Should Liberalization and Privatization of Pension Systems be on the APEC Countries’ Agenda
Jan 11, 2016
Should Liberalization and Privatization of Pension Systems be on
the APEC Countries’ Agenda
BACKGROUND: Pension Reform
• Demographic changes
• Budget constraints
Should liberalization be part of pension reform?
Meaning of Liberalization
For GATS/WTO: market access, national treatment, MFN
For APEC’s Group on Services: idem, + deregulation/ privatization
Here: . Privatization• Market access/national treatment for foreign
suppliers of financial services + MFN• Regulation for prudential purpose only• Choice of investment for workers• No restrictions on pension fund investments• Competition policy
Financial Services Liberalization So Far
• Uruguay Round: GATS and “Understanding on Commitments in Financial Services”
• WTO: the Doha agenda, the new negotiations and the Cancun debacle
• APEC Group on Services: Menu of Options; Individual Action Plans
• Shift to bilateral arrangements: e.g. US-Australia, US-Singapore, Australia-Singapore
Milestones of Pension Reform• Martin Feldstein’s 1975 article “Toward a
reform of social security”• 1985 Chilean reform• 1985-86 Australia introduces a mandatory
private DC system• 1985 UK White Paper Reform of Social
Security: Program for Action which brings occupational DC pension schemes into effect
• 1994 World Bank report Averting the Old Age Crisis which proposes the 3-pillar model
• 1996 report on US Social Security reform
Types of Pension systems
Universal
T argeted
Safety NetSocial Insurance
PAYGFunded
Publicly provided
Privately managedPublicly managedIndividual accounts
Publicly mandated
C ompulsoryE mployment R elated
E mployment related
T ax preferredNon-tax preferred(private saving)
Other
Voluntary Saving
The Three-Pillar Model
• First pillar: public DB/PAYG scheme aimed at poverty reduction through redistribution
• Second pillar: mandatory private DC scheme aimed at consumption smoothing
• Third pillar: voluntary savings accounts
The Debate
• How large and redistributive a first pillar?
• Should there be a second pillar, and if so, should it be:.Private v. public.Mandatory v. voluntary.Defined contribution v. defined benefit.Funded v. PAYG
• Equity, efficiency and efficacy• Does it achieve the goals of poverty alleviation
and consumption smoothing?• Does it have favorable macroeconomic effects
(on saving, investment and output)?• Does it have favorable external effects, e.g.
through financial sector development?• What are its effects on the labor market?• What is its financial performance? (Sharpe
index: )
How is a Pension Scheme Assessed?
Rp
RfRpESp
)(
APEC’s Pension Systems
• Broad spectrum of architecture
• Assess the extremes: Australia, Chile v. Malaysia, Singapore
• What are the costs and benefits of liberalization?
Australia: description
• Fully liberalized, 3-pillar system• Age pension: PAYG, DB, means tested• Superannuation Guarantee Charge: private, • DC, funded, supervised (APRA, ATO), no
guarantee• “Tax-advantaged” voluntary savings for
retirement• Comparison with Medicare
Australia: assessment
• Pros: increased savings (?) and inter-generational equity; good coverage for employees; financial sector development
• Cons:complexity;risks borne by retirees; high (variable?) cost; agency problem; super industry concentration; poor financial performance; revealed preference from NZ;; poor integration with first pillar; does not fully relieve pressure on age pension; mixed effects on labor market;low participation rate; easy access to savings
Chile: description
• No first pillar, but a minimum pension guarantee
• Mandatory DC system administered by private companies (AFPs)
• Restrictions on investments progressively eased• Greater choice introduced recently
Chile: assessment
• Pros: increase in savings (?); financial sector development; reduced taxation of labor; free access for foreign fund managers
• Cons: high but declining costs; AFDs compete mainly through marketing expenses
Malaysia: description
• Employees Provident Fund established since 1951, fully managed by the government (MoF), fully funded defined contribution
• Operated under EPF Act 1991, current contribution: 9% by employees, 12% by employers, minimum 2.5% dividend
• Investments under strict regulation: at least 70% in government securities (*), no offshore assets, but started liberalizing since 1996.
• Three accounts: retirement, housing, medical expenses
Malaysia: assessment
• Pro: high coverage rate (>95%), source of funds for national development projects, financial sector development, high return (?)
• Cons: only second pillar, high contribution rate, opaque management/investment, limited autonomy, hidden risks and liabilities
Singapore
• Several schemes. Central Provident Fund main one. Multi-faceted . Aimed at low and medium income wage earners.
• Contributions vary with age: for younger workers: 33% (employers 13%, employees 20; allocated 22% to ordinary account, 5 % to special account, and 6% to Medisave
• Recent changes to deal with ageing, including the Supplementary Retirement Scheme
• “The public must learn to make investment decisions for themselves and take responsibility for the outcomes, good or bad” Deputy Prime Minister Lee Hsieng Loong
Singapore: assessment
• Pros: good coverage for employees, low cost (no administrative charge), choice, deals with ageing, contributes to financial sector development, recent reforms helpful, good financial education program
• Cons: opaque, likely cross subsidization of schemes , not fully liberalized (investment restrictions, selection of fund managers), low rate of return on members’ balances
Financial Performance
Australia Malaysia Singapore
Average return 7.57% 6.13% 2.90%
Standard deviation 10.69% 1.27% 0.57%
Sharpe Index 0.23 -0.18 -2.90
Risk-free benchmark 5.12% 6.35% 4.55%
Balanced portfolio benchmark
8.34 4.58% 4.85%
Lessons from International Experience
• Prerequisites to liberalization: domestic capital market; regulation or investment restrictions; fee capping (?); transparency and disclosure
• There is a wide array of possible designs of pension systems and of policies to deal with ageing
• Privatization is more a public policy issue than an economic one
• Costs matter and size matters, limiting competition
Lessons fron Experience(continued)
• “Funding” is desirable for inter-generational equity reasons (as well as budgetary reason)
• Choice is expensive and requires financial education and disclosure
• Diversification and passive investing have clear benefits, but passive investing requires an efficient market (and many “active” investors)
• Financial sector development is an important objective but not the sole one
Pension Reform in China (1)Current System
Major problem due to SOE reform and ageing• First pillar: basic pension, supplemented by
individual accounts• 2nd pillar: occupational schemes: voluntary;
contributions by employers and employees; liberalized investment policy; limited scope (coverage is only 5% of that of basic pension)
• 3rd pillar: individual savings
Source: Tim Murton, DFACS Occasional Paper
China: Pension Reform (2)The Problems
• Large unfunded liabilities• Limited coverage (1/4 of labor force, 78% of
SOE workers)• Fragmentation at enterprise, municipality and
provincial levels• Little accumulation. Individual funds notional• Collection and administration problems• Transparency and governance issues
China: Pension Reform (3)Recent Reforms and Scope for Liberalization
• The National Social Security Fund
• The Liaoning Pilot Program
• China’s WTO commitments
• Costs and benefits of liberalization