their pensions would be too small to finance a comfortable retirement. The most often cited benefit of private retirement systems is that they can provide better returns to covered workers. If public systems were reformed to include advance funding and prudent investment of reserves, they could provide the same expected return to workers with far less financial market risk. An interesting question is whether such a reform is feasible or politically sustainable.
This chapter was prepared for the internatinal conference on 'Social Security Reform in Advanced Countries,' University of Tokyo, Japan, September 6-7, 1999. Partial research support for this chapter was received under a grant from the US Social Security Administration to the Retirement Research Consortium at Boston College. The views are soleley those of the author and should not be ascribed to the Social Security Administration, the Retirement Research Consortium, or the Brookings Institution.
Of course, workers who wish to save more for retirement than the amount they save in the public system can choose to invest their private funds in a way that offsets the portfolio choices of the system. However, empirical studies of saving behavior suggest that for a large percentage of workers, the overwhelming share of household saving takes the form of a home purchase and contributions to the public pension system. Many worker households have few assets aside from their home and pensions and thus cannot offset the portfolio choices of the public pension program.
Stock market data are based on the Standard and Poor Composite Stock Price Index dating back to 1871. These stock data and some of the price and interest rate data are taken from Chapter 26 ("Data Appendix") of Shiller (1989), with most series updated through 1999. See http://www.econ.yale.edu/∼shiller/chapt26.html. Estimates of the long-term government bond rate are published by the Federal Reserve Bank of St. Louis for years back through 1924. For the period from 1906 through 1923 I formed an estimate of the riskless long-term bond rate using Macaulay's estimates of the yield on high quality railroad bonds. Since even high quality private bonds are subject to default risk, I predicted the riskless (Treasury-equivalent) yield for 1906-23 by estimating the yield premium of railroad bonds over government bonds for the period 1924-36, when observations of both railroad bond rates and long-term Treasury bond rates are available. See http://www.stls.frb.org/fred/data/irates.html.
Estimates of annual earnings by age and gender can be found in US Census Bureau (1996).
The assumed rate of economy-wide wage growth has important effects on some of the calculations. With a slower assumed rate of growth, pension contributions and investment returns early in a worker's career become relatively more important in determining his pension, because earnings when the worker is young represent a larger percentage of the worker's lifetime wages. At the same time, with slower wage growth it is easier to attain a high pension replacement rate, where the replacement rate is defined as the real value of the pension divided by the worker's real average wages near the age of his retirement.
When a bond-investing worker reaches age 53 and is less than 10 years from retirement, he is assumed to invest in short-maturity rather than long-maturity bonds to avoid the risk of accepting capital losses when he converts his bonds
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Book title: Social Security Reform in Advanced Countries: Evaluating Pension Finance.
Contributors: Toshihiro Ihori - Editor, Toshiaki Tachibanaki - Editor.
Place of publication: New York.
Publication year: 2002.
Page number: 78.
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