Pension reform and fiscal policy: some (tentative) lessons from Chile - BBVA Research
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Pension reform and fiscal policy: some
(tentative) lessons from Chile
A. Melguizo, A. Muñoz, D. Tuesta, J. Vial
BBVA (Economic Research Department, Pensions and Insurance America)
11th Banca d’Italia Workshop on Pension Reform, Fiscal Policy and
Economic Performance
1
Perugia, March 26-28 2009
11th Banca d’Italia Workshop, Perugia. March 20091 2 3 4 Motivation
Chilean pension system is interesting for several reasons:
• Individual capital accounts managed by the private sector, functioning for 28
years: data and research (Corbo and Smidt-Hebbel, 2003, Gill et al., 2005).
• Social and political support.
• Benchmark for many emerging (and industrialized) economies.
• On-going second-generation reform, focused on the solidarity pillar.
• Favre et al. (2006), Comisión Marcel and many others.
Æ Fiscal cost of structural pension reform are high and persistent, but
affordable if ...
11th Banca d’Italia Workshop, Perugia. March 2009 2OUTLINE 1. The promise and outcome of pension reform. 2. On-going reform: strengthening the redistributive pillar. 3. On the exportability of the Chilean model. 4. Concluding remarks. 11th Banca d’Italia Workshop, Perugia. March 2009 3
1 2 3 4 The promise and outcome of pension reform
Macroeconomic benefits, plus fiscal consolidation.
• The main goal of pension reform is to achieve ‘adequate, affordable, sustainable
and robust pensions, while at the same time contributing to economic
development’ (Holzman and Hinz, 2005).
• Some macroeconomic benefits are expected from structural pension reform (i.e.
DC individual capital accounts vs. DB pay-as-you-go schemes):
• higher (formal) employment.
• higher domestic savings and investment rates.
• financial deepening and faster TFP growth.
• fiscal consolidation: long-term fiscal savings outpace short-run fiscal costs
(´transition costs’).
11th Banca d’Italia Workshop, Perugia. March 2009 41 2 3 4 The promise and outcome of pension reform
Defining the transition deficit.
• The ‘transition costs’ include various items:
• deficit of the old DB pay-as-you-go system (open or closed).
• accrued pension rights of affiliates who switch from the old to the new
pension system (if existing).
• contributory minimum pensions (in the new scheme vs. the old one).
• minimum non-contributory pensions (in the new scheme vs. the old one).
• others…
• Structural pension reform in Latin America has varied significantly (Mesa-Lago,
2004), and quantifying these items, even on a national basis, is not
straightforward.
11th Banca d’Italia Workshop, Perugia. March 2009 51 2 3 4 The promise and outcome of pension reform
The transition cost in backward-looking numbers.
Figure 2. Transition deficit of the Chilean civil pension system
(GDP share)
The Chilean
Minimum pensions
pension reform
6,0 Non contributory pensions shows that fiscal
Recognition bond costs are:
INP deficit
5,0
-high (4 p.p, of
4,0
potential GDP
per year).
3,0 - persistent
(since 1981).
2,0
- heterogeneous
1,0 (nature and
timing): INP,
0,0 Recognition
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Bonds, minimum
pensions.
11th Banca d’Italia Workshop, Perugia. March 2009 61 2 3 4 The promise and outcome of pension reform
Looking forward.
Figure 4. Density of contributions by gender in Chile, 2004-2006
60
Males Females
Chile shares a general
50 trend in emerging
economies:
Percent of affiliates
40
precarious insertion of
many people into the
30
labor market, with
frequent flows between
20 the formal sector, the
informal sector and
10 unemployment
0
0-20 20-40 40-60 60-80 80-100
Density of contributions
11th Banca d’Italia Workshop, Perugia. March 2009 71 2 3 4 The promise and outcome of pension reform
Looking forward: insufficient coverage (‘affordable but not adequate’)...
Figure 5. Projection of minimun pension beneficiaries in Chile
(No reform scenario, percentage of pensioners with pension rights < minimum pension)
• Actuarial-macro model,
0,5 2005-2050, based on
Not covered women
Not covered men public data: 19 cohorts,
Covered women
0,4
Covered men
differentiated by 5
densities of contribution,
0,3 gender and salary (Favre
et al., 2006).
0,2
• Includes the main
institutional features (RB,
0,1
official disability and
mortality tables, tariffs
0,0
2015 2025 2035 2045
and fees, phase-out).
Many affiliates would not accrue pension rights above the minimum, and would not
qualify either for contributory benefits (mostly women; Berstein et al., 2005).
11th Banca d’Italia Workshop, Perugia. March 2009 81 2 3 4 The promise and outcome of pension reform
Looking forward: … but significant fiscal leeway.
Figure 6. Projection of the transition deficit of the Chilean civil pension system
(No reform scenario, GDP share)
Minimum pensions
4,0 Non contributory pensions
Recognition bond
3,5 INP deficit
3,0
2,5
2,0
1,5
1,0
0,5
0,0
2010 2015 2020 2025 2030 2035 2040 2045 2050
The overall transition deficit would decrease down to 2.3 per cent in 2020 and 1.5
per cent in 2025: exhaustion of RB and the gradual decrease of the INP deficit (i.e.
‘pure’ transition cost).
11th Banca d’Italia Workshop, Perugia. March 2009 9OUTLINE 1. The promise and outcome of pension reform. 2. On-going reform: strengthening the redistributive pillar. 3. On the exportability of the Chilean model. 4. Concluding remarks. 11th Banca d’Italia Workshop, Perugia. March 2009 10
1 2 3 4 On-going reform: strengthening the redistributive pillar
The government has enacted an ambitious second generation reform.
Table 2. Chilean pension system. Diagnosis and reform
Diagnostic Law 20.255 (March 2008)
Poverty risk at old-age (coverage) New redistributive pillar (SPS)
Low density of contribution Gradual compulsory contribution
among self-employed Fiscal advantages (same as dependent)
Low projected replacement Public contributions in case of maternity
rates for women
Low competition Auctioning for new affiliates (based on fees)
Join bidding for survivors and diability insurance
Goals: strengthening the first pillar (minimum pensions), raising coverage and
density of contributions, increasing gender equality, improving competition and
reducing costs, and generating better conditions for investment (Consejo Asesor
Presidencial para la Reforma Previsional, 2006)
11th Banca d’Italia Workshop, Perugia. March 2009 111 2 3 4 On-going reform: strengthening the redistributive pillar
The new SPS in theory: old-age and disability progressive benefits.
Figure 7. Reformed old-age pension system in Chile
Figure 8. Reformed disability pension system in Chile
Final pension Final pension
PMAS
PBS
PBS
45'
45'
Base pension
Base pension
The new redistributive pillar SPS (Sistema de Pensiones Solidarias) strengthens
old-age and disability pensions for middle- and low-income citizens, based on two
new benefits: APS (complementary to accrued benefits) and PBS (lump sum).
11th Banca d’Italia Workshop, Perugia. March 2009 121 2 3 4 On-going reform: strengthening the redistributive pillar
The new SPS: significant and persistent fiscal effort…
Figure 9. Projection of the expenditure of the solidarity pillar in Chile
(Reform vs no reform scenarios, GDP share)
• Actuarial simulation
1,4 2008-2022 based on
Minimum pensions
public data. Affiliates are
1,2 SPS
‘regular’ (100 per cent) or
1,0 ‘informal’ contributors (20
0,8
per cent), differentiated
by gender and salary.
0,6
• The main macro and
0,4 technical assumptions
0,2 are in line with official
projections (Arenas et al.,
0,0
2008).
2010 2015 2020 2022
Significant additional fiscal cost (0.7 p.p. of GDP on average 2008-2022; official
estimate 1.0 p.p. Arenas et al., 2008), but i) good timing (RB is close to peak)…
11th Banca d’Italia Workshop, Perugia. March 2009 131 2 3 4 On-going reform: strengthening the redistributive pillar
The new SPS: … with a extraordinary and necessary social impact.
Figure 10. Projection of beneficiaries of the new solidarity pillar in Chile
(Persons)
2.000.000
Old-age APS Old-age PBS
1.750.000
Disability
1.500.000
1.250.000
1.000.000
750.000
500.000
250.000
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
… and ii) significant social impact (higher coverage). According to our projections,
in 2022 1.8 million people would benefit from the SPS (mainly old-age APS, 1.3 M).
11th Banca d’Italia Workshop, Perugia. March 2009 14OUTLINE 1. The promise and outcome of pension reform. 2. On-going reform: strengthening the redistributive pillar. 3. On the exportability of the Chilean model. 4. Concluding remarks. 11th Banca d’Italia Workshop, Perugia. March 2009 15
1 2 3 4 On the exportability of the Chilean model
Institutions and issues to be considered: Informality.
Figure 12. Informality and GDP per capita in LAC
(1990-2007, percentage of urban workers)
80
Informality
70
PER99
60 PER03
PER01
50
MEX02
COL02 MEX04
COL04
MEX06
MEX98
40 COL99 COL05
MEX05
CHI90
COL91
30 CHI98 CHI03
CHI06
CHI00 Income (2000 US$)
20
0 2.000 4.000 6.000 8.000 10.000
Public and market institutions are crucial, especially to elude a vicious interaction
solidarity pillar-contributions-labour market informality.
11th Banca d’Italia Workshop, Perugia. March 2009 161 2 3 4 On the exportability of the Chilean model
Institutions and issues to be considered: Fiscal policy and others.
Figure 3. Central government net lending in Chile
(Cash, GDP share)
10,0
5,0
0,0
-5,0
-10,0
-15,0
Pension reform
-20,0
1971 1973 1975 1977 1979 1981 1983 1985 1987 1989
Fiscal consolidation prior to the reform is key: macroeconomic benefits, and for
second generation reforms (in the right way). Other: gradual financial reform, social
preferences, etc (Barr and Diamond, 2006).
11th Banca d’Italia Workshop, Perugia. March 2009 171 2 3 4 On the exportability of the Chilean model
Pension reform and coverage in Latin America: ‘work in progress’.
Mandatory contributions for retirement insurance in Mexico
(percentage of worker's income) Extending coverage
14 in Latin American
Social Quota
reformed schemes
12
Other Fed. Gov. (CO, MEX, PER) is
Worker
10 Employer
limited by:
-fragmentation of
8
pension schemes
6 (MEX)
4 - informality (all).
2
- not mandatory for
independents
0 (MEX, PER)
1 3 5 7 9 11 13 15 17 19 21 23 25
Number of minimum wages - fiscal cost (all)
11th Banca d’Italia Workshop, Perugia. March 2009 18OUTLINE 1. The promise and outcome of pension reform. 2. On-going reform: strengthening the redistributive pillar. 3. On the exportability of the Chilean model. 4. Concluding remarks. 11th Banca d’Italia Workshop, Perugia. March 2009 19
1 2 3 4 Concluding remarks
1. The main rationale behind structural pension reform in Latin America has been
its long-term fiscal benefits (lower implicit debt), plus some related
macroeconomic benefits (formal employment, capital and financial deepening).
2. Chile is especially interesting for several reasons:
- Individual capital accounts managed by the private sector since 1981.
- Social and political support.
- Benchmark for many emerging and industrialized economies.
- On-going second-generation reform, including the solidarity pillar.
11th Banca d’Italia Workshop, Perugia. March 2009 201 2 3 4 Concluding remarks
3. Chilean pension and macroeconomic outcomes are supported by fiscal
orthodoxy (fiscal consolidation in the late 70s), and good public and market
institutions. The on-going second generation reform is fiscally affordable, and
would make the system ‘socially adequate and sustainable’.
4. The reform agenda is not closed, especially for other Latin American
economies (Colombia, Peru and Mexico).
- Mandatory and/or opt-out schemes for independents and informal.
- Solidarity pillar. Relaxation of eligibility criteria vs. (dis)incentives.
- Contribution rates. Evaluation of rates and taxable income.
- Disability and survivors benefits. DB/DC, and administrative control.
- Pension funds portfolio. Infrastructures, default allocation.
- Competition, fees and financial knowledge.
11th Banca d’Italia Workshop, Perugia. March 2009 21Pension reform and fiscal policy: some
(tentative) lessons from Chile
A. Melguizo, A. Muñoz, D. Tuesta, J. Vial
BBVA (Economic Research Department, Pensions and Insurance America)
11th Banca d’Italia Workshop on Pension Reform, Fiscal Policy and
Economic Performance
22
Perugia, March 26-28 2009
11th Banca d’Italia Workshop, Perugia. March 20091 2 3 4 Annex
Figure 1. Old-age dependency ratio, 1980-2025
(L+65/L15-64)
35
OECD
Chile
30
China
LatAm
25
India
20
15
10
5
0
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
Note: LatAm is the simple average of Colombia, Mexico and Peru
Source: United Nations. World Population Prospects: The 2006 Revision
11th Banca d’Italia Workshop, Perugia. March 2009 231 2 3 4 Annex
Table A1. Fiscal expenditure in pensions in Chile
(GDP share)
Year Old system deficit Recognition Minimum PASIS Total
Civil Military Bonds Pensions (non contributory)
1981 1,6 2,0 0,0 0,0 0,2 3,8
1984 4,7 2,2 0,2 0,0 0,5 7,6
1990 3,2 1,3 0,5 0,0 0,4 5,4
1995 2,7 1,2 0,7 0,0 0,3 4,9
2000 3,1 1,3 1,1 0,1 0,4 6,0
2005 2,2 1,3 1,2 0,1 0,4 5,2
2008 1,9 1,3 1,2 0,1 0,4 4,9
Note: The figure for the civilian deficit in the old system includes 0,3 p.p. in minimum pensions, Valdés (2006)
Source: National Budget Office
11th Banca d’Italia Workshop, Perugia. March 2009 241 2 3 4 Annex
Figure A1. Categories of affiliates by density of contributions in Chile
50
AFP Provida
45 HLSS
40
35
Percent of affiliates
30
25
20
15
10
5
0
A B C D
Density of contributions
Note: 'A' affiliate contribute over 80 percent of the time, 'B' between 60 and 80 percent, 'C' between
40 and 60 percent, and 'D' under 40 percent.
Source: 2002 Social Protection Survey and AFP Provida (data up to 2004)
11th Banca d’Italia Workshop, Perugia. March 2009 251 2 3 4 Annex
Table A2. Projection of replacement rates of Chilean pension system Table A3. Projection of the pension level in Chile
(Percentage over last 10 salaries, by cohorts, densities, salaries and sex)
(Monthly pension, 2004 Chilean pesos)
2010 2025 2050
2010 2025 2050
Men Women Men Women Men Women
Men Women Men Women Men Women
A 111,7 78,0 69,9 36,5 67,8 50,3 A1 1.107 750 930 487 1.336 829
A1 106,5 72,2 89,6 46,9 128,5 79,8 A2 768 515 652 337 1.070 701
A2 112,6 78,2 62,7 35,3 102,9 67,5 A3 365 250 323 176 588 401
A3 112,6 74,7 68,9 36,4 67,6 44,7 A4 210 143 182 96 333 222
A4 112,6 76,5 67,3 35,5 66,4 44,4 A5 121 79 104 50 182 114
A5 112,6 82,9 66,8 35,8 63,1 44,4 B 198 140 214 91 408 245
B 52,7 36,7 39,5 16,4 39,3 23,6 C 173 115 140 50 303 185
C 46,3 30,0 25,7 9,0 29,2 17,8 D 18 13 84 29 126 73
D 4,8 3,4 15,5 5,2 12,1 7,0 E1 721 445
E1 69,4 42,8 E2 619 404
E2 59,6 38,9 E3 348 238
E3 40,0 26,5 E4 196 131
E4 39,0 26,2 E5 108 67
E5 37,5 26,2 F 339 176
F 32,7 17,0 Average 206 146 244 83 320 204
Average 54,9 38,6 45,8 17,9 44,3 26,7 Minimum pension 77 94 121
Total average 44,9 29,0 33,8 Source: Favre et al. (2006)
Source: Favre et al. (2006)
11th Banca d’Italia Workshop, Perugia. March 2009 261 2 3 4 Annex
Table A4. Projection of fiscal expenditure in civil pensions in Chile
(No reform scenario, GDP share)
Year Old system Recognition Minimum PASIS Total
deficit Bonds Pensions (non contributory)
2010 1,7 1,4 0,1 0,3 3,4
2015 1,3 1,4 0,1 0,3 3,1
2020 1,2 0,7 0,0 0,3 2,3
2025 1,0 0,2 0,1 0,3 1,5
2030 0,8 --- 0,1 0,3 1,1
2035 0,6 --- 0,1 0,3 1,0
2040 0,5 --- 0,1 0,3 0,9
2045 0,4 --- 0,1 0,3 0,8
2050 0,3 --- 0,1 0,3 0,7
Source: Favre et al. (2006)
11th Banca d’Italia Workshop, Perugia. March 2009 271 2 3 4 Annex
Official' projection of the transition deficit in Chile
(No reform scenario, GDP share)
Minimum pensions
4,0 Non contributory pensions
Recognition bond
3,5 INP deficit
3,0
2,5
2,0
1,5
1,0
0,5
0,0
2010 2015 2020 2025 2030 2035 2040 2045 2050
Source: Arenas and Gana (2005), Favre et al. (2006) and Arenas et al. (2008)
11th Banca d’Italia Workshop, Perugia. March 2009 281 2 3 4 Annex
Figure 11. Market and public institutions rankings
(Doing Business 2009, Governance 2007, Best = 1.0)
1,0
0,9 Market institutions
Public institutions
0,8
0,7
0,6
0,5
0,4
0,3
0,2
0,1
0,0
OECD Chile Brazil India LatAm China
Note: LatAm is the simple average of Colombia, Mexico and Peru
Source: World Bank and own elaboration
11th Banca d’Italia Workshop, Perugia. March 2009 291 2 3 4 Annex
Figure A2. Replacement rate and GDP pc in OECD and Chile
(Percent of pre-retirement gross earnings)
100
Replacement
90
TUR
CHI_A GRE
SPA ITA
80
HUN AUS
FIN
70 NET
POR
SWE
60 POL SWI
FRA ICE NOR
50 JAP
SLO
CHI CZE GER
KOR CAN DEN
40 BEL
MEX NZ
UK US
30 IRE
20
10
Income (k US$ PPP)
CHI_D
0
0,0 5,0 10,0 15,0 20,0 25,0 30,0 35,0 40,0
Source: OECD and Favre et al. (2006)
11th Banca d’Italia Workshop, Perugia. March 2009 301 2 3 4 Annex
Structural pension reforms in Latin America.
System Contribution Benefit Regime Administration
Structural reforms
Sustitutive
Chile, May 1981
Bolivia, May 1997 Private DC Not defined Individual Private
Mexico, Sep 1997 account
El Salvador, May 1998
Dominican Rep, 2003
Nicaragua, Postponed
Parallel
Peru, June 1993 Public / Not defined / DB / PAYG / Public /
Colombia, April 1994 Private DC Not defined Individual Private
Mixed
Argentina, July 1994
Uruguay, April 1996 Public + Not defined + DB + PAYG + Public /
Costa Rica, May 2001 Private DC Not defined / Individual Multiple
Ecuador, Postponed
Source: Mesa-Lago (2004)
11th Banca d’Italia Workshop, Perugia. March 2009 311 2 3 4 Annex
On the benefits of portfolio allocation default options. Chile.
- From 56/51 years (men/women), affiliates cannot chose Fund A (40-80 per
cent in equities).
- Pensioners cannot choose Funds A and B.
- Default options decrease the equity composition of the portfolio as the
affiliate ages (from B to D).
Affiliates by pension multi-fund in Chile, 2008
Under 20 +20 -25 +25 -30 +30 -35 +35 -40 +40 -45 +45 -50 +50 -55 Over 55
Fund A 8,7% 21,1% 18,4% 15,1% 12,6% 11,1% 8,3% 4,0% 0,7%
Fund B 7,6% 18,1% 22,0% 23,6% 21,7% 2,2% 1,4% 1,6% 1,7%
Fund C 0,1% 0,6% 1,1% 1,5% 22,4% 26,9% 23,8% 16,4% 7,2%
Fund D 0,0% 0,1% 0,5% 0,9% 1,1% 1,3% 1,3% 27,1% 67,7%
Fund E 0,3% 1,8% 5,9% 10,2% 12,9% 15,1% 15,4% 14,2% 24,2%
Source: SAFP
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