PENSION REFORM IN LATIN AMERICA

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1 PENSION REFORM IN LATIN AMERICA Oscar Cetrángolo ECLAC, Buenos Aires Office Conference on Privatisation of Public Pension Systems - Forces, Experience, Prospects Vienna - June 19-21, 2003

2 Specific circumstances, general aspects and reform justifications Different types of reform in Latin America Some experiences (Chile and others) Argentine case Final remarks

3 Specific Circumstances in Latin- American Pension Reform Problems in Pension Systems during good times Reform during regional fiscal crises (exception: Chile) Heterogeneity of cases Reform paradigms: Chile vs. Argentina

4 Heterogeneity: Different Problems Mature Systems: Argentina, Chile, Uruguay Intermediate Systems: Brazil, Costa Rica, Panama Young Systems: Bolivia, Colombia, Ecuador, Paraguay, Venezuela

5 100 Heterogeneity: Ageing Process Population Older than 60 Beneficiary of a Pension (% of Total) Argentina Bolivia Brasil Chile Colombia Costa Rica Ecuador El Salvador Honduras México Nicaragua Panamá Paraguay Rep. Dominicana Uruguay Venezuela

6 Heterogeneity: Ageing Process Population older than 60 (% of Total) Argentina Bolivia Brasil Chile Colombia Costa Rica Ecuador El Salvador Honduras México Nicaragua Panamá Paraguay Rep. Dominicana Uruguay Venezuela

7 20 18 Heterogeneity: Ageing Process Population Older than 60 Beneficiary of a Pension (% of Total) Without pensions With pensions Argentina Bolivia Brasil Chile Colombia Costa Rica Ecuador El Salvador Honduras México Nicaragua Panamá Paraguay Rep. Dominicana Uruguay Venezuela

8 Pension Reform in LA and Heterogeneity: Different Ways of Introduction of Capitalisation Substitutive Model: Capitalisation replaces Public PAYG Regimes Parallel Model: Capitalisation as an alternative to Public PAYG Regimes Mixed Model: Public and Capitalisation components

9 Heterogeneity: Different Reform Models Substitutive Model: Chile (1981), Bolivia (1997), Mexico (1997), El Salvador (1998) Parallel Model: Peru (1993), Colombia (1994) Mixed Model: Argentina (1994), Uruguay (1996)

10 Heterogeneity: Options in Different Reform Models (selection of cases) Country Model Option of remain in a PAYG scheme Contributors in Contributors in Previous contrib. New contributors PAYG scheme Capitalization Argentina Mix Yes Yes 22.1% 77.9% Bolivia Substitutive No No - 100% Colombia Parallel Yes Yes 59.7% 40.3% Chile Substitutive First 6 months No 3.6% 96.4% El Salvador Substitutive Older than 36 years No 10.1% 89.9% Mexico Substitutive No No - 100% Peru Parallel Yes Yes 23.3% 76.7% Uruguay Mix Older than 40 years No 52.0% 48.0% Source: Mesa-Lago (2000)

11 Reform paradigms: Chile vs. Argentina Extreme arguments related to macroeconomic behaviour: Chilean macro success is related to the privatisation of the pension system vs. Argentina s failure is due to the pension system reform

12 The Successful Case: Chile (1980) From PAYG system (with multiple institutions, mainly public) to Individual Capitalisation run by private managers Mandatory for employees Optional for self-employed workers

13 Chilean Case: Positive Outcomes Retirement age Improvement of actuarial equilibrium Reduction in political pressure

14 Chilean Case: Reduction in Political Pressure Pensions are related to capital market returns Eliminate privilege pensions Reduces demographic change effects Private management of system

15 Chilean Case: Remaining Problems Coverage Fiscal costs of transition Need of social protection programme Weak impact on investment

16 Chilean Case: Coverage Contributors as % of active population Contributors as % of employed population

17 Chilean Case: Fiscal Costs Transition: Compensation Bond Pensions of old system Pensions remaining in public system Social Protection Programme

18 8 Chilean Case: Fiscal Costs % of GDP Old system

19 8 Chilean Case: Fiscal Costs % of GDP Transition Old system Compensation bond

20 8 Chilean Case: Fiscal Costs % of GDP Transition Old system Compensation bond Social protection

21 8 Chilean Case: Fiscal Costs % of GDP Transition Old system Compensation bond Social protection Military regimes

22 The Failure: Argentina (1993) Causes of crisis Crisis management Reform: motivations Reform: components of new mixed system Consequences of reform Present problems

23 Argentina: Causes of Public Pension System Crisis Demographic causes: Ageing process Macroeconomic behaviour: Crisis and labour market. Unemployment and informality Fiscal crisis and pensions (tax burden) System and crisis administration Design of the system

24 Consolidated Public Expenditure on Pensions Year % of GDP % of Consolidated Public Expenditure % of Public Social Expenditure Source: Grushka (2002).

25 Argentina: System and crisis administration Lack of planning Utilisation of first period surpluses Demagogic responses to first crisis signals Poor management Not fulfilment of legislation

26 Argentina: Design of the system (before 1994) Contributors: 4,1 millions Beneficiaries: 3,2 millions Rate of Dependency: 1.3 Payroll taxes: 26% of wages Rate of Replacement: 70-82%

27 Argentina: Design of the system (before 1994) System financing: 1.3 * 26 = 34% of wages Pension according to Law: 70-82% of wages Expectations: around 60% of wages

28 Argentina: Reform Motivations Fiscal pressures? Fulfilment of Legislation? Need of neo liberal reputation?

29 Argentina: Reform: components of new mixed system Public Component Universal Basic Pension Compensatory Pension Additional Pension per Permanence (PAYGS) Private Component Capitalisation System

30 Argentina: Public Responsibilities During Transition Old System Pensions Compensatory Pension During and after Transition Universal Basic Pension Additional Pension per Permanence

31 Argentina: Public Responsibilities During Transition The day after pension reform (for a person with 35 years of contributions): Universal Basic Pension: 27.5% of wages Compensatory Pension: 52.5% of wages Total: 80% of wages

32 Argentina: Fiscal Problems Related to the Reform Expenditure Increases Convertibility plan: Reduction in contributions Need for additional resources Federal Problem of Tax Distribution

33 Public Expenditures in National Pension System and Financing % of GDP Payroll taxes Other financing

34 Financing Requirements of Pension System (2000) Capitalisation 46% (1,5% of GDP) Payroll taxes 34% (1,7% of GDP) Other financing 66% (3,3% of GDP) Tax reductions 41% (1,3% of GDP) Other 13% (0,4% of GDP)

35 Public Expenditure, by Function and Level of Government % of GDP Federal Provincial Local Operative Education Health Pensions Other social expenditure Economic services Public debt

36 Argentina: Impact of Crisis on Public Pension Expenditure As a consequence of: 13% reduction in nominal pensions (July 2001) Not compensation for inflation (40% during 2002) Total expenditure on pensions: 2001: 6.3% of GDP 2002: 5.0% of GDP 2003: 3.8% of GDP

37 Argentina: Post Crisis Problems Capital Market Crisis: Assets of AFJPs (75% of portfolio in government bonds) Lack of credibility in financial institutions Coverage: Old Age Income Protection Programme

38 Argentine Reform: Coverage on Urban Population (as % of Active Population) 100% 90% Unemployed 80% 70% 60% 50% Informal workers 40% 30% 20% 10% Contributors 0% Source: SAFJP Oct-94 May-95 Oct-95 May-96 Oct-96 May-97 Oct-97 May-98 Oct-98 May-99 Oct-99 May-00 Oct-00 May-01 Oct-01 May-02

39 Concluding Remarks Different cases - different problems: There must not be a single reform recommendation Some systems became exhausted: Need of modernisation, changes in the parameters of the system and improvements of system administration Many systems reached poor coverage (unemployment, informality...) Many systems suffers from political pressures

40 Concluding Remarks Most reform needs are independent of Privatisation, but the introduction of Private Capitalization Schemmes has to be understood as a way of disciplining the system

41 Concluding Remarks Common features of most LA economies: Macroeconomic instability Fiscal Crises Labour Market Problems (Unemployment and Informality) Capital Market Fragility Institutional weaknesses

42 Concluding Remarks The successful case in LA capitalization scheme is a country where reform process has been simultaneous to an unusually high growth rate. Chile does not reflects LA macro behavior, It is an exception. In addition, Chilean reform was done by a military government and the subsequent political transition was exceptionally smooth

43 Concluding Remarks It does not seem that success of Chilean economy during last two decades was due to Pension Reform. But, There are good evidence that pension system reform in Argentina was one of the main causes of macro fiscal crisis in this country

44 Concluding Remarks Due to Macreconomic instability, the future of pension systems in Latin America depends mainly on Macro performance, specially in relation to the possibilities of reach sustaninable growth pattern, full employment, and also the consolidation of capital markets. If it fails, the main problem is to increase Tax Burden in order to finance social benefits for ageing population (and others)

45 Concluding Remarks Need for adequate combination of: Public PAYG system Private Capitalisation Scheme Public Social Protection Programme