. I
organized
a
lecture on
pensions
in the
undergraduate
course I teach at Yale on economic
policy
in Latin America
based
on
this
paper,
and it worked
very
well. In these
comments,
I
provide
additional evidence
illustrating
the
paper's
main
points
and discuss issues on
which I differ.
Among
the
latter,
I
argue
that
political economy
considera
tions
may temper
some of the
paper's policy
recommendations.
Promise
A
pension system
based on individual accounts as
part
of a
fully
funded
system
was introduced in Chile in 1981.
Argentina,
Bolivia, Colombia,
Costa
Rica,
the Dominican
Republic,
El
Salvador, Mexico,
Peru,
and
Uruguay
introduced similar
systems
in the decades that
followed,
sometimes as one of
many
options
and in other cases as the main or
only
option
available for new entrants to the labor force.2
Four main
arguments
for the Chilean
pension
reform were
given
in the
early
1980s.
First,
providing
well-defined
ownership rights
reduces the risk
of
opportunistic
behavior aimed at
obtaining
a
larger
share of accumulated
funds and current taxes destined to finance
pensions.
Both advocates and
detractors of the Chilean reform
provided ample
evidence that the old
system
was
plagued by blatantly
unfair and
corrupt practices.3
Second,
competition
1. I thank Eduardo
Bitran,
Ronald
Fischer,
Eduardo
Lora,
and Claudio Raddatz for com
ments and
suggestions.
2. Arenas and
Mesa-Lago (2006).
3. Arellano
(1985);
Pinera
(1991).
16
ECONOMIA,
Fall 2010
among pension providers
would lead to better service and
higher
returns on
savings, translating
into
higher pensions.
A third
argument, closely
related to
the first
one,
was that the new
system
would foster sounder
public
finances
by reducing
the burden on the
government
budget imposed by
the
partially
unfunded
systems
in
place
at the time. Jose
Pinera,
labor minister at the time
of the Chilean
reform,
went so
far as to claim that the fiscal cost of the reform
would be zero.4
Finally, many arguments
were
presented linking
a
system
based
on
individual accounts to the
development
and
deepening
of financial
markets.
Experience
As is so
often the case with economic
reforms,
the benefits are oversold and
a number of
problems
are not
anticipated.
The transition from a
system
with
defined benefits to one
with defined contributions based on
individual
accounts
evidently
has a cost for
public
finances. Taxes must finance
pen
sions for those
belonging
to the old
system
for
a
period lasting many decades,
with no recourse to social
security
contributions from workers
entering
the
new
system. Only
a
comparison
of
steady
states that
ignores
the transition
costs involves no fiscal cost.5
The
analysis by
Barr and Diamond also
tempers
the enthusiasm for
pen
sion
systems
based on
individual accounts as a means to
develop
financial
markets. I do not have
space
to address the debate on whether
pension
reform fosters the
development
and
deepening
of financial markets.6 The
potential
is
there,
especially
for countries that
privatized publicly
held utili
ties
concomitantly
with
reforming pensions,
since the
long-term financing
needs of
privatized
utilities match the
pension
fund
managers'
demand for
long-term
assets.
Nonetheless,
the
challenges
faced when
addressing
this
question empirically
based on
aggregate
evidence are
large,
since other
4. "20
respuestas
acerca de la
prevision
dio ministro
Pinera,"
El
Mercurio,
15 November
1980, p.
Al.
5. The
present
discounted value of
government
outlays
will also be
higher
with reform than
without
reform,
since the transition from the
partly
unfunded defined-benefits
system
to the
fully
funded
system
with individual accounts is the converse of the well
known result
according
to which
introducing
social
security
constitutes a Pareto
improvement
(Samuelson, 1958).
6. See Raddatz and Schmukler
(2005)
for a
good summary
of the main issues and references.
reforms coincided with
pension
reform in
many countries,
making
identifi
cation close to
impossible.7
A more
promising
route to
study
the
impact
of
pension
reform on
financial
markets is to use
microeconomic data to test
specific
channels for
potentially
beneficial effects. Raddatz and Schmukler
provide
an
interesting example
along
these lines.8
They
look at investment
strategies by
Chilean
pension
fund
managers
and find that
they mainly
hold bank
deposits, government
paper,
and short-term
assets;
that
they
tend to hold similar
portfolios
and fol
low momentum
trading strategies;
and that
they
do not
actively
trade the
assets
they
hold. All of this
suggests
that even if
pension
funds
helped
create
markets for
long-term
instruments,
as
they
most
likely
did,
they
did not con
tribute to
making
these markets
particularly liquid.
Raddatz and Schmukler
conclude that the observed investment
patterns
are not consistent "with the
initial
expectations
that
pension
funds would be a
dynamic
force
stimulating
the overall
development
of
capital
markets,
especially
that of
secondary
trad
ing
markets."9
Competition
The
advantages expected
from
competition
did not materialize. As noted
by
Barr and
Diamond,
the economics of information and behavioral economics
both
help explain why.
For
example,
95
percent
of account holders of Chile's
private pension providers
do not know the administrative
charges they pay,
despite
the fact that
they
receive
quarterly
statements
containing
these
charges
and that this is the main determinant of differences in returns across
pension
funds.10 It is therefore not
surprising
that
competition
among providers
has
been
weak,
leading
to
average
annual returns on
capital
for these
companies
that are
many
times those obtained
by
assets
facing
similar risk
profiles
else
where in the
economy.
For
example,
the
average
annual return of
pension
administrators in 1998-2003
was 53
percent,
which is four times
larger
than
normal returns.11
Despite
such
high
returns,
no new firm entered the
industry
7. For
example,
Morande
(1998) argues
that Chile's
high growth period beginning
in 1985
is
explained by
increased
savings
that resulted from
pension
reform.
8. Raddatz and Schmukler
(2005).
9. Raddatz and Schmukler
(2005, p. 7).
10. Berstein and Ruiz
(2004).
11. Valdes-Prieto and Marinovic
(2005).
18
ECONOMIA,
Fall 2010
between 1998 and
2010,
when the
system
was reformed to introduce
more
competition
(see below).
Interestingly, well-designed competition for
the field can be a
good
surro
gate
when
competition
in the field does not work
properly.12
Private
pension
markets
provide
an excellent illustration of this
powerful
idea. In
February
2009,
the Chilean
government
auctioned the individual accounts of all work
ers
entering
the labor market over a
two-year period,
with the accounts
being
awarded to the
pension provider bidding
the lowest fees. If an incumbent
won
the auction with a bid lower than the fees it
charged existing
customers,
it had
to
pass
on the reduction in
charges
to all customers. Workers
assigned
to the
winner
are free to move to another
provider
if
they
so desire.
The winner of the auction offered
a commission 16
percent
below the low
est commission in the market.
Furthermore,
the winner was new to the indus
try,
the first entrant in more than
a decade.
Having
a Demsetz auction lowers
entry
costs
significantly,
since
new firms can count on a
sufficiently large
number of clients
(approximately
7
percent
of the market in the Chilean
case)
to
operate
at an efficient scale without
having
to invest in
marketing. Despite
the fact that incumbent
pension providers
lobbied
strongly against
the auc
tion and succeeded in
watering
down the extent to which it reduced
entry
costs,
the outcome is
promising
and
may
lead to
significant
fee reductions in
years
to come.
Administrative Costs
Arellano was one of the first to
point
out the
high
administrative costs of the
Chilean
pension system.13
In
general,
the administrative costs of
private
investment funds in Latin America are
high.
As of December
2002,
fees as a
percentage
of total contributions
were are follows:
Argentina,
36.2
percent;
Chile,
15.0
percent;
Colombia,
14.0
percent;
El
Salvador,
12.5
percent;
Peru,
22.1
percent;
and
Uruguay,
13.5
percent.14
Bolivia is the one
exception,
with
administrative fees of
only
4.8
percent
of total contributions.
Why
are admin
istrative costs so much lower in Bolivia? Bolivia learned from the Chilean
experience
and used a Demsetz auction to reduce administrative costs
by
two
thirds. Instead of
allowing
free
entry,
Bolivia
opted
for two
pension providers
12. Chadwick
(1859);
Demsetz
(1968).
13. Arellano
(1985).
See also Diamond and Valdes-Prieto
(1994).
14. Barr and Diamond
(2008,
table
9.2, p. 166).
selected via
competitive bidding
based on the lowest
average monthly
admin
istrative
charges.15
Pensions and the Political
Economy
of Deficits
Unsustainable
public
deficits
played
a
major
role in most of the economic
crises that took
place
in Latin America in the second half of the twentieth cen
tury.
Governments
routinely
monetized their
deficits,
which time and
again
resulted in
major
recessions and economic and
political
crises.
Things
have
improved
in the last two
decades,
and inflation has been
considerably
lower
thanks to various institutional
reforms,
including
the creation of autonomous
central banks.
Nonetheless,
improving
fiscal institutions continues to be a
high priority
in
the
region.
For
example,
the second-most
promising policy proposal
for Latin
America,
according
to the Consulta de San
Jose,
is
improving
fiscal rules:
"Consolidating
the
budget process through procedural
rules that would set
structural deficit
targets,
limit
deficits,
spending,
and debt
levels,
and increase
budget transparency
would
help
avoid
insolvency
and excess
spending
in
good
times. At a low
cost,
this could
potentially
increase nations'
growth
rate
substantially."16 Underlying
the Consulta de San Jose's
proposal
is the fact
that the
temporal profile
of
government expenditure
is far from
optimal
in
most countries in Latin
America,
with
highly procyclical
fiscal
policy.17
This
is further
compounded
in some cases
by
a level of
expenditure
that continues
to be too
high.
For
example,
Brazil's chronic
high
interest rates have been
diagnosed
as the main factor
holding
the
country
back.
Underlying
these
high
rates are
overly generous pensions
and
high public
debt.18
15. Ban* and Diamond mention the
very
low administrative costs of the U.S. Thrift
Savings
Plan,
which are 0.6
percent
of
average
account balances. A
comparison
with the costs of
pen
sion administrators in Latin America is not
straightforward,
however,
since commissions are
generally
a
percentage
of contributions instead of
balances,
and
any comparison requires
mak
ing
allowances for differences in both labor costs and
average
balances across countries.
16.
Lomborg (2009, p. xxvii),
The Consulta de San Jose is an
expert panel
of nine distin
guished
economists
(namely,
Orazio
Attanasio,
Jere
Behrman,
Nancy
Birdsall,
John H.
Coatsworth,
Ricardo
Hausmann,
Finn E.
Kydland,
Nora
Lustig,
Jose Antonio
Ocampo,
and
Andres
Velasco)
who met in San
Jose,
Costa
Rica,
in October 2007 to assess more than
forty
solutions to the
biggest challenges facing
Latin America and the Caribbean. See
Lomborg (2009)
for details.
17. Gavin and Perotti
(1997);
Ilzetzki and
Vegh (2008).
18. Hausmann
(2008).
See also "Lula's
Legacy,"
The
Economist,
30
September
2010.
20
ECONOMIA,
Fall 2010
Understanding
the
political
economy
of
pensions
and its
impact
on the
level and
dynamics
of
government
debt remains
an
important
research
ques
tion for Latin America.
Policymakers
across a
broad
political spectrum
agreed, by
the late
1960s,
that the
pay-as-you-go pension systems
in
place
in
Latin America at the time were an
important
cause for chronic
government
deficits and inflation. Insufficient
government savings
combined with a ratchet
effect
on debt led to
higher
and
higher
deficits. A
pension system
based on
individual accounts was a
promising
idea to break this vicious
cycle.
The
argument
was that
clearly
defined
property rights
would create a
majority
of
voters
opposed
to
government expropriations
of resources set aside to finance
future
pensions.
Argentina's
nationalization of
private pension
funds in late 2008
provides
an
interesting
test for this
argument.19
Since
only
a
minority
of workers were
affiliated with the
private system
in
Argentina,
the median voter is
likely
to
have been in the
public system.
This
may explain why
there were
limited
protests
when the
government
of Christina Fernandez decided to use
private
pension
assets to finance current
spending
in the face of the international
financial crisis of 2008
(and
upcoming elections).
Looking
forward,
some
interesting
lessons
emerge
for countries that want
to maintain a
system
based on individual
accounts,
aimed at
making
it harder
for the
government
to
expropriate
the
private pension
funds.
First,
expropri
ation should be less
likely
when the reformed
pension system
is
mandatory,
at least for new entrants into the labor force.
Second,
to
keep
most funds out
of reach of the
government,
fund assets should be held abroad. This
stipula
tion does not
preclude
the
pension system
from
helping
fund domestic
firms,
as
they may
be
allowed,
for
example,
to
buy
American
Depositary Receipts
(ADR)
of local stock traded in the United States.20
Barr and Diamond's
argument
in favor of notional defined-contribution
(NDC) systems
is somewhat weakened once
political economy
considera
tions are
incorporated.
It is true that an
NDC
system
combines individual
19. Additional
examples
include the recent nationalization of assets held
by private pension
funds in Bolivia and
Hungary.
The law enacted
by
Bolivia in December of 2010 also lowers the
country's
retirement
age
to
58,
which
goes against
the trend to have
people
work
longer
due to
rising
life
expectancies.
This
change
raises doubts about the health of the
country's
medium
term
public
finances.
20. Lora
(2004) proposes
an alternative
design,
with an
important
role for international
financial
institutions,
aimed at
achieving
the same
objective.
accounts with low administrative
costs,
while
avoiding
a
substantial share of
the risks associated with short-term
capital
market
fluctuations,
which are a
concern
under the Chilean
system.
However,
the
political
risks associated
with
having
a notional interest rate that is set on an
annual basis can be con
siderable. This rate
may
end
up being negative
if the
government
decides to
use the accumulated funds to finance current
expenditures,
or it
may
rise far
above the
optimal
level should the incumbent
government
believe this bene
fits its reelection
prospects.
My
criticism of Barr and Diamond for not
incorporating political economy
considerations is
unfair,
since their
paper
is about the economics of
pensions,
not the related
political
economy.
Their choice is further
justified by
the fact
that the tools needed to
compare
the
political economy
of alternative
pension
systems
are less
developed
than those
necessary
to
compare
their economic
implications.
Nonetheless,
it
may
be too
strong
to state the choice
among sys
tems "should be
economic,
not
primarily political."
All of this
highlights
the
need for more research
on the
political economy
of
pension systems.
Concluding
Remarks
The
proponents
of
any major
economic reform will tend to oversell it to the
public.
Barr and Diamond remind
us
that
pension
reform in Latin America
was no
exception,
when
they
conclude that "the
litany
of funded schemes that
have failed
completely
or
that have not lived
up
to the
promises
that were
made for them attests to
...
the
dangers
of
basing policy
on
...
excessively
optimistic predictions."
Their
analysis
of
pension systems
based
on eco
nomic fundamentals
helps
avoid the
narrow discussion that often character
izes debates of these issues in Latin America.
Thus,
for
example,
the obvious
fact that individual accounts do not include
a
poverty
relief
component
is well
summarized when
they
state that "unless
accompanied by
a robust
system
of
poverty
relief,
individual accounts do not constitute a
pension system,
but
only part
of
a
pension system."
Their
description
of the Chilean
pension
reform of
2008,
which
incorporated
a
significant poverty
relief
component
while
maintaining
a
central role for individual
accounts,
also contains
impor
tant lessons for countries
throughout
the
region.21
21. See also the
chapter they
dedicate to this reform in Barr and Diamond
(2008).
22
ECONOMIA,
Fall 2010
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