The Future of Pension Reform in Latin America

AuthorDavid de Ferranti, Danny Leipziger, and P.S. Srinivas
PositionVice President of the World Bank's Latin America and Caribbean Regional Office/Director for Finance, Private Sector, and Infrastructure in the Region

    The Latin American countries are at the vanguard of global pension reform. Eight have reformed their pension systems in the past 20 years, and additional reforms are now being considered throughout the region. Did the earlier reforms work? What should new reforms aim for? And are the ideas driving the reforms sound?

Public pension systems in many developed countries face crises that are due largely to demographic factors-retiring baby boomers, shrinking working-age populations, and lengthening life spans. Public pension systems in many developing countries, including those in Latin America, also face crises. In these countries, though, while demographics do play a role, the principal problem is that benefits under the old publicly managed, defined-benefit, pay-as-you-go systems were disproportionately generous relative to contributions, encouraging early retirement and discouraging labor force mobility. The only options open to policymakers for sustaining these systems were to substantially raise taxes or cut benefits-neither of which was politically feasible.

Some Latin American countries therefore undertook systemic reforms. Although reforms differed across countries, most countries jettisoned all or a significant part of their public social security systems in favor of privately managed, individual-account-based, defined-contribution, funded systems (similar to the 401(k) plans in the United States, with the added twist that they are mandatory) largely along the lines suggested in Averting the Old Age Crisis, a study published by the World Bank in 1994. The new systems were supposed to improve sustainability, ease fiscal pressures, reduce old-age poverty, and strengthen financial markets-all of which were expected to stimulate economic growth.

The reformed systems have had impressive beginnings in terms of the volume of assets under the management of the private pension funds, gross returns, and number of participants (Table 1). Some analysts report that the benefits of the reforms have included lower implicit debt-to-GDP ratios, higher participation rates in terms of affiliates to the new systems, and increased equity in terms of rates of return on pension contributions obtained by participants across wage profiles and genders. Private pension funds-because of their large size relative to the overall economy-have also been driving financial sector reforms. While each country's experience is different, many of these benefits, as well as the question of whether the new regimes represent a net improvement over the old systems, are still very much a subject of debate.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Although there has been little criticism in Latin America of the decision to abandon the public systems-surprisingly, given the raging debate on the same issue in the developed world-the new private defined-contribution systems have come in for a fair amount of criticism, particularly in four areas: coverage, fund performance, governance, and fiscal costs. These criticisms have reignited the debate about the various approaches to pension reform. But the lack of information-or the misinformation-about pension systems has sometimes impeded a balanced assessment of these approaches. In reviewing the criticisms of Latin America's reformed pension systems, we hope to clarify some of the misconceptions associated with pension reform.

Coverage

There is a concern that Latin America's private pension systems, given their limited coverage, may not be able to achieve the stated goal of broad-based reduction of old-age poverty. These systems are mostly accessible only to formal sector workers, and only a fraction of these actually contribute, even though many workers are affiliated with the new systems. Therefore, many Latin Americans are still not covered by a formal system of retirement income security. At present, about one-third, on average, of the countries' economically active population is covered. In the two decades since Chile reformed its system, coverage in that country has barely increased...

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