The Political Economy of Social Security Reform: A Cross‐Country Review

Over the past two decades, many countries have been adopting multi-pillar old age security systems that include a substantial role for a privately managed fully funded (FF) defined contribution (DC) pillar, accompanied by a publicly managed tax financed defined benefit (DB) pillar to redistribute to low earners. Many other countries are currently contemplating such a switch. This contrasts with traditional systems which rely on a single public pay-as-you-go (PAYG) DB pillar. In a PAYG DB plan the benefits are defined in advance, usually based on years of contributions and average earnings during some part of the lifetime, and are financed through payroll taxes; tax rates change through time to cover the benefits promised to today's pensioners. In a DC plan the contributions are defined in advance, accumulated and invested, but the benefit is uncertain. When workers retire they get an annuity that depends on their lifetime contributions plus their investment earnings. This special issue of Annals presents case studies of several Latin American and OECD countries that have reformed their systems, in an attempt to explain why they made this decision, how they selected the particular forms for their first and second pillars, what old problems this solved and what new problems were created. Besides summarizing these case studies, this overview draws on other evidence to evaluate the reforms and the political economy factors involved. Part I contrasts three structural reform models that are now being implemented-the Latin American individual account model in which workers decide how their retirement savings will be invested, the OECD employer-sponsored model in which employers and/or union representatives control the investment strategy for an entire enterprise or occupation, and the Swedish model in which workers have large notional accounts which are simply bookkeeping entries, supplemented by small funded accounts with real savings and investments in them. The menu of choices for covering transition costs, and the political economy factors behind these choices, are discussed in Part II. Part III examines empirical evidence on the positive efficiency 2 and growth impact of these reforms and Part IV discusses new problems that have emerged. The Conclusion summarizes these recent policy developments and the implications they hold for countries that have not yet reformed.