Reforming Social Security Around the World: Common Solutions, Contrasting Solutions

This paper describes the multi-pillar social security reform strategy that many countries have been adopting in recent years. This strategy includes a public pillar that provides a social safety net, a privately managed funded pillar that handles peoples' mandatory retirement savings, and a voluntary pillar for people who want more consumption in old age. The basic rationale is that relying to some extent on funding and defined contribution plans enhances system sustainability and has a positive impact on the broader economy. The paper contrasts three variations on the multi-pillar model-the Latin American model pioneered by Chile, in which individual workers choose the investment manager for their retirement funds; the OECD model first adopted by Switzerland, in which employers are required to provide a retirement plan and (sometimes together with union trustees) choose the investment manager; and the Swedish model in which a large notional DC plan is supplemented by a smaller funded DC plan, with investment carried out by managers who agree to abide by special negotiated fees. Preliminary empirical evidence on the efficiency and growth impact of multi-pillar pension reform, mostly from Chile, indicates a positive impact on national saving and financial market development, and through these on economic growth. But new institutional arrangements also bring new problems, among them being administrative costs that in some cases are large. Switzerland was one of the first countries to institute a multi-pillar system and, as a result, its social security system is in relatively good shape. But old systems can always be improved and need to be adapted to changing demographic and economic conditions. The major change that might be considered in Switzerland concerns the liberalization of the investment strategy and degree of worker control in the second pillar to enable a higher rate of return and, relatedly, permitting greater flexibility in the annuity market. This might help reduce the contribution needed for the second pillar, thereby freeing up some funds to meet the increased cost of the first pillar, as populations age. 1 Over the next 35 years, the proportion of the world's population that is over age 60 will nearly double, from 9% to 16%. In OECD countries almost 30% of the population will be over age 60. (Figure 1). But due to rapid increases in life expectancy and declines in fertility rates, populations are aging much faster in developing countries than they did in industrial countries. As young …