Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth

Averting describes the World Bank's current thinking on how developed and developing countries can sustain economic progress in the face of the 'crisis' of ageing populations.  Its focus is pensions policy: designing policies which are redistributive while minimising the adverse effects on economic growth of high tax burdens and future public spending promises.  There are three problems with pension provision. First, the 'chain-letter' nature of pay-as-you-go social security is leading to unsustainable commitments.  In some countries, a downward spiral has arisen from attempts to maintain excessive initial returns on pension schemes across generations in the face of adverse demographic trends.   Higher pension taxes, payroll tax evasion and increasing scheme indebtedness result.  In a number of countries, pension scheme's debt exceeds the value of other government debt.  Secondly, there is the incentive within both social security programmes and private, final-salary, 'defined-benefit' schemes to use early retirement as a means of unravelling lifetime employment commitments.  With greater longevity, there are some countries in the world where periods of pensioned retirement are beginning to exceed the length of the working life.  This puts pressure on funded pension scheme finances, let alone those of unfunded (pay-as-you-go) schemes.  Finally, there is the alleged deleterious effect of public pension commitments on private savings rates.  But the Bank never clearly states either why high savings rates are important; after all, in standard models with ageing populations, a cut in the capital stock may be optimal. Accepting the broad thrust of the bank's policy agenda, there is the important issue of heterogeneity of pension provision across countries.  The basis of the Bank's generic pension reform package is the so-called 'three-pillar' approach: a first pillar of a mandatory state minimum pension (which might be income-tested, but not earnings-related); a second mandatory pillar of privately provided pensions from company defined-benefit plans or retirement savings accounts, held individually or group provided.  The third pillar would be voluntary through other forms of savings (typically defined-contribution schemes).For many countries, this 'ideal' represents a radical departure from existing practice, with much greater emphasis on private provision and funding, exploiting international capital markets to a greater extent than traditional 'provident' funds, and a significant downgrading of state, earnings-related provisions.  The Bank's proposals are clearly influenced by Latin American reforms, notably Chile. A good deal of attention is paid to the 'double burden' imposed on a single generation when switching from pay-as-you-go to full funding.     The defined-contribution environment needs careful domestic regulation from the outset, such as scheme would have the added attraction for many countries