Should Liberalization and Privatization of Pension Systems be on the APEC Countries’ Agenda

1. Should Liberalization and Privatization of Pension Systems be on the APEC Countries’ Agenda

2. BACKGROUND: Pension Reform • Demographic changes • Budget constraintsShould liberalization be part of pension reform?

3. Meaning of Liberalization For GATS/WTO: market access, national treatment, MFN For APEC’s Group on Services: idem, + deregulation/ privatization Here: . Privatization • Market access/national treatment for foreign suppliers of financial services + MFN • Regulation for prudential purpose only • Choice of investment for workers • No restrictions on pension fund investments • Competition policy

4. Financial Services Liberalization So Far • Uruguay Round: GATS and “Understanding on Commitments in Financial Services” • WTO: the Doha agenda, the new negotiations and the Cancun debacle • APEC Group on Services: Menu of Options; Individual Action Plans • Shift to bilateral arrangements: e.g. US-Australia, US-Singapore, Australia-Singapore

5. Milestones of Pension Reform • Martin Feldstein’s 1975 article “Toward a reform of social security” • 1985 Chilean reform • 1985-86 Australia introduces a mandatory private DC system • 1985 UK White Paper Reform of Social Security: Program for Action which brings occupational DC pension schemes into effect • 1994 World Bank report Averting the Old Age Crisis which proposes the 3-pillar model • 1996 report on US Social Security reform

6. Types of Pension systems

7. The Three-Pillar Model • First pillar: public DB/PAYG scheme aimed at poverty reduction through redistribution • Second pillar: mandatory private DC scheme aimed at consumption smoothing • Third pillar: voluntary savings accounts

8. The Debate • How large and redistributive a first pillar? • Should there be a second pillar, and if so, should it be:.Private v. public.Mandatory v. voluntary.Defined contribution v. defined benefit.Funded v. PAYG

9. How is a Pension Scheme Assessed? • Equity, efficiency and efficacy • Does it achieve the goals of poverty alleviation and consumption smoothing? • Does it have favorable macroeconomic effects (on saving, investment and output)? • Does it have favorable external effects, e.g. through financial sector development? • What are its effects on the labor market? • What is its financial performance? (Sharpe index: )

10. APEC’s Pension Systems • Broad spectrum of architecture • Assess the extremes: Australia, Chile v. Malaysia, Singapore • What are the costs and benefits of liberalization?

11. Australia: description • Fully liberalized, 3-pillar system • Age pension: PAYG, DB, means tested • Superannuation Guarantee Charge: private, • DC, funded, supervised (APRA, ATO), no guarantee • “Tax-advantaged” voluntary savings for retirement • Comparison with Medicare

12. Australia: assessment • Pros: increased savings (?) and inter-generational equity; good coverage for employees; financial sector development • Cons:complexity;risks borne by retirees; high (variable?) cost; agency problem; super industry concentration; poor financial performance; revealed preference from NZ;; poor integration with first pillar; does not fully relieve pressure on age pension; mixed effects on labor market;low participation rate; easy access to savings

13. Chile: description • No first pillar, but a minimum pension guarantee • Mandatory DC system administered by private companies (AFPs) • Restrictions on investments progressively eased • Greater choice introduced recently

14. Chile: assessment • Pros: increase in savings (?); financial sector development; reduced taxation of labor; free access for foreign fund managers • Cons: high but declining costs; AFDs compete mainly through marketing expenses

15. Malaysia: description • Employees Provident Fund established since 1951, fully managed by the government (MoF), fully funded defined contribution • Operated under EPF Act 1991, current contribution: 9% by employees, 12% by employers, minimum 2.5% dividend • Investments under strict regulation: at least 70% in government securities (*), no offshore assets, but started liberalizing since 1996. • Three accounts: retirement, housing, medical expenses

16. Malaysia: assessment • Pro: high coverage rate (>95%), source of funds for national development projects, financial sector development, high return (?) • Cons: only second pillar, high contribution rate, opaque management/investment, limited autonomy, hidden risks and liabilities

17. Singapore • Several schemes. Central Provident Fund main one. Multi-faceted . Aimed at low and medium income wage earners. • Contributions vary with age: for younger workers: 33% (employers 13%, employees 20; allocated 22% to ordinary account, 5 % to special account, and 6% to Medisave • Recent changes to deal with ageing, including the Supplementary Retirement Scheme • “The public must learn to make investment decisions for themselves and take responsibility for the outcomes, good or bad” Deputy Prime Minister Lee Hsieng Loong

18. Singapore: assessment • Pros: good coverage for employees, low cost (no administrative charge), choice, deals with ageing, contributes to financial sector development, recent reforms helpful, good financial education program • Cons: opaque, likely cross subsidization of schemes , not fully liberalized (investment restrictions, selection of fund managers), low rate of return on members’ balances

19. Financial Performance

20. Lessons from International Experience • Prerequisites toliberalization: domestic capital market; regulation or investment restrictions; fee capping (?); transparency and disclosure • There is a wide array of possible designs of pension systems and of policies to deal with ageing • Privatization is more a public policy issue than an economic one • Costs matter and size matters, limiting competition

21. Lessons fron Experience(continued) • “Funding” is desirable for inter-generational equity reasons (as well as budgetary reason) • Choice is expensive and requires financial education and disclosure • Diversification and passive investing have clear benefits, but passive investing requires an efficient market (and many “active” investors) • Financial sector development is an important objective but not the sole one

22. Pension Reform in China (1)Current System Major problem due to SOE reform and ageing • First pillar: basic pension, supplemented by individual accounts • 2nd pillar: occupational schemes: voluntary; contributions by employers and employees; liberalized investment policy; limited scope (coverage is only 5% of that of basic pension) • 3rd pillar: individual savings Source: Tim Murton, DFACS Occasional Paper

23. China: Pension Reform (2)The Problems • Large unfunded liabilities • Limited coverage (1/4 of labor force, 78% of SOE workers) • Fragmentation at enterprise, municipality and provincial levels • Little accumulation. Individual funds notional • Collection and administration problems • Transparency and governance issues

24. China: Pension Reform (3)Recent Reforms and Scope for Liberalization • The National Social Security Fund • The Liaoning Pilot Program • China’s WTO commitments • Costs and benefits of liberalization