Reforming Pensions

26 Pages Posted: 15 Dec 2008 Last revised: 17 Dec 2008

See all articles by Nicholas Barr

Nicholas Barr

London School of Economics

Peter A. Diamond

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 3 versions of this paper

Date Written: November 28, 2008


This article, based on two books (Barr and Diamond 2008, forthcoming), sets out a series of principles for pension design rooted in economic theory: pension systems have multiple objectives, analysis should consider the pension system as a whole, analysis should be framed in a second-best context, different systems share risks differently, and systems have different effects by generation and by gender. That discussion is reinforced by identification of a series of widespread analytical errors: tunnel vision, improper use of first-best analysis, improper use of steady-state analysis, incomplete analysis of implicit pension debt, incomplete analysis of the impact of funding (including excessive focus on financial flows, failure to consider how funding is generated, and improper focus on the type of asset in trust funds), and ignoring distributional effects.

The second part of the article considers implications for policy: there is no single best pension design; earlier retirement does little or nothing to reduce unemployment; unsustainable pension promises need to be addressed directly; a move from PAYG towards funding in a mandatory system may or may not be welfare improving; and implementation matters - policy design that exceeds a country's capacity to implement it is bad policy design. We illustrate the ranges of designs of pension systems that fit the fiscal and institutional capacity constraints typical at different levels of economic development. The potential gains from simplicity imply that a country capable of implementing an administratively demanding plan does not necessarily gain from doing so. New Zealand has a simple pension system through choice, not constraint.

Keywords: Pension, social security

JEL Classification: H55

Suggested Citation

Barr, Nicholas and Diamond, Peter A., Reforming Pensions (November 28, 2008). MIT Department of Economics Working Paper No. 08-22, Available at SSRN: or

Nicholas Barr

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Peter A. Diamond (Contact Author)

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