Social Security Reform in Advanced Countries
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Social Security Reform in Advanced Countries

Toshihiro Ihori, Toshiaki Tachibanaki

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eBook - ePub

Social Security Reform in Advanced Countries

Toshihiro Ihori, Toshiaki Tachibanaki

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Increasingly ageing populations and a slowing rate of growth in the macroeconomy are forcing advanced countries to reconsider their social security programmes. The need for detailed examination of the possible reforms and initiatives has never been greater.This book brings together internationally-renowned scholars to evaluate the effect of recent

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Publisher
Routledge
Year
2002
ISBN
9781134457762
Edition
1
1 Introduction
Toshihiro Ihori and Toshiaki Tachibanaki
1.1 Reason for this book
A large number of advanced countries have problems with their social security systems, in particular public pension systems. One of the most important causes of this problem is that many countries face an ageing trend in age–population structure. The number of people who contribute financially to the system is decreasing. The problem is serious particularly when the system is either a pay-as you-go scheme or an unfunded scheme.
There are, of course, several other factors such as the decrease in the participation of men in the labour force, the slow increase in female participation, the policy of early retirement to offset youth unemployment, which cause serious problems in social security. In several industrialized countries the following can be added: the weak performance in the macroeconomy which reduces the amount of contributions, and the low rate of interest which lowers the rate of return on asset management.
There are several studies which show projections of the fiscal liabilities of public pensions programmes and serious financial deficits, and present incapabilities of paying a sufficient amount of pension benefits continuously, when the current pay-as-you-go or the unfunded scheme is kept below the ageing trend. See, for example, OECD (1996) and Disney (2000) for advanced countries, specifically the OECD countries. If we look at studies for particular individual countries, we should be looking at an extremely large field.
Many countries contemplate policy reforms to modify public pension systems in order that the government can sustain the system without reducing the benefit level drastically and/or increasing the contributions level considerably.
Several countries have contemplated such reforms, and other countries have already finished implementing them. This book intends to investigate reasons for introducing policy reform, and outcomes derived from its introduction. The method for investigating these issues is both theoretical and empirical.
‘Theoretical’ implies that an evaluation is made by theoretical papers based on both efficiency and equity grounds. Efficiency means economic efficiency such as optimal resource allocation, higher economic growth, lower cost performance, while equity means that income is distributed without producing both desperately poor people and extremely rich people. ‘Empirical’ implies that an evaluation is made by empirical models which propose policy reforms for a particular country, and investigate the outcome induced by them.
Policy reforms in public pension programmes are not the only issues in advanced countries. A large number of developing countries also face serious problems. Several countries have committed themselves to drastic reforms. The famous example is the Chilean one which initiated privatization of social security, and then, several other South American countries followed Chile’s example regarding the privatization of social security. See, for example, Edwards and Edwards (1991). Even advanced countries have been influenced by similar privatization experiences.
This book is concerned only with advanced and industrialized countries for the following reasons. First, the social and economic conditions, and the degree of development in public pension programmes between developing countries and advanced countries are so different that it is difficult to put the case for policy reforms based on common concepts and implementation methods.
Second, old age pension programmes are not the only means of supporting income after retirement in developing countries, because families and other institutions support the economic life of the elderly in these countries. Families are crucial in these countries, particularly many Asian countries. Thus, we have to take into account the role of families and other arrangements, even when the role of public pension programmes is evaluated. In other words, investigating only public pensions gives only part of the story.
Third, political instability is frequently observed in these countries. One example was Chile where a drastic change in the political system enabled Chile to introduce privatization. A drastic reform in advanced and democratic countries may be difficult for implementation for various reasons.
The key concept which characterizes policy reform in advanced countries is the pay-as-you-go (unfunded) scheme versus the funded scheme. Retaining an unfunded component was called a ‘parametric’ reform strategy by Chand and Jaeger (1996), and a funded component is called an ‘actuarially fair’ system. Disney (2000) classified the latter into two parts: a ‘clean break’ privatization and a ‘partial’ privatization.
Disney separated the current reform strategies into four parts based on the above two classification criteria: (1) a parametric reform of the unfunded programme, (2) an actuarially fair unfunded programme, (3) clean break privatization, and (4) partial privatization.
The crucial distinction appears between unfunded schemes (normally defined benefit plan: DB plan) and funded schemes (normally defined contribution plan: DC plan), and a shift from the former to the latter is often proposed in order to solve the current social security problem. A further shift may be called privatization. We can see such strong propositions by many economists in the US such as Feldstein (1998), Kotlikoff (1996), Mitchell and Zeldes (1996), and others. This idea influenced economists in a large number of advanced countries, and the received wisdom is that a shift to fully funded is the best solution.
It is, nevertheless, important to note three different views in this received wisdom. First, several studies do not accept such a shift even in the US as given by Aaron (1999) and Diamon (1999), who prefer unfunded schemes. The reasons for disliking the funded scheme are that they are too high a risk on the rate of return and have high administration costs. Second, several European studies, in particular Continental European ones, also provide critical evaluations of funded schemes as shown by Boldrin, Dolado, Jimeno and Peracci (1999), and Miles and Timmermann (1999), for various reasons. Of course, there is non-negligible number of studies which prefer funded to unfunded schemes even in continental Europe. Third, we tend to ignore one idea and proposition in the discussion of financing social security, a shift from insurance financing to tax financing. Several authors propose that general tax revenues rather than social insurance contributions should be used to finance old-age pensions. In fact, there are several countries such as Canada, Denmark, and some others where general tax revenues are used to finance social security.
The present book attempts to investigate these controversial issues such as: (1) unfunded versus funded, (2) American (or Anglo-American) versus continental Europe, (3) the role of tax financing, which is common in many advanced countries. Several additional issues are, (4) the relationship between the labour supply of the elderly and penions benefits, (5) the risk aspect of pension fund and administration costs in managing funded scheme.
It is emphasized, again, that this book investigates these issues both theoretically and empirically. Theoretical chapters present useful propositions under reasonable assumptions and behavioural actions regarding the working of social security, and empirical ones show evaluations of policy reforms in social security on whether such reforms are useful or not for several countries. Suggestions for social security reforms are presented based on these theoretical and empirical works.
1.2 Summary of the content
The content of each chapter will be summarized below. Because the defined contribution (DC) pension model is as yet new to Japan, it is likely that the experience of other countries who have previously adopted this approach to pensions may be useful in designing the required investment and governance frameworks to support these plans. Chapter 2, which is written by Olivia S. Mitchell, intends to highlight global innovations in the design, structure, and governance of pensions, so as to emphasize those points that will require special attention in the Japanese context as the pension system continues to evolve. She first outlines the legacy of defined benefit plans and explains what has motivated the global transition to defined contribution pensions. This movement to DC plans occurred in two waves, with a first followed by a second wave of DC plan growth. This second phase was spurred on in the US by the passage of legislation allowing for the development of 401(k) pensions. She shows that these plans pose new challenges to the pension market, and to the government seeking to regulate them to ensure that they deliver a reasonable retirement income. She concludes with an overview of the most important governance and regulatory implications of the new pension model, lessons for Japan.
Chapter 3, which is written by Mats Persson, investigates five fallacies in the social security debate which are as follows:
1 The present problems in the social security systems are due to demography.
2 A pay-as-you-go system is inferior to a funded system since it has a lower rate of return.
3 In a riskless world, a low-return PAYG system is dominated by a high-return funded system.
4 The social security system is a suitable instrument for intergenerational risk sharing.
5 The government is a safe provider of social security.
He points out that the first step of a reform should be to make the benefit rules actuarial. After then, the gains from proceeding further, into a funded system, are not due to the fact such a system has a higher yield. The gift to the first PAYG generation has already been given, and a funded system cannot remove that cost. What we can accomplish by means of government debt management, is to shift it over the generations. The main reason for funding the system seems to be that it can thus be privatized. And the main reason for privatization is that of transparency and safety; competition will guarantee that the rules remain actuarial and the political risk may thus be reduced.
Chapter 4, which is written by Gary Burtless, surveys the relative advantages of public and private systems. More important, he assesses the financial market risks facing contributions in a private system based on individual retirement accounts. The first part of the chapter describes the difference between public and private systems and considers the main economic and political arguments for privatization. A principal claim is that private plans can provide better returns to contributors. If this were true, it seems appropriate to weigh possible risks associated with the improved returns. Some of the most important risks are those associated with financial market fluctuations. The second part of the chapter provides evidence for these risks by considering the hypothetical pensions US workers would have obtained between 1911 and 1999 if they had accumulated retirement savings in individual accounts. He shows that the financial market risks in a private retirement system are empirically quite large. Although some of these risks are also present in a public retirement system, a public system has one important advantage over private ones. Because a public system is supported by the taxing and borrowing authority of the state, it can spread risks over a much larger population of potential contributors and beneficiaries. This makes the risks more manageable for active and retired workers, many of whom have little ability to insure themselves privately against financial market risk.
Chapter 5, which is written by Hazel Bateman, Suzanne Doyle and John Piggott, addresses two important questions: administrative charges and payout design and market structure by drawing on Australian and Chilean experience. Their chapter also aims to relate to a generic economy in which private mandatory retirement provision is being implemented or considered. In 1992 Australia introduced the Superannuation Guarantee, the first private mandatory retirement saving policy in the English-speaking world. At that time the only country to have adopted a policy of this type was Chile, in 1981. Private mandatory policies require either employers or employees to invest some fraction of the employee’s wages with a private sector organization, with the aim of eventually helping to finance the employee’s retirement. Typically, these worker accumulations are defined contribution DC, fully funded, and kept in individual accounts. In the eight years since 1992 more than a dozen countries, mostly in Latin America and the transition economies of Central Europe, have either mandated private retirement provision or have stated their intention to reform their pension policies along these lines. Further, a number of developed countries have either reformed their pension systems in this direction (for example, the UK) or have debated doing so (the US). Rarely has a novel policy design spread so swiftly across disparate nations. This chapter suggests that administrative cost and retirement income stream policy will be critical areas of policy design within the mandatory private paradigm, and that this is borne out by Australian and international experience. It is these questions which have proved the most controversial in the policy debate, and which have been the most challenging in terms of policy design.
Chapter 6, which is written by Tatsuo Hatta and Noriyoshi Oguchi, investigates the plausibility of switching the Japanese social system from pay-as-you-go to actuarially fair. Under the current Japanese pension system the lifetime pension benefit of an average salaried man born in 1935 is greater than his lifetime pension contributions by $500,000. If he had been faced with the contribution and benefit schedules that a person born in 2000 faces, his lifetime benefit would be less than his lifetime contributions by $250,000. This means that the net pension benefit is different between the two cohorts by $750,000 even under the assumption that their lifetime incomes are equal. Such extreme disparity between different cohorts is caused by the fact that Japan’s public pension system is essentially a pay-as-you-go one. This chapter outlines the ‘23 per cent Reform Plan’ and shows its effects both on the public fund accumulation and on the net benefits of different cohorts. This chapter briefly outlines the current structure of Japan’s public pension system and examines its redistributional effects. The pay-as-you-go scheme and the actuarially fair scheme will be compared. Then they analyse the 23 per cent reform plan. Finally, privatization is discussed. If we privatize the system now, the government still must continue to financially support pensions for an extended period. Privatization does not reduce the financial burden of the government by itself. This chapter points out that whether the system is privatized or not, it is necessary to make the pension system actuarially fair, and spread the net burden of pensions evenly among generations.
Chapter 7, written by Akira Okamoto and Toshiaki Tachibanaki, studies the integration of the social security and tax systems. The essence of their proposal includes the following two ideas. First, the social security and the tax systems should be integrated. In other words, social security contributions should be replaced by the general tax revenue. Second, a progressive consumption tax is recommended to raise a major part of the general tax revenue. A progressive consumption tax is a direct tax, which falls on consumers, namely, an expenditure tax. Their proposal is to introduce a progressive consumption tax and to substitute it for other taxes such as a labour income tax or an interest income tax. There are four reasons why integration is desirable. First, integration facilitates an introduction of the idea of a minimum contribution for all people in the field of social security because a universal minimum level which guarantees the necessary payment of public pensions and medical costs to all people can be covered from the general tax revenue more efficiently and equitably. Second, the integration can eliminate the concept ‘who gained and who lost from the both intergenerational and intragenerational aspects’ under the social insurance system where cost is covered by social insurance contributions. Third, a minimum subsistence guarantee from general tax revenue is consistent with the principle of social security, which intends to produce no desperately poor individuals. Fourth, the integration of the social security and the tax systems reduces considerably administration costs of the revenue side because only one institution collects revenue from the private sector. There is a potentially difficult problem in the implementation of a progressive expenditure tax in the real world. It is indicated that the savings figure can be consolidated by using an individual tax number and an electrictronic collection system.
Chapter 8, which is written by Ashwin Kumar, reviews pension reform in the UK from contribution to participation. This chapter seeks to draw out the implications of the reform proposals, over time and across the earnings distribution and to place them in the wider context of the concepts behind pension provision. The UK government’s main proposal was a new contract for welfare, Partnership in Pensions, which was published in December 1998. The proposals contained within this document represented a fundamental shift in the concept behind state second tier pension provision in the UK. This shift was from the contributory and earnings-related principle of the 1970s to the wider entitlement of a participatory principle and to the flat rate benefit principle enshrined in the Beveridge Report of 1942. The UK government identified guaranteeing a minimum standard as a more impo...

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