In response to escalating pension expenditures, an increasing number of countries across the development spectrum are evaluating the sustainability of old-age social insurance systems.
Expenditures in today’s 25 EU countries consumed one-eighth of gross domestic product in 2003 (Figure 12). In the future, the economic well-being of older populations will depend on a combination of income sources—earnings from continuing to work, social insurance programs, occupational pensions, and private savings. Public policies affect each of these sources, and proposed policy reforms have both costs and benefits. More empirical research, including cross-national comparative research, is needed to inform the development of policy.
Many countries already have taken steps toward reforming their old-age social insurance programs (see box on “The Chinese Experience: Rethinking Social Security in an Emerging market Economy”). One common reform has been to raise the age at which workers are eligible for full public pension benefits. In 1983, the United States changed the age at which workers are eligible for full retirement benefits to increase incrementally beginning in 2003. Japan raised the pension age for men from 60 to 65 and for women from 57 to 65 in the past 15 years. The highest current statutory pensionable age is 67 for workers in Norway and Iceland. Increases in pensionable age have focused on women, who as recently as the early 1990s were entitled to draw pensions at a younger age than men in most countries. About 60 percent of countries now have the same pensionable age for both men and women. While the trend is to raise the pensionable age, nearly one-third of African countries that offer social insurance benefits to their older populations have a life expectancy less than the statutory pensionable age for men and, in most cases, also for women.
Another strategy for bolstering economic security for older people has been to increase the contribution or tax rate on workers. Twenty-four countries (two-thirds of which are in Europe) now have payroll tax rates that equal or exceed 20 percent of wages. While payroll taxes raise needed revenues, they have the potential to discourage work in the formal sector. Other measures to enhance income for older people include new financial instruments for private savings, tax incentives for individual retirement savings, and supplemental occupational pension plans. Eight countries already have chosen to make occupational pension plans mandatory.
Sixteen countries, primarily in Asia and the Pacific, have a Provident Fund, a compulsory savings program that is funded fully with investments typically managed by the government. Most existing Provident Funds were established in the 1950s; very few have been established since 1985. Instead, countries wishing to achieve a closer link between contributions and benefits have adopted some form of individual accounts. Chile, in the early 1980s, was the first to introduce individual accounts as part of a defined contribution plan. More than 20 other countries, mostly in Europe and South America, have since followed suit. In some countries, however, individual accounts are notional—in other words, no real accumulation of wealth exists because workers’ contributions fund existing pension obligations. Depending on their design, individual retirement accounts may be risky for account holders who make uninformed decisions about diversification.
A trend toward defined contribution plans (in which employees contribute a portion of earnings, sometimes with matching contributions from employers, into investment accounts that they control) rather than defined benefit plans (in which employers guarantee specified levels of pension payments in the future) is evident. Among private-sector workers covered by an occupational pension plan in the United States, 40 percent were in a defined benefit plan in 2000, down from 84 percent in 1980. In contrast, the number of workers in defined contribution plans increased nearly fivefold from 1975 to 1998. In the private sector, the popularity of defined contribution plans is not driven by population aging but by increased job mobility, global competition, and the growth in the number of smaller firms. An important question concerning this trend is whether defined contribution plans, which shift risk and decisionmaking to the employee, will provide adequate income security for the duration of retirement.
|Country||Percentage of GDP|
Note: Pensions include old-age, anticipated old-age, partial, and disability benefits, as well as early retirement benefits due to reduced capacity to work. Source: European Statistical System (EUROSTAT). Available at: http://epp.eurostat.ec.europa.eu . Accessed January 8, 2007.
The Chinese Experience: Rethinking Social Security in an Emerging Market Economy
Although China is rapidly urbanizing, it remains a predominately rural country. The majority of Chinese workers are not yet covered by any formal pension system. Among those who have been and are now covered, there has been a steady rise in the number receiving formal pensions during the past 25 years. Concurrently, there has been a sustained decline in the ratio of covered workers to pensioners in China, a trend that threatens the well-being of the Nation’s formal old-age security system (Figure 13).
Following a decade of experimentation, a new framework for old-age security emerged in the mid-1990s. The intent is twofold: (1) To replace cradle-to-grave support provided by State-owned enterprises with an expansion of coverage beyond the State sector and (2) to introduce pooled funding, which deflects risk. The new system includes a defined benefit pension providing a 20-percent replacement rate of the average wage and a defined contribution individual account. Owing to the unfunded liabilities of the former system, individual accounts have remained largely notional as today’s workers pay for today’s pensioners.
Social security reforms in China were brought about primarily because of the restructuring of State-owned enterprises and changes associated with the movement toward a market economy. However, new pressures have emerged in light of the rapid pace of population aging. Researchers are calling for a higher retirement age to counter the falling ratio of workers to pensioners. The Government is also considering converting to a system with a fully funded component, which raises questions about funding the transition to a new system. Another concern with this approach is where to invest funds that will accumulate in individual accounts, given that China’s capital markets are relatively immature.
|Year||Millions of pensioners||Ratio of pensioners to workers|
Source: China Ministry of Labor and Social Security and China National Bureau of Statistics. China Labor Statistics Yearbook. Beijing: China Statistics Press, various years; and China National Bureau of Statistics. China Statistical Abstract. Beijing: China Statistics Press, 2006.