Reforming Pensions: Principles, Analytical Errors and Policy Directions

25 Pages Posted: 27 Apr 2009

See all articles by Nicholas Barr

Nicholas Barr

London School of Economics

Peter J. Diamond

New York University (NYU) - School of Continuing and Professional Studies (SCPS)


This article, 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 - errors that appear in World Bank work, but by no means only in World Bank work: 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 pay-as-you-go 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.

Suggested Citation

Barr, Nicholas and Diamond, Peter J., Reforming Pensions: Principles, Analytical Errors and Policy Directions. International Social Security Review, Vol. 62, Issue 2, pp. 5-29, April/June 2009, Available at SSRN: or

Nicholas Barr (Contact Author)

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)20 7955 7482 (Phone)
+44 (0(20 7955 7546 (Fax)


Peter J. Diamond

New York University (NYU) - School of Continuing and Professional Studies (SCPS) ( email )

New York, NY
United States

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