Pension Regimes in Latin American Emerging Countries: Do and can Individual Capitalization and PAYG Systems coexist?

Ascea Marina (Provincia de Salerno)

Congreso; Ascea Marina Summer Course; 2014

Universidad de Salerno

As of the eighties and later in the nineties, several countries in Latin America began to assess the convenience of substituting the existing PAYG pension schemes or of adding privately managed fully funded pension systems ?based on individual capitalization accounts- leaving on contributors hands´ (labor and self employed workers) the decision over the preferred system. In some cases, the switch took place all of a sudden following bankruptcy situations faced by PAYG regimes, whose causes could be traced back to sharp inflationary processes and economic and demographic unbalances that dwindled to unbearable levels the workers/retirees ratio and increasing existing pension regimes´ deficits; the massive incorporation of beneficiaries (specially self employed) through ad-hoc plans amounting to a bail out and the channeling of pension resources to general fiscal revenues, in order to deal with the important deficits originated by a growing public spending and the difficulties in tax collection and budgetary financing, must also be accounted for at the moment of explaining the crisis of unfunded pension schemes. Nevertheless, it needs to be acknowledged that a widespread fall in saving rates occurring by the time in many Latin American countries, must also be acknowledged as an important motivation underlying substantial changes in pension systems, as the idea prevailed that the accumulation of pension fund assets would definitely encourage aggregate savings and contribute also to enlarge domestic capital stock markets. In this connection, the paper reviews fully funded pension regimes in all the eight countries chosen (Argentina, Bolivia, Brazil, Colombia, Mexico, Peru and Uruguay), and analyzes determined features concerning affiliations, compliance, investment portfolio structure and some other related indicators with the expectation of shedding light on individual capitalization´ performance in the Region following something more than two decades since it came into being. One underlying rationale behind what Bertranou et al (2009) called the First Round of Reforms was the idea that defined contribution schemes were going to enhance not only the level of coverage, but also tax compliance, given the fact that individuals would not only find a stronger connection between contributions and benefits but also because they would regard contribution payments as a save instead of a tax; nevertheless, supporting evidence shows that the rate of coverage fell in all the eight countries once fully funded schemes started to operate, accounting for this to happen the existing structure of labor markets in which informality was by no means a minor feature, apart from other features such as the high unemployment level. A second important reason explaining why fully funded regimes fell short of fulfilling expectations was that, contrariwise to PAYG systems, they did not solve the problem of inter and intra generational solidarity for what public intervention had to be called upon in order to handle, via non contributory regimes, the situation of the elderly with no incomes. A third worth emphasizing matter was that, after an initial enthusiasm with fully funded schemes, a feeling of disappointment grew among retirees when they realized that the quantum of their benefits was by far much smaller than originally expected, as rates of return resulted negatively affected by the excessive burden of items such as fees, insurance premium and other costs detracted from their original contributions. A last but by no means less important matter referred to imperfect regulation, one of whose flaws was a marked degree of financial weakness caused by political interference with funds´ investment policies whereby pension administrators suffered an enormous pressure from governments to increase the share of public bonds in the portfolios. In sum, a fair answer to the question posed above should be that many Latin American countries managed to legally enact ?and operate- sophisticated fully funded pension regimes that not only relieved governments in a moment of fiscally strained fiscal budgets but also served the purpose of enhancing aggregate saving and of furthering financial markets. Nevertheless, the experience of almost two decades of fully funded regimes clearly shows that important changes are indispensable should countries intend to continue running pension systems based on individual capitalization accounts. Although many experts have pointed out that the use fully funded schemes en Latin American countries gathered recently political rejection and experienced setbacks, the prevailing idea is that fully funded and unfunded regimes can and should coexist for what individual accounts should be improved while accepting ?at the same time- that PAYG and non contributory regimes should accompany properly designed and run defined-contribution schemes as the former could better meet solidarity, equity and distributional goals. Given that the performance of any pension regime, or combination of pension regimes, must be judged for the efficacy in reaching expected levels of coverage, equity and efficiency as well as for its success in guaranteeing long run financial sustainability, any social security economic policy must necessary address a set of matters which, for the sake of illustration are listed below: 1. Non contributory pensions will be necessary, on grounds of distributional, solidarity and equity goals and they should be used in connection to programs aimed at checking poverty and structural unemployment. 2. Coverage and tax compliance need to be expanded, both in fully funded and unfunded regimes, one obvious sector to aim at is in this regard that of self employed workers. 3. Individual capitalization may be improved and turned more attractive in various ways: as for instance by reducing administrative and commercial costs in order to allow rates of return to increase and by offering a more varied portfolio composition both in term of financial instruments and of levels of risk. 4. Competition between fully funded and unfunded regimes, in so far as this permits affiliates to switch from one to another, could at the end be favorable in terms of efficiency. 5. Financial sustainability of PAYG regimes may be deepened by resorting to ad-hoc reserve funds, as for instance the Sustainability Guarantee Fund in Argentina.