The Political Economy of Structural Pension Reform

This paper examines the political economy of structural social security reformthe shift from a publicly managed, pay-as-you-go, defined benefit system to one that includes a defined contribution, funded, privately managed pillar. We analyze the connection between the preexisting conditions in a country and the reforms that are likely to succeed and describe some of the strategies that policy-makers have used to overcome opposition to reform. The paper addresses three central questions. How have political and economic forces influenced the probability of structural reform? How have these factors influenced the nature of reform, especially its public-private mix? How have reforming countries overcome resistance from powerful interest groups? We answer the first two questions through quantitative analysis and the third question through qualitative case studies of a smaller number of reforming countries in Latin America and the transition economies. We provide examples of the many trade-offs and forms of compensation that governments have used to build a coalition in favor of reform when political power is dispersed. Results of the analysis show that a large implicit pension debt (the present value of the pension obligations of the government to contributors under the old pay-as-you-go system) helps put pension reform on the political agenda but then constrains the degree of funding and privatization that can be achieved—this offers evidence of path dependency. The existence of private financial organizations such as funded voluntary pension plans signals institutional interests that speed the adoption of a mandatory funded pillar. Factors such as cultural, linguistic and geographic proximity to “first movers” play a key role in explaining how reform ideas diffuse across countries.