Pension Fund Capitalism

The Privatization of Pensions in Developed and Developing Countries

Leokadia Oręziak

• Publisher: Routledge
• Year: 2022
• ISBN:
  9781000568530
• Edition: 1
• Topic: Personal Development
• Subtopic: Personal Finance

This book examines the origins and consequences of so-called pension fund capitalism, which has spread around the world since 1981, when the pension system was completely privatized in Chile. The author highlights the driving forces behind the privatization of pensions, its forms and tools used in practice, and the risks and costs related to private pensions.

The reader can also learn about the experiences of various developed countries (including the USA, Canada, Australia, and Germany), as well as Latin American (including Chile) and Eastern European countries, related to the privatization of pensions. Particular attention is paid to Poland as an example of a country where such privatization failed completely. This book provides a source of serious reflection on what this privatization has led to, what its real economic and social consequences are and what the likelihood is of reversing it and strengthening the public pension system.

Academic researchers and students of economics and finance, as well as social and political sciences, will find the book invaluable in understanding the problems arising from the privatization of pensions. It will also be of interest to professionals: institutions that shape or influence economic and social policy, including political parties, trade unions, non-governmental organizations, the media, and institutions operating on the financial market.

1 Structure of pension systems

DOI: 10.4324/9781032078649-1

The essence of the pension system, its shape, and functions

The rights of older people to social security and an adequate standard of living to support their health and well-being, including medical care and essential social services, are set out in the main international human rights instruments: the Universal Declaration of Human Rights and the International Covenant on Economic, Social and Cultural Rights (ILO, 2017, p. 77).

The roots of modern pension systems go back to the nineteenth century. In most countries, however, it was not until the second half of the twentieth century that the state became involved in the creation of universal pension security systems. The essence of the pension system is basically the reallocation of national income between the economically active generation and the retired generation. In practice, this means that some goods and services produced by the working generation are allocated to people who, due to their age, can no longer work (Eatwell, 2003). The shape of the pension system is essentially not only an economic, but also a political, social, and moral issue related to the distribution of income in society. The public pension system is one of the greatest achievements in the history of human civilization. Since the mid-twentieth century, it has been introduced to most countries of the world, which has allowed for a significant reduction in poverty among older people, possible thanks to a growing size of the economically active population and increased productivity achieved owing to technological progress and better education.

Historically, there are essentially two main pension systems: William Beveridge is the patron of the former and Otto Bismarck of the latter. Under the Beveridgean system, every citizen is provided with a flat-rate pension, which generally depends on a person’s wealth at retirement, regardless of earnings during their working life. Citizens may decide to supplement this old-age pension with benefits resulting from contracts with employers. This system has been introduced, in various forms, to the United Kingdom, Denmark, Ireland, and the Netherlands, among other states. It largely corresponds to the system currently operating there, consisting of a flat-rate pension from the public system, supplemented by a benefit from compulsory or partially compulsory occupational pension schemes (plans) and voluntary savings schemes. On the other hand, the Bismarckian system assumes that the right to social security benefits can only be acquired through employment. Retirement benefits are linked to earnings and are usually subject to a maximum limit and often to minimum pension guarantees. In this system, applied in Germany and France, and many other European countries, occupational pension schemes generally play a smaller role than in the Beveridgean solution. However, it should be emphasized that the distinction between the first and the other system is to some extent arbitrary, as both have evolved differently depending on a country and its reforms (Lannoo et al., 2014, p. 15).

Some empirical data on demographics, aging societies, and pension expenditure

Due to the demographic changes taking place, pensions will become an increasingly important social issue. In 2020, there were 727 million people aged 65 and over in the world. During the next three decades, the number of elderly people in the world will more than double, reaching over 1.5 billion in 2050. The increase in the number of older people in 2020–2050 will take place in all regions of the world. The global share of the population aged 65 or over is projected to increase from 9.3% in 2020 to around 16.0% in 2050. This change in the age structure of the global population, as a UN report shows, is driven by prolonged life expectancy and decreasing fertility. It means that people are living longer lives and both the share and the number of older persons in the total population are growing rapidly. The report notes that population aging is occurring alongside broader social and economic changes taking place throughout the world (UN, 2020, p. 1).

The level of national public pension expenditure in relation to GDP depends on many factors, including the demographic structure of a population, effective coverage, and adequacy of benefits. The role played by private pension schemes in the entire pension system may also be important. Public social security expenditure on pensions and other non-health benefits for older persons, according to the ILO, amounts on average to 6.9% of GDP globally. The highest proportion (10.7% of GDP) is recorded in Northern, Southern and Western Europe, that is, in the region with the world’s highest ratio of older persons to the total population (19.6%). It should be noted that Central and Western Asia as well as Latin America and the Caribbean have relatively high average expenditure ratios at 6.8 and 6.0%, respectively, whilst their population ratios of older persons are relatively low at 7.7% and 7.5%, respectively. The ILO notes that Northern America has the same average GDP expenditure indicator as Central and Western Asia (6.8 per cent), while the ratio of its older population is nearly double that of Central and Western Asia. The data presented by the ILO allow to identify a general trend of developed countries allocating a higher ratio of their GDP to provide the income security to older persons than developing countries. This is due not only to the high proportion of older people in the general population, but also to achievements in terms of adequacy and effective coverage, being the proportion of older persons receiving pension benefits (ILO, 2017, p. 84).

Pension spending is defined by the OECD as all cash expenditures (including lump-sum payments) on old-age and survivor’s pensions. Old-age cash benefits provide income for persons retired from the labour market or guarantee incomes when a person has reached a “standard” pensionable age or fulfilled the necessary contributory requirements. This category also includes, among others, early retirement pensions: pensions paid before a beneficiary has reached the “standard” pensionable age relevant to the programme. This indicator is measured in percentages of GDP broken down by public and private sector. Private pension spending includes payments made to private pension plan members or dependants after retirement and covers persons working in both the public and private sectors (OECD, 2021a).

Box 1.1 Pension spending in selected OECD countries in 2019

Spending on public pensions in OECD countries averaged 7.7% of GDP and on private pensions 1.6% of GDP.

• The countries with the highest public pensions ratio to GDP are Italy (15.6%), Greece (15.5%), France (13.6%), Spain (10.9%), and Germany (10.2%).
• At the same time, these countries are characterized by a very low ratio of private pensions expenditure to GDP: 0.3%, 0.0%, 0.4%, 0.6%, and 0.2%, respectively.
• On the other hand, the countries with the lowest ratio of public pensions to GDP are: Iceland (2.6%), Chile (2.8%), Australia (4.0%), Canada (4.9%), Netherlands (5.19%), United Kingdom (5.63%), Switzerland (6.59%), the United States (7.0%), and Denmark (8.0%).
• These countries are characterized by a relatively high share of private pension expenditure in relation to GDP: 5.2%, 2.3%, 5.1%, 3.0%, 4.1%, 3.1%, 4.8%, 5.2%, 5.9%, respectively.

Source: Based on OECD, 2021a.

As shown in Box 1.1, OECD countries differ significantly as regards the role of public and private pensions in providing income in old age. Where expenditure on public pensions constitutes a relatively large percentage of GDP, the privatization of pensions has not achieved the same scale as in countries where private pensions constitute the largest share of GDP.

The taxonomies of pension systems and the role of public and private pension provision

The main features that define a pension system are:

• Whether pensions are provided by the state or the private sector;
• The method of financing pensions, i.e., whether from current contributions collected on the wages of people currently working, like in public PAYG (pay-as-you-go) systems, or through pre-financing, i.e., from accumulated assets (mainly financial) from which future benefits will be paid;
• Who bears the pension risk, i.e., whether it is a defined benefit (DB) or a defined contribution scheme (DC).

When pensions are provided by the state, we are dealing with a public pension system. It may include non-contributory and contributory pensions. Non-contributory pensions are generally of a social nature, as their main purpose is to prevent poverty among the elderly. Benefits are generally neither linked to the duration of employment nor to the amount of contributions that a person makes to a scheme. However, their use may depend on meeting certain conditions related to the income earned by a retiree and/or their property and sometimes also to the period of residence in a given country.

Box 1.2 Pension systems in the world

• A vast majority of countries (186 out of 192 for which information is available) in the public system provide pensions in the form of a periodic cash benefit through at least one scheme and often through a combination of different types of contributory and non-contributory schemes. The remaining six countries do not offer periodic benefits.
• In 72 countries, there are only contributory schemes; a vast majority operate under a social insurance scheme, mainly covering employees and self-employed workers.
• In 102 countries, there are both contributory and non-contributory pension schemes: it means that a combination of contributory and non-contributory schemes is the most common form of organization of pension systems in the world. As regards non-contributory schemes: 14 countries provide universal benefits to all older persons above a certain age threshold; 24 countries provide pensions-tested benefits to older persons who do not receive any other pension; and 64 countries provide means-tested benefits to older persons below a certain income threshold.
• The key point is that, at a global level, only a quarter of the working-age population (24.9%) participates in any pension system, with large regional differences ranging from 6.3% in Sub-Saharan Africa to 76.2% in North America. Such large differences result from the fact that in lower-income countries usually only a very small part of the employed are wage and salary earners with formal employment contracts and thus are relatively easily covered by contributory pensions. It is also of key importance that labor market characteristics in these countries, such as a high degree of informality, contribution evasion, and weak institutional capacity to ensure law enforcement, limit the functioning of any pension system.

Source: ILO, 2017, pp. 76–80.

Contributory pensions under the public system generally operate on a PAYG basis, which means that the pensions currently paid are financed from current pension contributions (or other earmarked taxes) collected on wages and sometimes additionally from taxes. The compulsory and universal nature of the public system and its economic impact on the standard of living of the elderly make it decisive for maintaining social and economic order. The functioning of public pension systems is based on the principle of social solidarity. This solidarity, which is a condition of broadly understood social justice and human rights, is the foundation of public pension systems that ensure a socially desirable level of income redistribution, both intergenerational and intra-generational (Kalina-Prasznic, 2019).

The need to ensure such redistribution causes public PAYG systems to operate generally on a DB basis. This means that, although pensions are computed taking into account earnings achieved by workers during their professional career and the period of employment, the purpose is to ensure a socially acceptable level of retirement income. Most defined benefit public pension systems redistribute income from high- to low-income people, from men to women, and from single to married people: in fact, one of the advantages of a defined benefit arrangement is that it can be designed to provide greater generosity to disadvantaged groups (Clements et al., 2014). Few countries in Europe, such as Poland in 1999, have departed from this principle in the public pension system and apply the principle of defined contribution, though in practice it’s rather notional defined contribution (NDC). Contrary to the application of the DB principle, where the state is obliged to provide a pension at a certain level, there is no such obligation when the NDC principle is applied. In this case, the pension results from total contributions transferred to the system and credited to individual accounts during a professional career and life expectancy prevailing at the time of retirement. Only in certain situations (e.g., after meeting the requirement for a minimum contribution period to the system) can the state guarantee a certain minimum level of a pension if a person does not achieve it on the basis of the contributions paid.

Apart from the public pension system organized by the state, in practice there may also be occupational (workplace, company) pension plans and personal pension plans, which are usually managed by private entities. Funded plans set up by employers from the public or private sector on behalf of their employees are considered occupational, and access to these plans is conditioned by employment. Generally, occupational plans are compulsory for employers and voluntary for employees (sometimes automatic enrollment of workers to these programs is applied). The plans are personal: individuals choose a provider and may decide on some aspects of the plan (for example, an investment strategy).

Pension plans (programs) may be funded through the establishment of pension funds, pension insurance contracts or the purchase of other authorized retirement savings products. Pension funds are defined as a pool of ringfenced assets forming an independent legal entity (OECD, 2020, p. 52). Pension contributions, drawn from workers’ salaries, are transferred to the funds for investment, mainly in assets available on the financial markets. Most often, these investments are made in financial assets such as company shares and related instruments, as well as bonds issued by various entit...

Table of contents

• Cover
• Endorsements
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of illustrations
• Preface
• 1. Structure of pension systems
• 2. Neoliberalism as an ideological basis for pension fund capitalism
• 3. The supporters and instruments of pension privatization
• 4. Costs and risks associated with private pensions
• 5. The experience of different countries with pension fund capitalism
• 6. Poland as a case of pension privatization failure
• 7. Conclusions: Pension fund capitalism – what next?
• Index