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Pension reform in Hungary : a preliminary assessment

  • Rocha, Roberto
  • Vittas, Dimitri
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    Hungary is entering the fourth year of a multi-pillar pension reform that has proved popular among workers despite initially lukewarm support from the government that succeeded the reforming government, and despite the poor initial performance of capital markets because of Russia's crisis in 1998. Roughly half the labor force joined the new system voluntarily. Most who switched were younger than 40. Many people switched to the system because it offered more risk diversification. The pay-as-you-go (PAYG) system, which had been severely damaged by repeated manipulation of its parameters, clearly offered a low return on contributions. The new system is still predominantly PAYG. The first pillar accounts for more than two-thirds of the total contribution, but the new second pillar offers the chance of higher average returns on contributions. Most workers probably intuited the risk and returns inherent in a pure PAYG system and mixed system, including the capital market risk in the second pillar and the political risk in the PAYG pillar. The new system offers better prospects of long-run risk-adjustment returns for young workers, and most young workers effectively opted for the new system. But the new system was probably oversold as well, making older workers - who would be better off staying in the reformed PAYG system - switch too. The government has so far decided not to increase the contribution to the second pillar from 6 to 8 percent, as originally planned, so efficiency gains in labor and capital markets may also be smaller than expected. Addressing projected deficits in the PAYG system may require further adjustments, such as delaying the retirement age and shifting to indexed prices, reducing netbenefits to future generations. Reform has sharply reduced the severe initial bias against future generation but hasn't eliminated it altogether. The voluntary switching strategy achieves the same outcome as a forced switch based on an arbitrarily cutoff age, while preventing legal problems and contributing to the reduction of the implicit pension debt. But it leaves a few individuals worse of the if they'd chosen their best option - a problem a well-designed public information campaign can reduce.

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    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2631.

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    Date of creation: 31 Jul 2001
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    Handle: RePEc:wbk:wbrwps:2631
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    1. Iglesias, Augusto & Palacios, Robert J., 2000. "Managing public pension reserves - Part I : evidence from the international experience," Social Protection Discussion Papers 21311, The World Bank.
    2. DeMarco, Gustavo & Rofman, Rafael & Whitehouse, Edward, 1998. "Supervising mandatory funded pension systems : issues and challenges," Social Protection Discussion Papers 20113, The World Bank.
    3. Laurence J. Kotlikoff, 1995. "Privatization of Social Security: How It Works and Why It Matters," NBER Working Papers 5330, National Bureau of Economic Research, Inc.
    4. Corsetti, Giancarlo & Schmidt-Hebbel, Klaus, 1995. "Pension reform and growth," Policy Research Working Paper Series 1471, The World Bank.
    5. Palacios, Robert & Rocha, Roberto, 1998. "The Hungarian pension system in transition," Social Protection Discussion Papers 20048, The World Bank.
    6. Vittas, Dimitri, 1998. "Regulatory controversies of private pension funds," Policy Research Working Paper Series 1893, The World Bank.
    7. Martin Feldstein, 1995. "Would Privatizing Social Security Raise Economic Welfare?," NBER Working Papers 5281, National Bureau of Economic Research, Inc.
    8. Martin Feldstein, 1996. "The Missing Piece in Policy Analysis: Social Security Reform," NBER Working Papers 5413, National Bureau of Economic Research, Inc.
    9. Disney, Richard, 1999. "Notional accounts as a pension reform strategy : an evaluation," Social Protection Discussion Papers 21302, The World Bank.
    10. Vittas, Dimitri, 1996. "Private pension funds in Hungary : early performance and regulatory issues," Policy Research Working Paper Series 1638, The World Bank.
    11. Disney, Richard & Whitehouse, Edward, 1992. "The personal pensions stampede," MPRA Paper 10476, University Library of Munich, Germany.
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