Assessing Fiscal Costs and the Distribution of Pensions in Transitions to FDC and NDC Systems: A Retrospective Analysis for Chile
Countries assessing structural pension reforms to address problems of financial sustainability and improve economic incentives face the choice between moving to a financial defined contribution (FDC) system, or to a notional defined contribution (NDC) system (or one of its variants). Unfortunately, comparisons regarding the performance of the two systems in terms of the pensions provided and transition costs are normally based on prospective actuarial estimations. In this paper, we follow a retrospective approach by simulating what would have happened in Chile if instead of the original FDC system introduced in 1981, the country would have implemented an NDC scheme. We find that transition costs under an FDC system can be considerably higher than under an NDC. In the case of Chile, other things being equal, introducing an NDC system would have generated fiscal savings during the first 45 years after the reform equivalent to 50% of initial GDP. The cost of the minimum pension guarantee would have been higher under an NDC system that pays the growth rate of the covered wage bill. This is because during the first twenty years after the reform the rate of return on financial assets was higher than the growth rate of wages. Our analysis suggests, however, that this does not have to be always the case. Depending on the assumptions regarding the stochastic process driving the dynamics of the rate of return paid by the FDC system, expected replacement rates under the NDC are not necessarily lower.
Colombia's pension reform : fiscal and macroeconomic effects
In 1994 Colombia started replacing its state-run and pay-as-you-go (PAYG) pension system by a privately-run and fully-funded scheme. This study analyzes prospective fiscal and macroeconomic implications of this reform. It compares the features of Colombia's old and new pension system, puts them into broader international context, and looks at the reform transition. Numerical simulations for the government's reform transition reveal implicit PAYG debt levels and corresponding reform transition deficits that are high relative to other countries, considering that Colombia's old pension system was characterized by low coverage, low system maturity, and a young population. Simulation results show that output could increase by 10 percent due to higher future saving caused by financing the pension deficit by a fiscal contraction - but this would occur only in the very long term. Sooner and possibly larger gains could be reaped from higher employment and production in formal sectors, and the development of capital markets spurred by the reform. In addition, Colombia's new pension system - which includes a redistributive pillar targeted at the poor -- is potentially more equitable than the old scheme. To reap these efficiency and equity benefits, however, the Colombian government would have to adopt complementary reforms. They include giving the private fully-funded pension pillar a commanding role, supporting the development of capital markets, and bolstering formal-sector employment by the reduction of deadweight tax burden of non-pension programs that are currently financed by payroll taxes on labor.
The Use of Qualitative Information in Macro-Economic Policy Analysis
The majority of macro-economic policy models takes for granted that conflicts among objectives can be assessed by means of a tradeoff analysis. Such tradeoffs imply that sacrifices and benefits of various impacts of decisions can be measured on a cardinal scale, so that a conventional macro-economic utility or welfare analysis can be applied.