Protecting the old and promoting growth : a defense of averting the old age crisis

The current social security systems in many OECD countries were adopted before World War II, when private financial markets were underdeveloped or in disrepute. They expanded sharply in the 1950s and 1960s, when real wages and population were growing rapidly. Under those circumstances, it seemed natural to rely on a publicly managed payroll-tax-financed pay-as-you-go (PAYG) system. But in the past 40 years, real wage growth has slowed and population growth has come to a halt in OECD countries, so tax rates must go up sharply if PAYG systems are to be retained. It has become increasingly important to minimize work disincentives and to increase labor productivity through capital accumulation, which the public pillar is not well-suited to do. Shifting partial responsibility to privately managed plans that are funded and that tie benefits to contributions is likely to improve economic growth and provide better benefits than will continued reliance on a payroll-tax-financed PAYG system, concludes the World Bank. The OECD countries can shift gradually to a two-pillar system by reducing and flattening the benefits in their public pillars and using the released resources (plus some additional contributions) to build funded defined contribution accounts in a new mandatory saving pillar. If developing countries follow the path of the OECD countries once followed, they will encounter dramatically escalating contribution rates, great intergenerational transfers, and related problems. Given their rapid rate of demographic aging, it is important for them to establish a multi-pillar system from the start. The author argues that the World Bank position differs from those of the International Labour Organization (ILO) and International Social Security Association (ISSA) because the Bank is more concerned about how social security systems affect the general economy; is troubled by inequities often found in current systems (in practice, if not on paper); believes that behavioral responses and factors of political economy sometimes make nonviable the design changes the ILO and ISSA recommend for public systems; and values risk diversification. (Financial markets are now both better and more global than before, so multipillar systems benefit from revenue and managerial diversificaiton, including international diversification.)