The Challenge of Public Pension Reform in Advanced and Emerging Economies Mauricio Soto Fiscal Affairs Department International Monetary Fund January 212 The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management
Motivation Fiscal crises in many countries have underscored the need for credible medium-term adjustment plans Given high levels of taxation in many countrie, fiscal consolidation will often need to focus on expenditure side Pensions comprise high share of public expenditure and spending is projected to rise further Several benefits to pension reform 2
Plan of Presentation Trends and drivers of public pension spending Projected spending increases and risks to projections Pension reform options 3
Pension Spending After rapid increases over 197-199, reforms have slowed spending growth in advanced economies Evolution of Public Pension Expenditures in Advanced Economies, 197 21 (Percent of GDP) 1 9 8 7 6 5 4 3 2 1 197 198 199 2 21 4
Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Contribution to Spending Growth Higher replacement rates and aging have driven spending in advanced economies Evolution of Public Pension Expenditures in Advanced Economies, 197 21 (Percent of GDP) 3 2 2, 1,5 1,9,3,4 -,1-1 -,6 -,5-2 -3 197-199 (Advanced) 199-21 (Advanced) 5
Pension Spending Large increases in pension spending in emerging economies, but from a low level outside Europe Evolution of Public Pension Expenditures in Emerging Economies, 199 21 (Percent of GDP) 12 1 Emerging Europe 8 6 Latin America 4 2 Other Emerging 199 2 21 6
Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Contribution to Spending Growth Higher replacement rates and aging have driven spending in emerging economies Evolution of Public Pension Expenditures in Emerging Economies, 199 21 (Percent of GDP) 3 2 1,4 1,8 1,5 1,9,7,8,2,1, -1 -,7 -,5-2 -1,5-3 199-21 (Latin America) 199-21 (Emerging Europe) 199-21 (Other Emerging) 7
Spending (percent of GDP) Spending (percent of GDP) The variation in spending reflects differences in aging, system generosity, and coverage rates Pension Spending, Replacement Rates, and Aging, 21 2 16 12 8 4 Advanced ITA FRA AUT GRC PRT BEL JPN SVN GER FIN SWE ESP CHE LUX CZE DNK NLD SVK USA NOR GBR NZL AUS CAN IRL ISL KOR 1 2 3 4 5 6 7 Replacement Rate (percent of average wage) Old-age dependency ratio=-1 Old-age dependency ratio=2-3 2 Emerging UKR 16 12 POL HUN EST BRA 8 ROM LTU RUS BGR ARG LVA TUR CHL 4 JOR CHN EGY MYS ZAF SAU PHL THA PAK IDN IND MEX 1 2 3 4 5 6 7 Replacement Rate (percent of average wage) 1 12 14 16 2 46 8 Old-age dependency ratio=1-2 -8 12 Old-age dependency ratio=3-4 8
Turkey Egypt China Jordan Russia Saudi Arabia Malaysia Ukraine Romania Argentina Brazil Mexico Latvia Philippines South Africa Lithuania Thailand Indonesia Pakistan India Bulgaria Chile Poland Estonia Hungary Luxembourg Korea Slovenia Belgium Netherlands New Zealand Norway Switzerland Finland Canada United States Germany Austria Australia Ireland Portugal Slovakia Spain United Kingdom Iceland Greece France Czech Republic Japan Denmark Sweden Italy Spending pressures will intensify in many countries 6 4 2 Increase in Pension Spending, 21 23 (Percent of GDP) Advanced Economies Average=1.2-2 8 6 4 2-2 -4 Emerging Economies Average=1. 9
Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Aging Eligibility Replacement rate Labor force participation Contribution to Spending Growth Enacted reforms are expected to help contain impact of population aging on spending Evolution of Public Pension Expenditures, 21 23 (Percent of GDP) 6 4 3,3 3,9 3,8 2 1,6-2 -,2-2,1 -,5-1,2-1,2 -,3-1,5-1,7 -,3 -,1,1, -4-6 21-23 (Latin America) 21-23 (Advanced) 21-23 (Emerging Europe) 21-23 (Other Emerging) 1
Percent of GDP Percent of 21 GDP The challenge for the emerging economies becomes more pronounced after 23 Evolution of Public Pension Expenditures, 21 25 2, 1,5 1,2 Pension spending increase 1,4 1,7 5 4 NPV 41,1 1, 1, 3 2 26,7,5 1 9,1 7,, 21-23 23-25 21-23 23-25 21-23 23-25 21-23 23-25 Advanced Emerging Advanced Emerging 11
Percent of GDP Percent of 21 GDP The challenge for the emerging economies becomes more pronounced after 23 Evolution of Public Pension Expenditures in Latin America, 21 25 2,5 2, Pension spending increase 2, 5 4 NPV 1,5 3 22,1 1, 2,5,5 1 2,9, 21-23 23-25 21-23 23-25 Latin America Latin America 12
Philippines Thailand Indonesia India Pakistan China Malaysia Average Mexico Chile Argentina Brazil Average Jordan Egypt South Africa Saudi Arabia Average Hungary Poland Turkey Estonia Latvia Lithuania Ukraine Bulgaria Russia Romania Average Pension coverage could increase in the future Pension Coverage in Emerging Economies (Pensioners to Population Above Retirement Age) 1 93 8 68 6 59 4 26 2 Asia Latin America Middle East and Africa Eastern Europe 13
21 Projected 23 21 Projected 23 21 Projected 23 Baseline Increased coverage Baseline Increased coverage Baseline Increased coverage Pension Coverage (Share of Elderly Receiving Pensions) Pension spending increase 21-23 (percent of GDP) The cost of increasing coverage can be substantial Pension Coverage in Emerging Economies 1 75 71 93 97 3 2 2,5 5 25 59 41 48 1,5 1,7,4,7 1,7 Latin America Emerging Europe Other Emerging Latin America Emerging Europe Other Emerging 14
Considerable uncertainty and upside risks to projections Demographic and macroeconomic risks High longevity (>1 percentage point of GDP in 23 spending) Low productivity (>.5 percentage points of GDP in 23 spending) Czech Republic, Russia, Slovakia, Turkey, and Ukraine Italy, Portugal, and Spain Labor force participation (>.5 percentage points of GDP in 23 spending) Brazil, Japan, Korea, Ukraine, the United Kingdom, and the United States 15
Considerable uncertainty and upside risks to projections Other risks Reform reversal (Reform impact >5 percentage points of GDP in 23 spending) Shortfalls in private DB plans (DB plans 3 percent or more underfunded in 29) Austria, France, Hungary, Italy, and Poland Belgium, Japan, and Sweden High share in private DC plans (Pension fund assets >4 percent of GDP) Australia, Canada, Denmark, Finland, Iceland, Ireland, Netherlands, Switzerland, the United Kingdom, and the United States 16
Pension reform options: general considerations Pension reform can play a role in fiscal adjustment strategies in many countries Pension reforms raise important equity issues Some pension reforms can have a positive impact on labor supply and growth 17
Advanced economy reform options Gradually raising retirement ages is an attractive option Reductions in replacement rates could be considered where they remain high Increased payroll contributions could help offset increases in pension spending 18
Reduction in benefits (in percent) Advanced economies: options to stabilize pension spending Tradeoffs Across Reform Options to Stabilize Spending, 21 23 16 14 12 1 8 Increase in payroll taxes (in percentage points) 2.8 2.1 1.4.7 6 4 2,5 1 1,5 2 2,5 3 Increase in retirement age (in years) 19
Emerging economy pension reform options In Latin America and other emerging economies, challenge is to expand coverage in a fiscally sustainable manner In emerging Europe, increases in retirement ages and other parametric reforms could be considered Non-contributory social pensions could be considered in countries with low coverage 2