Abstract

Prepared by Jaume Puig, based on a study of long-term fiscal gaps in Latin America and the Caribbean by a team led by Lorenzo Figliouli (IMF 2018). The study covered 17 countries in Latin America: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela.

Introduction

Even as they are now experiencing a demographic dividend, Central American countries are not exempt from the same economic challenges from population aging that blight long-term growth prospects in countries where the dividend is spent. Falling fertility rates in CAPDR countries have increased their shares of working-age population relative to the elderly. And although their demographic dividend is projected to last longer than in other Latin American and emerging market economies, given less steep declines in fertility rates, population aging may come to exert a huge fiscal burden.

Increasing old-age dependency (the ratio of retirement-age population to working-age population) will indeed create important fiscal challenges in countries with generous public defined-benefit pay-as-you-go (PAYG) pensions (Table 8.1) and comprehensive public health systems. Other countries with less generous and comprehensive pension and health care systems may also eventually struggle. Fiscal pressures will undoubtedly mount as states are forced to weigh in to provide socially acceptable levels of coverage and benefits.

Table 8.1.

Key Pension System Parameters in CAPDR

article image
Sources: Organisation for Economic Co-operation and Development (OECD, 2013 and 2015) (average contribution rates; average pensionable age); OECD/IDB/World Bank 2014 (type of system; gross replacement rates); US Social Security Administration 2016 (pensionable age; vesting period; contribution rates).Note: Ages in parentheses are for women where different from those for men. DB 5 defined benefit; DC 5 defined contribution; N/A 5 not applicable.

DC systems may include a DB pillar in the process of being phased out. For countries with fragmented systems, the largest single component is taken as a benchmark.

Actual retirement ages may be lower than the statutory age in many Latin America Countries (LAC) if a large fraction of contributors retire several years earlier based on the length of their contributing history.

In percent of reference salary. Includes old-age, disability, and survivors.

Latest available. Gross pension entitlement in percent of gross pre-retirement earnings. Comparisons are based on a specific set of assumptions. See OECD/IDB/World Bank 2014 for detailed information. Data for some LAC are from OECD 2015.

This chapter examines some of the fiscal challenges likely to affect economic growth prospects in CAPDR in the future. It aims to address the following questions: (1) What is special about the demographic conditions in CAPDR? (2) What are the main characteristics of pension systems and health coverage in CAPDR? (3) What are the fiscal costs associated with public PAYG pension systems with defined benefits? (4) What are the fiscal costs associated with public health coverage? (5) Are there potential contingent fiscal risks in countries with inadequate coverage of PAYG and public health care systems, or with defined contribution systems likely to generate socially unacceptable pension benefits?

Demographic projections underlying the estimated fiscal costs from population aging in this chapter are drawn from the UN’s World Population Prospects report of 2015. The report projects population growth until 2100 for about 200 countries.

The methodologies for the UN’s demographic projections and for our projections of fiscal costs from population aging are described in Annex 8.1.

Demographic Dividend Delays Reckoning on Aging

CADPR’s working population is younger and more concentrated in the informal sector than in the rest of Latin America. Despite sharp declines over the last few decades, fertility rates are still relatively higher in CAPDR countries than other Latin American countries. Even with substantial negative net migration of mostly working-age citizens, the projection is for a more durable demographic dividend and later onset of fiscal pressures from aging than in the rest of Latin America, with the notable exception of Costa Rica. At the same time, UN long-term projections indicate that the average old-age dependency ratio in CAPDR could be among the highest in the world by 2100.

High informality of employment is another important phenomenon in several CAPDR countries, especially Guatemala and Honduras (Figure 8.1). This is a key driver of the low coverage of contributory pension and health care provision in many of these countries. Frequent transitioning between informal and formal employment sectors also has a negative impact on the density of contributions to contributory systems, thereby limiting the accrual of pension rights. These considerations have important implications for the fiscal costs of aging, through non-contributory pension schemes, for those who either do not qualify for benefits, or do not receive adequate benefits, from contributory pension funds.

Figure 8.1.
Figure 8.1.

Demographic and Labor Characteristics in Latin America

Sources: Inter-American Development Bank 2016, and International Labor Organization.Note: The bars in panel 1 depict the period in which the total dependency ratio is falling. The total dependency ratio is those not in the labor force (ages 0 to 15 years and ages 65+ years) over those in the labor force (typically ages 15 to 64 years). LAC = Latin America and the Caribbean. ARG = Argentina; BOL = Bolivia; COL = Colombia; CRI = Costa Rica; DOM = Dominican Republic; ECU = Ecuador; SLV = El Salvador; GTM = Guatemala; HND = Honduras; MEX = Mexico; NIC = Nicaragua; PAN = Panama; PER = Peru; PRY = Paraguay; URY = Uruguay; VEN = Venezuela.

Pensions and Health Care Characteristics

Pensions

Public spending on pensions is low by international standards, given generally low coverage of PAYG pension systems and limited non-contributory benefits, as well as transition to defined contribution systems in some countries.

  • Five out of the seven countries in CAPDR have public PAYG systems: Costa Rica, Guatemala, Honduras, Nicaragua, and Panama. These are integrated into the social security system and funded by worker and employer contributions. Since the 1990s, four out of the seven countries have also introduced public non-contributory pensions, following the general trend in Latin America: Costa Rica (1995), the Dominican Republic (2003), El Salvador (1998), and Panama (2009). Total public spending on these systems is comparatively low, at about 1.9 percent of GDP on average in 2015, compared with a 3.7 percent average in Latin America, 8.7 percent in high-income countries, and 9.5 percent in emerging Europe (Table 8.2). In addition to CAPDR’s less-advanced stage in population aging, this reflects the low coverage of most PAYG and non-contributory systems (below 20 percent in Guatemala, Honduras, El Salvador, and Nicaragua), the absence of non-contributory systems in some countries (Guatemala, Honduras, and Nicaragua), and the advanced stage of the transition to a system funded by defined contributions in the Dominican Republic (Figure 8.2).

  • Regarding pension system parameters, pensionable ages are broadly in line with international averages, between ages 60 and 65, except in El Salvador and Panama, where women retire earlier. In contrast, PAYG systems have relatively generous benefits and low contribution rates by international standards (panel 2). On the funding side, particularly low contribution rates of 6 percent in Guatemala and Honduras stand out. On expenditure, replacement rates in Costa Rica, Nicaragua, and Panama are well above the average for the wider region (Table 8.1).

Table 8.2.

Latin American Pension Expenditure

(Percent of GDP)

article image
Source: IMF staff estimates and projections.
Figure 8.2.
Figure 8.2.

Pension and Health Care System Characteristics

Sources: Inter-American Development Bank, 2014 and 2016; Organisation for Economic Co-operation and Development, 2015; SIMS; World Health Organization; and IMF staff estimates and projections.Note: In panel 3, where available, earlier data are reported for countries where the latest disaggregation between contributory and non-contributory coverage was not available as of 2016–15. Data for Venezuela was not available as of 2016–15. LA-26 = Latin America 26. ARG = Argentina; BOL = Bolivia; BRA = Brazil; CHL = Chile; COL = Colombia; CRI = Costa Rica; DOM = Dominican Republic; ECU = Ecuador; GTM = Guatemala; HND = Honduras; MEX = Mexico; NIC = Nicaragua; PAN = Panama; PAR = Paraguay; PER = Peru; PRY = Paraguay; SLV = El Salvador; URU = Uruguay; VEN = Venezuela.1 Includes expenditures covered by private plans and the non-profit sector.

Several countries use systems funded by defined contributions, resulting in potentially inadequate benefits when not coupled with a PAYG pillar. In the late 1990s and early 2000s, several CAPDR countries joined the regional trend of transitioning from unfunded PAYG systems to funded defined contribution systems. Costa Rica and Panama maintain combinations of DB and defined contribution systems, with workers generally1 having the obligation to contribute to both pillars. In contrast, the Dominican Republic and El Salvador are phasing out the preexisting DB pillars, and the new defined contribution systems are generating low replacement rates that may not be socially sustainable.2

Health Care Systems

Varying levels of coverage and quality of care drive public spending on health care across the region. On average, public outlays in CAPDR are similar to those in other emerging and developing regions, at 4.7 percent of GDP in 2015 (Table 8.3). This masks considerable variations, with public spending ranging from 2–3 percent of GDP in Guatemala and the Dominican Republic to 6–8 percent in Panama and Costa Rica, consistent with higher income status and coverage. In Guatemala, Honduras, Nicaragua, and El Salvador, most people are uninsured and rely on basic government health services, which may not always be easily accessible or free of charge, particularly for medicines, as indicated by the higher share of out-of-pocket spending in some these countries (Figure 8.2).

Table 8.3.

International Comparison of Public Health Expenditure

(Percent of GDP)

article image
Source: IMF staff estimates and projections.

Potential Fiscal Costs: Pensions

As populations age, public spending on pensions in some CAPDR countries is expected to rise sharply, generating large fiscal gaps. The empirical analysis in this chapter projects average public spending on PAYG and non-contributory systems in Costa Rica and Nicaragua to climb over the next few decades, increasing from about 2¾ percent of GDP in both countries in 2015 to 15.8 percent in Costa Rica and 13 percent in Nicaragua by 2100 (Table 8.2).3 With revenues from pension contributions projected to grow broadly in line with GDP, and investment revenue dwindling as reserves are depleted,4 pension deficits are projected to increase in line with expected increases in pension spending. Through a combination of large coverage, generous benefits, and comparatively adverse demographic trends, the pension systems of both countries are projected to generate two of the largest long-term fiscal gaps in Latin America—almost 400 percent of GDP in Costa Rica and 275 percent of GDP in Nicaragua. These systems are well beyond reasonable estimates of fiscal sustainability absent parametric reforms.

Questionable Sustainability

CAPDR countries beyond Costa Rica and Nicaragua are not troubled by fiscal pressures under current policies, but the social sustainability of their pension systems is questionable, suggesting contingent fiscal risks. While the long-term increase in public spending on existing pension systems is expected to be quite limited in other CAPDR countries, these results reflect two aspects that raise questions about their social sustainability. The first is the starting low coverage of pension systems, at around 15 percent of the population above pensionable age for example in Guatemala and Honduras. This is assumed to remain constant under projections in this chapter where policies are unchanged. However, social demands for reforms to increase coverage to cater to the needs of a rising share of elderly in the population are likely to lead to policy changes that will put pressure on these countries’ fiscal situations. The second factor behind the projections of low public expenditure under current policies is the transition to defined contribution systems in the Dominican Republic, El Salvador, and Panama. This obviously shrinks—or even cancels out—projected increases in public spending on pensions. However, improved fiscal sustainability under current defined contribution systems can come at the cost of inadequate benefits, as average replacement rates tend to be lower in countries that have transitioned (Table 8.1 and Figure 8.2). This again raises questions about the social sustainability of current policies in these countries, and associated contingent fiscal risks if states are eventually forced to step in and top up pensions.

Adequacy Doubts in Defined Contribution Systems

Simulations of replacement rates suggest that adequacy issues are likely to intensify over time in countries transitioning to fully funded defined contribution pension systems. Calculations of theoretical adequacy ratios and replacement rates in countries with a defined contribution component in their pension systems suggest that current adequacy issues are likely to persist and even worsen (Figure 8.3).

Figure 8.3.
Figure 8.3.

Pension Adequacy Ratios and Main Drivers

Sources: International Association of Pension Supervisors, Inter-American Development Bank, national sources, Organisation for Economic Co-operation and Development, and IMF staff estimates and projections.Note: The projection of theoretical replacement rates in defined contribution systems is done in five steps: (1) Projection of the average wage life-cycle profile for each year over the projection horizon. In the baseline scenario, contributors earn the average wage in the economy over the entire contribution career; (2) Computation of pension contributions by age for each year, based on the assumed wage profile, contribution density, and the applicable contribution rate. The baseline projection considers a 75 percent contribution density; (3) Computation of the value of individual retirement accounts or sum of accrued contributions and earned interest (after costs) by age for each year; (4) Computation of gender-specific pension annuities based on life expectancy at retirement, the expected real rate of return, and the rate of indexation of future pensions; (5) Finally, two indicators are computed to assess two key dimensions of pension adequacy, namely the extent to which pension schemes help to smooth income over the life cycle (using the replacement rate, which relates the starting pension of a new retiree to his/her last earnings before retirement) and to what extent they can alleviate old-age poverty risk (using the adequacy ratio, which compares the starting pension of a new retiree directly to the average earnings of the working population).

Replacement rates relative to salary before retirement and adequacy ratios relative to average earnings are projected to remain relatively unchanged from starting low levels in the Dominican Republic, reflecting the advanced stage of the transition to a defined contribution system in the country. Meanwhile, in Panama, where the PAYG system is already closed to new entrants but not expected to end until 2055–60, adequacy ratios are projected to drop sharply in the long term. In El Salvador, the minimum pension guarantee will help alleviate the risk of old-age poverty, but replacement rates for higher-income pensioners imply a sharp decline in their incomes relative to pre-retirement earnings.5

Low replacement rates in our projections for contributory schemes in CAPDR are driven by current contribution rates, assumed low contribution densities— linked to high informality—as well as assumed limited real returns on assets, based on historical experience in the region.

Potential Fiscal Costs: Health Caret

CAPDR is the region with the largest projected increase in health care expenditure and resulting long-term fiscal gap. Health care expenditure is projected to rise faster than economic growth in all countries due to population aging, as most health expenditure occurs later in life. Moreover, technological improvements result in better, but costlier, services for any patient (this is reflected in the “excess cost growth” factor in our model). In the baseline scenario in this chapter, with a 1 percent annual excess cost growth based on historical trends in health expenditure in advanced economies (IMF 2012), average health care spending in CAPDR would more than triple by 2100, from 4.7 percent to 15.2 percent of GDP. Most countries in the region would reach higher projected public health expenditures than the projected average for advanced economies (13.8 percent of GDP), and would be well above other emerging market economies (Table 8.3). This reflects the already relatively high public expenditure on health care as a share of GDP in many countries, as well as the intense projected aging from a relatively less advanced stage in the process compared to other emerging market economies. The high projected expenditure on health care is mirrored in the estimates of projected long-term fiscal gaps from health spending, with four CAPDR countries—Costa Rica, Panama, Nicaragua, and Honduras—in the five Latin American countries with largest estimated gaps, reflecting both relatively high starting levels of expenditure and projections of rapid population aging. While acknowledging the high uncertainty in making long-term projections,6 the ones in this chapter are broadly consistent with literature on the impact of aging on health care spending.7

Policy Options

Carefully designed reforms will be needed to ensure fiscal sustainability while providing socially acceptable levels of coverage and adequacy of pensions and health care. Policymakers grappling with the fiscal challenges of aging populations can reshape the fiscal profile directly through parametric reforms to pension and health care systems or indirectly through policies related to fertility, migration, and formal labor force participation with the aim of mitigating the decline in the working-age population.

On Pension Reforms

Parametric pension reforms in CAPDR can effectively slow the growth of age-related public spending. Raising the retirement age in line with higher life expectancy, especially for women, would improve pension sustainability, as a longer working life reduces the length of benefits while increasing the contributions to the system. Linking retirement ages to (rising) life expectancy could therefore be particularly effective as a reform that would introduce an automatic stabilizing mechanism while insulating reforms from political pressures that accompany discretionary decisions. Increases in the retirement age should be accompanied by improved disability systems to protect vulnerable segments of the workforce who might not be able to prolong their careers for health reasons.

An exercise with consistent objectives for reducing long-term fiscal gaps provides specific parametric reform recommendations for PAYG pension systems in CAPDR countries. To provide a unifying and comparable framework across countries, Table 8.4 presents results from an exercise that quantifies parametric reforms needed to reach consistent reform objectives across countries. The two objectives analyzed are keeping medium-term pension deficits in line with GDP (stable deficit-to-GDP ratio between 2015 and 2030) and limiting the increase of the long-term deficit to an additional 3 percent of GDP (in 2015–65). Consistent with the size of estimated fiscal gaps, the most aggressive parametric reforms are required in Costa Rica, while Nicaragua is the only other CAPDR country where reforms are needed to reach fiscal sustainability objectives set out for the end of the century.

Table 8.4.

Parametric Reforms for Public Pension Systems

article image
Source: IMF staff.Note: Deficit increases are with respect to 2015. N/A 5 not applicable.

Reform measures are not necessary to achieve the targets.

Rapidly widening fiscal gaps in some CAPDR countries, especially if coverage were increased to socially acceptable levels, would require a more balanced approach to PAYG systems.8 Beyond the specific results of the cross-country exercise outlined above—with specific asumptions such as constant coverage at current levels through the projection period—several CAPDR countries would benefit from parametric changes to make the system less financially unbalanced and so support expanded coverage without adding to fiscal costs. In addition to the Costa Rican case, Guatemala and Honduras would benefit from increases in PAYG contribution rates as these are exceedingly low by international standards. Reductions in benefits are recommended in countries with high replacement rates, including Nicaragua and Costa Rica. Even in countries such as Guatemala and Honduras, where estimated long-term fiscal gaps would not be large if currently low coverage is unchanged, efforts to make their pensions systems socially, as well as fiscally, sustainable by expanding coverage to adequate levels could require lowering replacement rates from levels that are now slightly above international norms (Figure 8.2).

Regarding the pace of reforms, gradual adjustments mitigate potentially negative social effects, suggesting that pension reforms should be initiated while countries still have the fiscal space needed to make gradual change possible. Individuals also require time to adjust to pension legislation changes (through additional savings, for example), so the necessary reforms should be legislated and communicated well in advance.

Gradual increases in the retirement age combined with immediate rises in contribution rates would also be needed to increase pension adequacy in defined contribution systems. Higher contribution rates will be needed to ensure pension adequacy in countries with defined contribution systems—especially those with low current and projected replacement rates. Figure 8.3 shows that even under optimistic scenarios of high contribution density, adequacy ratios will remain or fall under 50 percent in all CAPDR countries with defined contribution or mixed systems, except in Costa Rica. Figure 8.4 illustrates the effect of a reform scenario on adequacy rates in Latin American countries where current defined contribution or mixed systems are more likely to produce pension benefits that are socially unacceptable. The reform involves a gradual increase in retirement ages to 67 for both genders, and an immediate rise in the contribution rate to 17 percent, which comes close to the average rate currently observed in advanced economies.9 A combination of both measures would increase adequacy ratios for average wage earners with a 75 percent contribution density above or very close to the threshold of 50 percent in 2065. While higher than in the baseline scenario, adequacy ratios in the Dominican Republic would still remain far below the 50 percent threshold in 2030. This suggests that unless rates of return turn out significantly higher than expected, improving the adequacy of defined contribution pensions would require important reforms, not very different from the ones needed to ensure the fiscal sustainability of PAYG systems.

Figure 8.4.
Figure 8.4.

Defined Contribution/Mixed System Adequacy under Reforms Scenarios

Source: IMF staff estimates and projections.Note: BOL = Bolivia; CHL = Chile; DOM = Dominican Republic; MEX =

On Health Care Reforms

Health care reforms should aim to manage growth in spending while preserving health outcomes and ensuring equitable access to basic services. A combination of tight budget controls and efficiency-enhancing measures will be key to health care reforms in all countries. The relative importance and desirability of reforms will vary across countries. Countries aiming to expand coverage of public health systems, such as Guatemala and Honduras, should focus first on providing the most essential health services, with greater emphasis on preventive and primary care. Given typically large informality in CAPDR countries with greater need to expand coverage, the tax-financed provision of universal basic health care may be the best starting point, with social insurance contributions playing a greater role at later stages of development consistent with greater labor market formalization. Meanwhile, countries with more extensive health care coverage, such as Costa Rica and Panama, should put greater emphasis on budget controls. In these countries, a mix of instruments to contain costs and improve efficiency can help preserve access to high-quality health care while keeping public spending in check (Clements, Coady, and Gupta 2012).10

Policies to Affect Demographics and Labor Markets

Policies aimed at promoting labor participation, particularly by females and the elderly, would help delay the impact of aging. An effective way to mitigate the fiscal consequences may be to increase the contribution base in the existing population, by bringing a larger share of the inactive population (particularly women and elderly people) into the labor force and by bringing a larger share of informal-sector workers into the formal labor sector, from which pension contributions can be collected. The gap between male and female participation is particularly large by international standards in CAPDR, suggesting a potential role for policies to promote female labor force participation (Chapter 3). Policy measures will also be needed to increase labor force participation among older people to increase contributions and reduce payouts from pension systems. Taxes, pensions, and social security benefits can be designed to provide incentives for older workers as additions to extending the formal retirement age.

Policies to promote formalization in labor markets would help achieve socially sustainable levels of coverage for the old-age population. To incentivize firms to formalize employment, policy can address the high costs of formal contracts relative to the low average productivity of labor through avoidance of excessively high statutory minimum wages and improvements in education policies (Loayza and others 2009; Levy and Schady 2013). Since workers may also choose between formal and informal employment opportunities based on the perceived value of future benefits from formal employment relative to current contributions, pension schemes may be designed in a way that increases incentives to participate (Levy 2008; Pagés, Rigolini, and Robalino 2014).11, 12 Increased formalization and coverage may need to be accompanied by adequately calibrated parametric reform to ensure the long-term fiscal and social sustainability of public pensions and health care systems.

References

  • Acosta-Ormaechea, S., M. Espinosa-Vega, B. Paczek-Jarmulska and D. Wachs (forthcoming). “Demographic Changes in Latin America – The Good, The Bad and The Ugly,” IMF, forthcoming.

    • Search Google Scholar
    • Export Citation
  • Aterido, R., M. Hallward-Driemeier, and C. Pagés, 2011. “Does Expanding Health Insurance Beyond Formal Sector Workers Encourage Informality? Measuring the Impact of Mexico’s Seguro Popular,” IDB Working Paper 280, Washington D.C.: Inter-American Development Bank.

    • Search Google Scholar
    • Export Citation
  • Attanasio, O., C. Meghir, and A. Otero. 2011. “Pensions, Work and Informality: The Impact of the 2008 Chilean Pension Reform”, mimeo.

  • Bérgolo, M., and G. Cruces, 2014. “Labor Informality and the Incentive Effects of Social Protection Systems”, in Social Insurance, Informality, and Labor Markets: How to Protect Workers While Creating Good Jobs, Oxford University Press.

    • Search Google Scholar
    • Export Citation
  • Clements, B., D. Coady, S. Gupta, 2012: “The Economics of Public Health Care Reform in Advanced and Emerging Economies”, Washington D. C., International Monetary Fund, 2012.

    • Search Google Scholar
    • Export Citation
  • Clements, B., K. Dybczak, V. Gaspar, S. Gupta, and M. Soto. 2015: The Fiscal Consequences of Shrinking Populations. IMF Staff Discussion Note, October 2015.

    • Search Google Scholar
    • Export Citation
  • Cuesta, J., and Bohórquez, C., 2011. “Labor Market Transitions and Social Security in Colombia”, World Bank Policy Research Working Paper 5650, Washington D.C.: The World Bank.

    • Search Google Scholar
    • Export Citation
  • de la Maisonneuve, C. and J. Oliveira Martins (2013). “Public spending on health and long-term care: a new set of projections”, OECD Economic Policy Papers, No. 06, OECD Publishing.

    • Search Google Scholar
    • Export Citation
  • Glassman, Amanda and Zoloa, Juan Ignacio (2014). How Much Will Health Coverage Cost? Future Health Spending Scenarios in Brazil, Chile, and Mexico, Working Paper 382. Washington DC. Center for Global Development.

    • Search Google Scholar
    • Export Citation
  • Harris, J.E. and Todaro, M. P., 1970. Migration, Unemployment and Development: a Two Sectors Analysis. American Economic Review 60, 126142.

    • Search Google Scholar
    • Export Citation
  • IDB (2016) Saving for Development: How Latin America and the Caribbean Can Save More and Better. Cavallo, E. and T. Serebrisky (Eds.): Palgrave Macmillan US, 2016.

    • Search Google Scholar
    • Export Citation
  • IMF (2012): The Economics of Public Healthcare Reform in Advanced and Emerging Economies.

  • IMF (2015): The Fiscal Consequences of Shrinking Populations. IMF Staff Discussion Note, October 2015.

  • IMF (2016): How to Assess Fiscal Implications of Demographic Shifts? A Granular Approach, How-to notes series, Note 2, forthcoming.

  • IMF (2018): Growing Pains. Is Latin America Prepared for Population Ageing? Departmental Paper No. 18/05. April 2018

  • Levy, S., 2008. Good Intentions, Bad Outcomes: Social Policy, Informality and Economic Growth in Mexico. Washington D.C.: Brookings Institution Press.

    • Search Google Scholar
    • Export Citation
  • Levy, S. and N. Schady, 2013: Latin America’s Social Policy Challenge: Education, Social Insurance, Redistribution. The Journal of Economic Perspectives, Vol. 27, No. 2, Spring 2013, pp. 193218.

    • Search Google Scholar
    • Export Citation
  • Lewis, A., 1954. Economic Development with Unlimited Supplies of Labour. Manchester School of Economic and Social Studies 22, 13991.

  • Loayza, N. V., L. Serven, N. Sugawara, 2009: Informality in Latin America and the Caribbean. World Bank Policy Research Working Paper 4888, Washington, DC: The World Bank, March 2009.

    • Search Google Scholar
    • Export Citation
  • Miller, R., C. Mason, and M. Holz, 2011: The Fiscal Impact of Demographic Change in Ten Latin American Countries: Projecting Public Expenditures in Education, Health, and Pensions. In: D. Cotlear (Ed.): Population Aging: Is Latin America Ready? The World Bank, 2011.

    • Search Google Scholar
    • Export Citation
  • OECD/IDB/The World Bank, 2014, Pensions at a Glance: Latin America and the Caribbean, OECD Publishing, http://dx.doi.org/10.1787/pension_glance-2014-en.

    • Search Google Scholar
    • Export Citation
  • Pagés, C., J. Rigolini, and D. Robalino, 2014. “Social Insurance, Informality, and Labor Markets: How to Protect Workers While Creating Good Jobs”, in Social Insurance, Informality, and Labor Markets: How to Protect Workers While Creating Good Jobs, Oxford University Press.

    • Search Google Scholar
    • Export Citation
  • PAHO/WHO, 2016: Health Situation in the Americas, Core Indicators 2016, Washington DC, 2016.

  • Perry, G., W. Maloney, O. Arias, P. Fajnzylber, A. Mason, J. Saavedra-Chanduvi (2007): Informality: Exit and Exclusion. Washington, DC: The World Bank, 2007.

    • Search Google Scholar
    • Export Citation
  • Prettner, K., D. E. Bloom, H. Strulik, 2013: Declining fertility and economic well-being: Do education and health ride to the rescue? Labor Economics Vol 22., June 2013, p. 7079.

    • Search Google Scholar
    • Export Citation
  • SSA 2016: Social Security Programs Throughout the World: The Americas, 2015. SSA Publication No. 13–11802, March 2016.

  • United Nations, 2015: World Population Prospects: The 2015 Revision. Key Findings and Advance Tables. United Nations, 2015.

  • WHO, 2016: World Health Statistics 2016: Monitoring Health for the SDGs, World Health Organization, Geneva, 2016.

Country-Specific References

Costa Rica

  • CCSS, “Valuación actuarial del seguro de salud,” Agosto, 2014.

  • CCSS, “Valuación actuarial de largo plazo del seguro de invalidez, vejez y muerte,” Julio, 2015.

  • Universidad de Costa Rica, Facultad de Ciencias, Escuela de Matemáticas, “Estudio Actuarial del seguro de invalidez, vejez y muerte administrado por la Caja Costarricense de Seguro Social,” Diciembre, 2016.

    • Search Google Scholar
    • Export Citation

Dominican Republic

  • Robert J. Palacios (2003), Pension Reform in the Dominican Republic, Social Protection Discussion Paper Series No. 0326, The World Bank, December 2003.

    • Search Google Scholar
    • Export Citation
  • Clements, B., K. Dybczak, V. Gaspar, S. Gupta, and M. Soto. 2015. “The Fiscal Consequences of Shrinking Populations.” IMF Staff Discussion Note 15/21, International Monetary Fund, Washington, DC.

    • Search Google Scholar
    • Export Citation
  • Gasparini, Leonardo, Javier Alejo, Francisco Haimovich, Sergio Olivieri, and Leopoldo Tornarolli. 2007. “Poverty among the Elderly in Latin America and the Caribbean.” Background paper for the World Economic and Social Survey 2007: The World Ageing Situation. New York: United Nations Department of Economics and Social Affairs.

    • Search Google Scholar
    • Export Citation
  • International Federation of Pension Fund Administrators (2011), Non-Contributory Pension Programs in FIAP Countries, July 2011.

El Salvador

  • Acuña R., 2005, “Pension Reform in El Salvador,” Social Protection Discussion Paper No. 0507, World Bank.

  • Asafondos (2013) “Diagnóstico del sistema de pensiones en El Salvador,” junio http://www.asafondos.org.sv/vpublicaciones.asp?id=97.

    • Search Google Scholar
    • Export Citation
  • Gobierno de El Salvador (2016) “Propuesta del Sistema Previsional Mixtohttp://www.mh.gob.sv/portal/page/portal/PMH/Novedades/Publicaciones_y_Boletines/Boletin,Boletin:Reforma_Pensiones.

    • Search Google Scholar
    • Export Citation
  • Lazo, J. F., and others, 2010, “Reforma al sistema de pensiones: cobertura, brechas de género y poder adquisitivo,” Universidad Centroamericana “José Simeón Cañas.”

    • Search Google Scholar
    • Export Citation
  • Mesa-Lago, C. (2011) “Diagnóstico del Sistema de Pensiones en El Salvador (1998–2010),” Estudio sobre políticas públicas No 1, Fundación Dr. Guillermo Manuel Ungo (FUNDAUNGO).

    • Search Google Scholar
    • Export Citation
  • SURA Asset Management (2014/15)Cómo fortalecer los sistemas de pensiones latinoamericanos: Experiencias, lecciones y propuestas Estudio internacional: Tomos I y II.”

    • Search Google Scholar
    • Export Citation

Guatemala

Nicaragua

  • Alonso, Javier, Carmen Hoyo, and David Tuesta (2015). A model for the pension system in Mexico: diagnosis and recommendations. Journal of Pension Economics and Finance, Vol. 14, pp. 76112.

    • Search Google Scholar
    • Export Citation
  • CONSAR, 2015, Diagnóstico del Sistema de Pensiones, Comisión Nacional del Sistema de Ahorro para el Retiro, Mexico, D.F.

  • INSS, 2016, Anuario Estadístico 2015 (Managua: INSS).

  • Martinez Franzoni, J., 2013, Social Protection Systems in Latin America and the Caribbean: Nicaragua (Santiago de Chile: ECLAC).

  • OECD, 2016, OECD Reviews of Pension Systems: Mexico, OECD Publishing, Paris.

  • Rofman, R. and Oliveri, M. L., 2012, “Pension Coverage in Latin America: Trends and Determinants”, World Bank Social Protection & Labor Discussion Paper No. 1217. (Washington: World Bank).

    • Search Google Scholar
    • Export Citation
  • SURA Asset Management, 2015, “Cómo fortalecer los sistemas de pensiones latinoamericanos. Experiencias, lecciones y propuestas.” SURA Asset Management.

    • Search Google Scholar
    • Export Citation
  • World Health Organization, 2015, Health System Financing Country Profile, Nicaragua 2014 (WHO: Geneva).

Panama

  • PAHO, 2012. Health in the Americas: 2012 edition: Country Volume. Washington DC: PAHO.

  • Rodriguez Mojica, A., 2013, Social Protection Systems in Latin America and the Caribbean: Panama. (Chile: United Nations).

  • WHO, 2015. Health System Financing Country Profile: Panama. Geneva: WHO.

Annex 8.1: Methodology to Compute Fiscal Costs from Population Aging

Demographic projections used in this annex are from the UN’s World Population Prospects report of 2015, which uses a probabilistic approach for key parameters like fertility and life expectancy to determine the median trajectory of these components within statistical bounds of uncertainty. Drawing on these projections of population growth until 2100 for about 200 countries ensures the consistency and comparability of demographic projections underlying the estimated fiscal costs from population aging.

The characteristics of national systems are the other key factor in projected fiscal costs of population aging related to methodologies for assessing the funding of pensions and health care provision. The analysis examines two types of pension systems: defined benefits and defined contributions. The fiscal costs of health care services are projected assuming that the coverage and generosity of the system is unchanged.

  • a. For pension systems promising defined benefits associated fiscal costs are projected using a simple expenditure identity (Clements, Coady, and Gupta 2012):13
    PEGDP=population65+population1564Oldagedependencyratiopensionerspopulation65+ElderlycoverageratioaveragepensionaveragewageReplacementratepopulation1564workersInverseemploymentratiolaborincomeGDPLaborshareofGDP(1)
  • where PE/GDP denotes the ratio of pension spending to GDP, population 65+ is the population aged 65 years or older,14 and population 15–64 is the population between ages of 15 and 64. The employment ratio (labor force participation) and the labor income share of GDP are typically assumed to be constant over time. Hence future pension spending growth is essentially determined by parametric changes in the system (that is, changes in the elderly coverage ratio or the replacement rate) and demographic changes captured by the old-age dependency ratio. In countries with mature systems with a given coverage ratio and replacement rate and an aging population, a rising old-age dependency ratio drives the increases in pension spending to GDP. In the absence of anticipated reforms, such as a planned increase in contribution rates or a switch from PAYG to defined contribution systems, pension system revenues are assumed to represent a stable fraction of GDP. Therefore, the present discounted value (PDV) of projected increases in pension spending on public PAYG systems as a share of GDP provides a reasonable estimate of the expected fiscal gap under current policies (IMF 2016).

  • b. For pension systems without defined benefits but defined contributions, the potential contingent fiscal costs relate to the concept of pension adequacy.

    • In contrast to PAYG systems, and absent an explicit minimum pension guarantee from the government, defined contribution systems do not a priori involve public expenditures as pensions are determined solely by accumulated past contributions and returns. However, fiscal costs could still arise if there are minimum pension guarantees or if replacement rates turn out to be below socially acceptable levels, giving rise to political pressures to top up pensions with public funds.15

    • While we do not quantify the potential size of such contingent fiscal costs in this chapter, we provide some indication of where such contingent costs might arise. To do this, we compute for countries with a defined contribution component in their pensions systems two indicators that help assess two key dimensions of pension adequacy: first, a replacement rate (relating the starting pension of a new retiree to his/her last earnings before retirement) helps assess the extent to which extent pension schemes smooth income over the life cycle; second, an adequacy ratio (which compares the starting pension of a new retiree directly to the average earnings of the working population) helps assess the extent to which pensioners can alleviate old-age poverty risk.16

Health expenditures as a share of GDP are computed using the following formula:

HEGDPt=HE0PopulationGDP0Generosityofcurrenthealthsystem(ΣiPopulationi,tHEi,tPopulationi,tHEref,tPopulationref,tAgespendingprofile)(1+excesscostgrowth)t(2)

where HEt denote public health expenditures at time t, the subscript i corresponds to the specific age-group i, and the ref subscript indicates the age group used as reference to compute the age-spending profile (assumed to be the 40–44 year group). Starting from current expenditure per capita as a measure of the generosity of the existing health system, population aging drives projected health care spending as a share of GDP. Excess_cost_growth represents the excess growth in health spending not due to demographic changes, for instance due to costly medical innovation.17

1

In Panama, low-wage earners only participate in the DB system.

2

As part of reforms introduced in 2017, El Salvador raised the contribution rate in the defined contribution scheme to 15 percent from the level shown in Table 8.1, in addition to introducing changes in some other parameters. The simulations shown in the chapter are however based on the parameters that were in effect prior to the 2017 reform. Preliminary actuarial studies indicate that the 2017 reform only marginally tackled the key social sustainability problems of high inequality of benefits and of low coverage and replacement rates, as the latter are estimated to increase only slightly relative to the pre-reform scenario.

3

The rationale behind the choice of years 2030 and 2065 as intermediate points for the analysis presented in Table 8.2 is to focus on: (1) a relatively early period (2030) when currently unforeseen changes in demographic trends resulting from potential new policies could not yet have an impact on pension expenditure projections; and (2) a sufficiently long period of time when new workers joining the workforce under less generous pension system conditions would start having an impact on pension expenditure projections as they retire (2065).

4

In some country cases with approved future increases in contribution rates, such as Costa Rica, these are already incorporated in the projections. Depletion of pension system reserves where available are also taken into account in the projections.

5

Projections in Table 8.2 of public spending on pensions falling to 0.2 percent of GDP in El Salvador are based on the actuarial model of the authorities. Alternative calculation of the cost of minimum pensions consistent with IMF projections of pension adequacy in Figure 8.3 could rise as high as 1.5 percent of GDP. In practice these estimates are highly uncertain as they depend on the density of contributions and people’s choices (whether to take a lump-sum reimbursement or continue to work beyond statutory retirement age to try to qualify for minimum pension rights).

6

Long-term projections for health care spending are even more uncertain than for pension spending. In addition to the same uncertainties regarding long-term demographic projections, uncertainties about the evolution of the excess cost growth parameter significantly widen the range of possible outcomes.

8

Raising contribution rates is the least preferred option due to its impact on labor demand, competitiveness, and economic growth. Regarding its effects on informality, international evidence indicates that the pension system design is less relevant compared to the design of the health care system for the choice between formal and non-formal work (Aterido, Hallward-Driemeier, and Pagés 2011; Attanasio, Meghir and Otero 2011; Bérgolo and Cruces 2014; Cuesta and Bohórquez 2011; Levy 2008; Levy and Schady 2013; Loayza and others 2009; Lewis 1954; Harris and Todaro 1970; Pagés, Rigolini, and Robalino 2014; IDB 2016).

9

Such an adequacy reform scenario is meant to present the extent of reforms required to put defined contribution schemes on a (socially) sustainable footing and should not be interpreted as an exact policy recommendation. In fact, the analyzed immediate rise in defined contribution rates to 17 percent might not be politically feasible; the implementation of pension reforms essentially remains a political decision. The 17 percent contribution rate excludes administrative fees or survivor pension contributions. The retirement age is increased to 69 in Chile, which has a higher life expectancy at retirement.

10

Possible control measures include: budget caps on hospitals subject to central oversight; increased public management and coordination measures to screen out unnecessary services; increased local and state government involvement in resource decisions to help tailor services to local conditions and increase responsibility over inefficiencies; greater use of market mechanisms with built-in incentives to minimize waste, including increased cost-sharing with customers, accompanied by measures to ensure access to basic health services; and restricting the supply of health inputs and outputs—for example, by rationing high-technology equipment.

11

Contributions could be linked more closely to benefits, and contributors could be given more choice in selecting their bundle of benefits. Older workers with informal employment histories, for instance, may not want to contribute to pension systems if they cannot expect to accumulate the minimum contributions required to receive a pension. In such cases, the option of receiving reduced proportional benefits for shorter contribution periods (such as implemented in Paraguay in 2011) could provide an incentive. A larger portion of social security could also be financed out of general revenues or from consumption taxes to reduce the adverse incentive from high social security contributions.

12

Structural and demographic changes, including urbanization, may also help increase formaliza-tion of labor markets (Loayza and others 2009).

13

In the cases of El Salvador and Panama projections obtained with this model were replaced by more accurate actuarial projections by national authorities or other international institutions, given the complexities inherent in the ongoing transitions between DB and defined contribution systems.

14

The formula is adjusted as needed for country estimates based on country-specific retirement ages.

15

Projections of fiscal costs from minimum pension guarantees/non-contributory systems are included in the exercise above on projections of public expenditure from PAYG systems.

16

The calculations of replacement and adequacy rates take into account projected combined benefits under existing PAYG, non-contributory and defined contribution pension systems to help assess the likely social acceptability of benefits under existing pension systems.

17

The changing age profile of the population drives projected changes in health expenditure due to higher health spending per capita of older age groups compared to the population in younger groups. Based on historical trends, the excess cost growth in health spending in real per capita terms over real GDP per capita not due to demographic changes is assumed to be constant over time and equal to 1 percent, also contributing significantly to long-term growth in health spending.

Contributor Notes

Prepared by Jaume Puig, based on a study of long-term fiscal gaps in Latin America and the Caribbean by a team led by Lorenzo Figliouli (IMF 2018). The study covered 17 countries in Latin America: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela.