INTRODUCTION
Labor
market reform includes a wide range of issues aimed at increasing
competitiveness, boosting productivity, and improving the lives of the labor
force (Lusinyan & Muir, 2013).
However, no issue has been more important than ensuring that the pension system
delivers on its promises. This has been a key issue for the labor force,
continue to be to live gracefully after retirement. Countries around the world have tried to improve their pension systems (Whitehouse et al., 2009).
Some have privatized it to make it more efficient and less taxing on the public
sector (Grech, 2018).
Some have continued to put more resources on their public sector pension
systems to make it more comprehensive and accessible, though with levying
higher taxes and social contributions on the active labor force and companies (Borzutzky & Hyde, 2016; Grech, 2018).
There are also countries who have blended public and private sector pension
system with the hope of benefiting from both systems’ advantages and mitigate
negative spillovers.
This
paper tries to look at the different pension system around the world and to
give an assessment of their effectiveness. Using a simple model, it tries to
show the relationship between the type of pension system and its success. The
paper then introduces the results of some simple pension reform simulations and
discusses policy recommendations. The paper concludes with a brief discussion
of its findings. Four annexes at the end go deeper into the stylized facts and
model results.
METHOD
The qualitative
approach method case report study is used in this study. The researcher will
gain specific expertise or insight into the issue they have chosen to
investigate, which is usually a current one, by using case study research. Case
study research allows the researcher to investigate the phenomenon in its
context. Case studies are empirical investigations in the sense that they are
based on knowledge and experience, or, to put it another way, they entail data
collection and analysis (Creswell & Poth, 2016). This study also
included a review of the literature. A literature review article provides a
comprehensive assessment of relevant literature and instantiates prior studies
to construct a knowledge framework (Paul & Criado, 2020). The theoretical
framework for the study is provided by the literature review.
RESULTS AND DISCUSSION
Countries
around the world have made different choices about how to meet the retirement
needs of their populations. Some have chosen to finance
their retirement incomes largely by contributions or taxes, in pay-as-you-go
(PAYG) systems. Others have relied on mandatory private savings to fund
retirement income (Barr & Diamond, 2008). The
public sector approach is called the first pillar, whereas the private sector
approach is called the second pillar (Chibba, 2009).
The
two pillars are part of a larger five-pillar pension framework outlined by the
World Bank. Broadly, the five pillars are
a) Zero
pillar – Non-contributory schemes designed to ensure pensioners receive some
absolute, minimum standard of living.
b) First
pillar – Public mandatory earnings-based schemes designed to replace some
portion of pre-retirement income. They are typically financed on a PAYG basis.
c) Second
pillar – Private mandatory savings-based schemes designed to achieve some
target standard of living in retirement. They could be partially or fully
funded, defined contribution (DC) or defined benefit (DB) plans, offered
directly to workers (personal) or via employers (occupational).
d) Third
pillar – Private voluntary savings-based schemes designed to provide
discretionary and flexible income replacement options. As with second pillar
schemes, there are a wide variety of design options observed across countries.
e) Fourth
pillar – Non-financial schemes designed to provide informal support or other
social programs such as healthcare and housing.
Figure
1 categorizes mandatory pension systems according to pension pillars. Most countries –
approximately 77 percent of countries – rely on mandatory public pension
systems or Pillar I to fund retirement incomes. They range from emerging
countries such as Nepal and Vietnam, to large economies like China and India,
to advanced countries such as France, Germany, Canada, and the United States.
Six percent of countries, including Australia, Iceland, and Chile, rely
primarily on mandatory private pension savings or Pillar II. In 18 percent of
countries, such as Croatia, the Netherlands, and Mexico, both public and
private mandatory pension systems co-exist side-by-side.
Figure 1. Categorization of Pension Systems by Country
Figure 2 does not show Pillar III pension
systems where they are widely adopted in countries, for example 401(k) pension
plans in the United States. Source: World Bank International Patterns of
Pension Provision II (2012). Comparing these diverse pension systems requires
an objective benchmark for assessing performance. The World Bank’s handbook on
outcomes-based assessment for private pensions provides such a benchmark for
evaluating pension systems (Price, Ashcroft, et al., 2016). The
framework defines five desirable outcomes of a pension system: sustainability,
adequacy, coverage, security, and efficiency (Price, Rawlins, et al., 2016).
a) Sustainability
– A pension system must be able to meet its financing obligations without
imposing undue burden on the government, employers, or workers. This tends to
be a challenge for countries with rapidly ageing and shrinking populations
given their impact on the fiscal sustainability of tax- or contribution-based
pension systems.
b) Adequacy
– Pension benefits should protect the population from a severe drop in living
standards at retirement.
c) Coverage
– A successful pension system maximizes the proportion of retirees receiving
financial support at retirement.
d) Security
– Pension systems should minimize the risk of losing or misappropriating funds
before benefits are delivered. This could happen, for example, due to poor
returns to investment or expropriation by governments or employers.
e) Efficiency
– This outcome relates not just to optimal investment strategies and cost
structures, but also to the deepening of domestic capital markets and the
minimization of labor market distortions.
A. Stylized
facts and modeling
This
section presents some stylized facts and the results of the modeling exercise.
With the discussion of the previous section in mind, it
seems that countries reliant on Pillar II pensions tend to have more
sustainable, secure, and efficient pension systems without compromising on
adequacy and coverage. Figure 2 compares pension systems according to each
of these outcomes-based indicators. Panel A shows negative relationship between
replacement rates from the first and second pillar and lower public pension
expenditure as a share of Gross Domestic Product (GDP) for countries more
reliant on Pillar II. The figures suggest that Pillar II pensions reduce the
need for Pillar I pensions, which in turn lowers the fiscal burden on
governments to fund pensions. Panel B shows total mandatory replacement rate
and the number of pension beneficiaries as a share of a country’s population
aged 65 and above plotted against a country’s reliance on Pillar II. The
horizontal trend line suggest that adequacy and coverage do not vary
systematically by funding source. Panel C shows that pension system that rely
more on Pillar II tend to have more assets backing pension claims, as measured
by the value of total pension assets as a share of GDP. Furthermore, the size
of a country’s pension assets is positively correlated with its investment
returns.
Panel A
Panel
B
Panel C
Figure
3.
Pension system outcomes across 26 OECD countries (excluding countries with
substantial Pillar III pension systems). Values in parenthesis represents
standard errors, significance: ***1%, **5%, *10%.
Source: OECD Pensions
at a Glance 2017, author’s calculations
However, there is no indication that countries with more
successful pension systems rely more heavily on Pillar II pension systems.
Table 1 compares the outcomes of pension systems across countries with Pillar
II pensions. Each outcome is proxied by a measurable pension indicator. For
example, sustainability is proxied by public pension expenditure as a share of
GDP, where a country with lower public expenditure to GDP scores higher for
sustainability. Adequacy is proxied by the total mandatory replacement rate,
coverage by the number of pension beneficiaries as a share of old- age
population, efficiency by the five-year average real return on total pension
assets, and security as the size of total pension assets as a share of GDP. A
country is individually ranked on each measure, and an overall equally weighted
aggregate score is constructed from these ranks. From the scores of each
country, it is not obvious that countries that do the best tend to have higher
Pillar II replacement rates. For example, Sweden and Iceland have identical
scores but Sweden relies less on Pillar II to fund pension benefits. The
Netherlands comes up top as having the best pension system among comparable
countries. The country has also been proposed as having the best pension system
by the Melbourne Mercer Global Pension Index in 2018.
Table 1
Comparison of pension system outcomes across
12 OECD countries and Croatia. Average score is constructed as equally-weighted
average of the inverse-rank for each outcome
|
Sustainability
|
Adequacy
|
Coverage
|
Efficiency
|
Security
|
|
|
|
Country
|
Public Pension Expenditure/
GDP
(%)
|
Total Mandatory Replacement Rate
(%)
|
Pension Beneficiaries/
Population Age 65+
(%)
|
5-year Average Real Return, 2012-2016
(%)
|
Total Pension Asset/
GDP
(%)
|
Average Score
(out of 10)
|
Pillar II Replacement Rate
(%)
|
|
Netherlands
|
5.4
|
96.9
|
109.7
|
6.7
|
180.3
|
8.2
|
68
|
|
Sweden
|
7.7
|
55.8
|
185.6
|
6.5
|
110.1
|
6.6
|
19
|
|
Iceland
|
2.0
|
69.0
|
72.4
|
5.2
|
150.7
|
6.6
|
66
|
|
Australia
|
4.3
|
32.2
|
114.2
|
5.8
|
131.2
|
6.3
|
32
|
|
Israel
|
4.9
|
67.8
|
83.7
|
6.0
|
55.7
|
6.0
|
48
|
|
Denmark
|
8.0
|
86.4
|
104.2
|
5.1
|
209.0
|
5.8
|
72
|
|
Switzerland
|
6.4
|
42.1
|
103.6
|
5.3
|
141.6
|
5.2
|
18
|
|
Croatia
|
6.9
|
32.0
|
152.6
|
5.7
|
26.0
|
4.9
|
3
|
|
Norway
|
5.8
|
45.1
|
111.4
|
4.6
|
17.1
|
4.6
|
6
|
|
Estonia
|
6.4
|
49.7
|
137.7
|
3.2
|
16.4
|
4.3
|
21
|
|
Chile
|
3.0
|
33.5
|
83.0
|
3.9
|
73.2
|
4.3
|
34
|
|
Slovak Republic
|
7.2
|
64.3
|
133.8
|
1.7
|
11.2
|
3.7
|
25
|
|
Mexico
|
2.3
|
26.4
|
101.0
|
2.3
|
16.8
|
3.4
|
22
|
Source: OECD Pensions at a Glance 2017, OECD, OECD Pension
Markets in Focus 2017, author’s calculations.
A
fiscally sustainable solution to the pension adequacy problem will most likely
involve ambitious labor market reforms to increase labor participation rates (Clements et al., 2014).
For example, it has been argued that
increasing labor force participation rates is the most effective policy
intervention for alleviating demographic pressures in Central and Eastern
European countries (Bloom et al., 2003; Jaumotte, 2004). In
turn, this would allow Pillar II contribution rates to be increased without
raising Pillar I pension deficits. In fact, the 2019 IMF report considers two
labor market reform packages that accompany an increase in the overall pension
replacement rates to 40 percent:
1) A
relatively moderate reform scenario assumes moderately paced increases in the
labor force participation rates of young women (age 25-45) to the highest EU
levels, an increase in the participation rate of older workers (age 55+) from
59.5 to 82 percent for men and from 52.5 to 64.8 percent for women by 2050, and
retirement age increases in line with life expectancy but not higher than 67.
2) An
ambitious reform scenario assumes rapid increases in the labor force
participation rates of young women to the highest EU levels, an increase in the
participation rate of older workers to 86.1 percent for men and 78.1 percent
for women by 2050 and raising the retirement age above 70 by 2050.
Figure 3. Impact of reforms on pension costs
Source: IMF
Demographic Headwinds in Central and Eastern Europe 2019.
Figure 3 compares the fiscal cost savings from
the labor market reform scenarios with the fiscal cost increase from raising
pension replacement rates. For example, raising pension replacement rate to 40
percent is estimated to increase fiscal costs of pensions in Croatia by 4.5
percent of GDP.
B. Policy
implications
There are important steps that need to be
taken for a successful pension reform. First, moderate labor market reforms would help offset a
quarter of the projected increases in pension costs. Ambitious labor market
reforms, on the other hand, will offset almost all the projected increase in
pension outlays (Batog et al., 2019).
Second, additional fiscal space would also need to be preserved for measures to
increase labor market participation rates. For example, providing tax
incentives for hiring older workers could lower labor costs for firms and boost
job creation, but would lead to revenue losses (Pagés, 2017).
Increased participation of older workers could also generate additional demand
for health care services. Finally, active labor market policies such as
training, job creation programs, or extended childcare services to increase
female labor force participation would also have budgetary effects.
Countries
could consider measures undertaken to encourage participation rates.
1) Fostering
older workers’ participation
Provide
stronger incentives for employing older workers, as done in Romania, and
delaying retirement, as implemented in Russia. Policies that link retirement
ages to life expectancies and reduce early retirement benefits can also boost
participation rates among older workers.
2) Improving
female labor participation
Expand
childcare services, as done in Hungary, and promote flexible and temporary
employment, as done in Turkey. To this end, authorities should also consider
undertaking active labor market policies to provide career guidance and support
re-entry in the labor force for women with extended employment gaps due to
childcare priorities.
CONCLUSION
Having
a financially secure retirement age brings a peace of mind for labor forces.
Countries around the world have made different choices about how to meet the
retirement needs of their populations. Most countries – approximately 77
percent of countries – rely on mandatory public pension systems or Pillar I.
However, it seems that countries reliant on Pillar II pensions tend to have
more sustainable, secure, and efficient pension systems without compromising on
adequacy and coverage. A fiscally sustainable solution to the pension adequacy
problem will most likely involve ambitious labor market reforms to increase
labor participation rates. There are important steps that need to be taken for
a successful pension reform. Firstly, moderate labor market reforms would help
offset a quarter of the projected increases in pension costs. Secondly,
additional fiscal space would also need to be preserved for measures to
increase labor market participation rates. Finally, active labor market
policies such as training, job creation programs, or extended childcare
services to increase female labor force participation would also have budgetary
effects.
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