Reforming Pensions: Lessons from Economic Theory and Some Policy Directions

Abstract

ension systems have wide-ranging and important effects.They influence the living standards of older people and hence the welfare of both older people and their children.They can also affect national economic performance through potential effects on the labor supply and saving.The design of pensions therefore matters.In discussing the topic, this paper draws on two of our earlier works. 1 It starts by setting out some central lessons from economic theory.The second section derives some policy implications of particular relevance to Latin America.The policy chapters in our two earlier books focus particularly on two countries in which we have worked: China, which is important because of its size, and Chile, which is important because its 1981 reforms were widely adopted in Latin America and elsewhere and which has become an exemplar in the pension debate.Box 1 defines some of the relevant terms.The final section concludes. Key Lessons from Economic TheoryEconomic theory offers a series of conclusions that should frame policy design.Some of them, though apparently obvious, are frequently forgotten; others can be counterintuitive.We focus on five sets of lessons: pension systems have multiple objectives; different pension systems share risks differently, both across people and over time; there is no single best pension system; pensions should be analyzed in a second-best context, that is, taking account of market imperfections and other distortions; and a move to funding may or may not be the right policy.

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