25
Feb
10

Decent and sustainable pensions?

Por Edwin van Gameren

In the labor economics course I spent some time talking about retirement pensions, in particular we discussed some aspects of the reform in Mexico from a pay-as-you-go system with defined benefits to a system of personal retirement accounts with defined contributions. Leaving out all the details, before the reform (for the IMSS in 1997, for the ISSSTE in 2008) everyone who met the criteria could be confident of the income after retirement, independent of the amount contributed during work life. However, for those who started to work after the reform the future pension largely depends on the savings accumulated in a personal account: defined contributions but uncertainty about the future benefits. For the transition generation who contributed under the pre- and post-reform systems, a choice option of the retirement regime has been facilitated. A system funded by defined contributions to individual accounts is generally considered to be more robust in an aging population (see e.g. the book by Barr and Diamond (2008), Reforming Pensions: Principles and Choices), although the actual performance will depend a lot on the precise rules and regulations (and of course on the performance in the financial markets, something we cannot ignore).

Despite the reforms, a very large fraction of the elderly in Mexico isn’t expected to receive anything, as a result of spending the major part of their work life in the informal sector. Wouldn’t it show great civilization if every elderly would be guaranteed a pension in order to be able to maintain a decent, humane standard of living even if (health or other) circumstances do not permit the acquisition of income from labor or other sources? In the Distrito Federal a start has been made with the pensión alimentaria for elderly over 70 years residing in DF. Would it be feasible to broaden the program, for example by increasing the amount of the pension (now some 800 pesos per month), reducing the eligible age to 65, or by a nationwide availability?

It all sounds great, but we can expect to run into problems when initiating a rapid expansion. The only way to introduce a universal pension both for formal sector workers, informal sector workers, and people who did not have a job, is through taxes (essentially it means the comeback of a pay-as-you-go system that was abolished with the reforms in IMSS and ISSSTE). The questions regarding tax collection raised by Raymundo Campos (this blog, Feb.9) suggest that that’s not going to be easy. Another fact is that, although the Mexican population is still relatively young, it is clear that this is not going to last forever. Fertility rates are decreasing while life expectancy is increasing: two factors that in the long run imply a population with a much larger fraction of elderly people, as is clearly observed from the graph with the projections by CONAPO (Zúñiga (2004) La situación demográfica de México, Gráfica 4).

Tendencias y características del envejecimiento demográfico en México

The combination of more elderly claiming pensions and a smaller working-age population will imply a strongly increased tax burden for the latter. In addition to that, tax burden may negatively affect the labor decision (working becomes less attractive) and also the improved pension rights will negatively affect participation (it is well-known that financial incentives are very important in retirement decisions, see e.g. the book by Gruber and Wise (eds.) (2004) Social Security Programs and Retirement Around the World: Micro-Estimation. See also the paper here). Both effects lead to a further reduction of the tax base.

Introduction of a universal retirement pension requires careful thought, not only with regard to the current financial requirements, but also on the long-term sustainability. Once introduced, it is quasi impossible to cut back pension privileges in the future. Personally, I wonder if the pension rights that I built while living in the Netherlands will have any value once I reach retirement age: every year of residence in the Netherlands between ages 15 and 65 gives right to 2% of the full (first tier of the) pension. Discussions about the sustainability are in full swing, but a reduced generosity is hard to accept (see e.g. NRC (2009) Government unveils retirement age rise plan).

Let Mexico avoid the problems encountered by many countries in Europe by taking into consideration the future demographic situation and the economic consequences!

Edwin van Gameren es Doctor en Economía por la Vrije Universiteit Amsterdam (Holanda). Actualmente labora como profesor – investigador en El Colegio de México.


2 Responses to “Decent and sustainable pensions?”


  1. 1 Anónimo
    28 febrero, 2010 a las 20:24

    I was wondering if changes in the age structure of the Mexican population, and a intention of giving more rights to elderly people, will imply an altruistic behaviour of latter generations about their predecessors; or in a repeat game approach, will imply a commitment with next generations for receiving the rights if they guarantee these rights for their predecessors.

    What do you think about it?

    • 2 Edwin van Gameren
      4 marzo, 2010 a las 19:18

      A PAYG system obligates the young to be altruistic towards the old (in European terms: the young show solidarity with the older generation). The elderly can leave a bequest (altruism from old to young), but that’s a voluntary choice. The old generation cannot make a credible commitment that the young will receive pension benefits once they become old: that depends on the altruism of the next younger generation (I wonder if a repeated game approach is correct, the players change over time). The intergenerational redistribution implied by a PAYG pension increases (financial) well-being of the elderly and might increase the utility of younger generation (if they value their parents’ well-being) despite the fact of being financially worse off. But if the altruism imposed by a pension system implies that an increasingly large fraction of the income must be transferred to the elderly – because of a growing number of elderly and/or higher benefits – there may come a time that younger generations do not want or are not able to continue the intergenerational transfers.


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