Pension reform in small developing countries

The authors provide a framework in which small countries can assess the proper role for the state and the private sector in pension policy. Based on industrial organization theory and pension economics, this framework draws on experience in small countries. The authors identify how optimal pension policies can change in small countries (those with fewer than 1 million active contributors to pension funds), explore optimal pension reform design for small countries, and incorporate other stylized assumptions about small countries into the discussion: the relatively greater international mobility of labor and capital, the greater scarcity of human capital specialized in financial supervision and tax administration, fewer independent interests, and higher political volatility and risk over long time horizons. They conclude that: 1) For small countries the Chilean model should be modified to include greater reliance on international trade in financial services -- especially services that benefit from economies of scale and scope, such as collections, account processing, and benefit payments. Such an approach would require a greater harmonization of accounting and regulatory standards between small developing countries and the countries from which financial services are imported. 2) The unbundling of pension services is more advantageous in small than in large countries. 3) The collection of contributions and the payment of benefits (which are subject to substantial economies of scale for small countries) should be mandatorily unbundled from other pension services. 4) Those services should be provided separately to ensure competition in the selection of trustees and competitive investment management services. This type of pension system design may be preferable to having a foreign firm provide all pension services. 5) When other assumptions (such as susceptibility to large gross migration flows) are combined with the assumption of a small-country base, mandatory pension systems or fiscal incentives are found to be less effective in small than in large countries. Large countries have broader contribution bases and much smaller gross migration flows, making them demographically more stable. 6) The relatively greater international migration in small countries makes full funding of pension systems even more important in small than in large countries.