Protecting the Old and Promoting Growth: A Defense of Averting the Old Age Crisis
30 Pages Posted: 20 Apr 2016
Date Written: January 1996
A summary of recommendations in the recent World Bank report on old-age security programs, and an analysis of why the International Labour Organisation and the International Social Security Association came to different policy conclusions. In the World Bank's view, these programs should protect the old, but because such massive resources are involved, one must also consider how they affect the general economy.
The current social security systems in many OECD countries were adopted before World War II, when private financial markets were underdeveloped or in disrepute. They expanded sharply in the 1950s and 1960s, when real wages and population were growing rapidly. Under those circumstances, it seemed natural to rely on a publicly managed payroll-tax-financed pay-as-you-go (PAYG) system.
But in the past 40 years, real wage growth has slowed and population growth has come to a halt in OECD countries, so tax rates must go up sharply if PAYG systems are to be retained. It has become increasingly important to minimize work disincentives and to increase labor productivity through capital accumulation, which the public pillar is not well-suited to do. Shifting partial responsibility to privately managed plans that are funded and that tie benefits to contributions is likely to improve economic growth and provide better benefits than will continued reliance on a payroll-tax-financed PAYG system, concludes the World Bank.
The OECD countries can shift gradually to a two-pillar system by reducing and flattening the benefits in their public pillars and using the released resources (plus some additional contributions) to build funded defined contribution accounts in a new mandatory saving pillar. If developing countries follow the path the OECD countries once followed, they will encounter dramatically escalating contribution rates, great intergenerational transfers, and related problems. Given their rapid rate of demographic aging, it is important for them to establish a multi-pillar system from the start.
James argues that the World Bank position differs from those of the International Labour Organisation (ILO) and International Social Security Association (ISSA) because the Bank:
- Is more concerned about how social security systems affect the general economy. - Is troubled by inequities often found in current systems (in practice, if not on paper). - Believes that behavioral responses and factors of political economy sometimes make nonviable the design changes the ILO and ISSA recommend for public systems. - Values risk diversification. (Financial markets are now both better and more global than before, so multipillar systems benefit from revenue and managerial diversification, including international diversification.)
This paper - a product of the Poverty and Human Resources Division, Policy Research Department - is part of a larger effort in the department to study the economic impact of population aging and old age systems.
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