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