Back Matter
Author: Mr. N. A. Barr1
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

References

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1

This paper was written during my time as Visiting Scholar in FAD. I am grateful for help from Dierdre Shanley, the FAD Librarian, and for very helpful comments from Emanuele Baldacci, Robin Brooks, Ke-young Chu, Peter Heller, Richard Hemming, George Kopits, Vito Tanzi, and participants at two seminars at the IMF. I am also grateful for comments from people outside the IMF, including Phil Agulnik, Gary Burtless, Peter Diamond, Howard Glennerster, Robert Holzmann, David Linderaan, Pierre Pestieau, Michal Rutkowski, Stanford Ross, Alan Thompson, and Lawrence Thompson. Responsibility for the views expressed and remaining errors is mine alone.

2

Department of Economics, London School of Economics and Political Science, Houghton Street, London WC2A 2AE, U.K. Tel:+44-20-7955-7842, Fax: +44-20-7831-1840

3

A funded scheme pays pensions out of a fund built over a period of years from the contributions of its members. Pay-As-You-Go (PAYG) schemes pay pensions out of current contributions or taxes.

4

An exception is owner-occupation, which is a way of storing housing services.

5

For detailed comparison of defined benefit and defined contribution schemes, see Bodie and others (1988).

6

Heller (1998) also makes this point. A simulation exercise by Brooks (2000) based on a stochastic overlapping generations model with stocks and bonds shows the general equilibrium effects on asset returns of demographic change, showing in detail how this result emerges.

7

Though this would have to be phased carefully to prevent another demographic crunch in 30–40 years time.

8

Note that when Nuti uses the word ‘privatise’ he is referring to a PAYG scheme run by a private entity.

9

Geanakoplos, Mitchell and Zeldes (1999, p. 80) reach a parallel conclusion: “We prove that in an ongoing social security system, with or without a trust fund, the net present value of transfers to all generations must sum to zero.”

10

This simple argument deliberately abstracts from complications such as the fact that inflation erodes pensioner purchasing power continuously, whereas pensions are increased only periodically.

11

Insurance is efficient only if a number of technical conditions are met (see Barr, 1998, Ch. 5), of which two are relevant in this case: (a) the relevant probabilities have to be independent; and (b) the probability distribution of outcomes has to be known. In the context of pensions, if one member of a pensioner generation experiences inflation, they all do, violating (a); and future inflation rates are unknown even over a 5-year period, let alone the much longer periods relevant to pension schemes, thus violating (b). For both reasons, inflation is an uninsurable risk.

12

In the United Kingdom, personal pensions can be converted into an annuity at any age between 50 and 75.

13

Merton (1983) and Merton, Bodie and Marcus (1987) argue that a mixed system, with an unfunded state pension tied to earnings growth and a diversified, funded component tied to stock market performance can reduce risk relative to a fully-funded system.

14

Murthi, Orszag and Orszag (1999) report administrative costs absorbing 40 percent of the value of individual accounts in the United Kingdom. See also Report of the Panel on Privatization of Social Security, 1998.

15

Holzmann (1999) makes just such an argument.

16

Heller (1998) distinguishes contingent and conjectural liabilities.

17

The pressure to move out of the government fund is considerable. A draft law in mid-2000 proposed that there should be no state fund, and that people would not be allowed to take a job until they had chosen their private fund.

18

Hidden charges for private pensions have been a besetting problem in the United Kingdom. As an example of what is needed, credit card companies in Western countries are all required to use the same definition in their promotional literature of the interest rate they charge customers, making it easy for people to see who is offering the best rate. In contrast, the price structures of airlines and telephone companies are not comparable.

19

Progress in Poland has been rapid. In January 1990, I was faced with a radical pension privatisation proposal at a time when the monthly inflation rate was 80 percent and when—since there were no financial markets—there was no financial market regulation, thus violating two essential pre-requisites. At the time I wrote (World Bank, 1993, paragraph 277): “[T]he need to restructure the state pension scheme [in Poland] is urgent, and clear-cut recommendations for immediate action are [discussed in) Chapter 11…. Private pensions, in contrast, raise major issues winch require detailed study beyond the remit of this report; moreover, the time scale for phasing in private pensions is longer term. For both reasons, this chapter seeks only to set out some of the central issues. Up to a point it indicates potential problem areas. The reason is not to discourage the development of appropriately designed complementary private schemes, but to counter excessive optimism in at least some quarters in Poland about how much can be achieved, and how soon …. The general thrust of the recommendations is that, over the medium term, the system of pensions should evolve into a system with three elements: a basic, state-run social insurance pension; a mandatory system of appropriately regulated complementary private pensions; and a system of voluntary private pensions. The balance between the three elements should be a matter for public debate.” By 1998 the time for reform was right.

20

Suppose that there are three income groups, poor, middle-income, and rich. The purpose of an income test is to ensure that only the poor get benefits; thus benefits are clawed back rapidly as a person’s income rises. The purpose of an affluence test is different—to keep benefits out of the hands of the rich; thus benefits are clawed back less rapidly so that both poor and middle-income people receive benefits.

21

Though Libertarians oppose compulsion, it can be justified for the first-tier pension, even in Libertarian terms, because non-insurance imposes an externality. If someone chooses to make no pension provision, the costs of his decision fall on others, either on the taxpayer (if he is bailed out via social assistance) or, if he is not bailed out, on others, such as his family (if they thereby face starvation) or wider society (if he resorts to crime).

22

This is particularly an argument for social insurance, which can address uncertainty as well as risk.

23

If there is a minimum guarantee, low-income people will have little incentive to make voluntary provision.

24

For discussion in the context of transition countries, see Barr (1994, Ch. 9; forthcoming) and World Bank (1996, Chapter 4).

25

The good feature of the Swedish scheme is that the pension formula takes account of the life expectancy of the cohort. However, the endogenous variable is not the minimum permissible age of retirement but the size of the pension. In a world of rationality and perfect information this would not be a problem; but if people have a personal discount rate higher than the discount rate used for actuarial adjustment of the pension, they will continue to retire as soon as possible, with progressively larger actuarial adjustments. In the limit, this pulls everyone down to the minimum pension. I am grateful to Lawrence Thompson for this point.

26

For details, see Australia, Commonwealth Department of Family and Community Services, 1998, Table 1.

27

The pensions formula is applied to a person’s indexed monthly earnings averaged over the 35 years with the highest earnings (call this W). In 2000, the formula is as follows:

article image

28

If someone retires aged 62 with a full contributions record, her pension is 80 percent of what it would be if she delayed retirement till age 65.

Reforming Pensions: Myths, Truths, and Policy Choices
Author: Mr. N. A. Barr