Reforming Pensions: Principles and Policy Choices

Reforming Pensions: Principles and Policy Choices

Reforming Pensions: Principles and Policy Choices

Reforming Pensions: Principles and Policy Choices


Mandatory pensions are a worldwide phenomenon. However, with fixed contribution rates, monthly benefits, and retirement ages, pension systems are not consistent with three long-run trends: declining mortality, declining fertility, and earlier retirement. Many systems need reform. This book gives an extensive nontechnical explanation of the economics of pension design. The theoretical arguments have three elements:

• Pension systems have multiple objectives--consumption smoothing, insurance, poverty relief, and redistribution. Good policy needs to bear them all in mind.

• Good analysis should be framed in a second-best context-- simple economic models are a bad guide to policy design in a world with imperfect information and decision-making, incomplete markets and taxation.

• Any choice of pension system has risk-sharing and distributional consequences, which the book recognizes explicitly.

Barr and Diamond's analysis includes labor markets, capital markets, risk sharing, and gender and family, with comparison of PAYG and funded systems, recognizing that the suitable level of funding differs by country.

Alongside the economic principles of good design, policy must also take account of a country's capacity to implement the system. Thus the theoretical analysis is complemented by discussion of implementation, and of experiences, both good and bad, in many countries, with particular attention to Chile and China.


A key test of a decent society is the living standards of its older people, particularly the poorer among them. This includes their ability to participate in their community and thus their relative income and access to health care and other services. The financing of their consumption in old age depends on the accumulation of past resources, by themselves and by the state, and its reflection in overall current income flows. Any sensible set of policies must take into account both the effects on such accumulation and the uncertainties surrounding life expectations, abilities, and disabilities. Thus policy analysis must examine issues of efficiency, distribution within and across generations and over individual lifetimes, as well as substantial uncertainties in individual circumstances.

Any approach to the formulation of policies toward pensions that tries to oversimplify by focusing on just one element, such as efficiency, risks grave policy errors, which can have a profound effect on the welfare of many individuals. It is a special strength of this book that it refuses to oversimplify in this way, while at the same time offering clear and analytically sound principles for the formulation of policy. It shows not only where these principles lead but also the mistakes that can be made when simplistic or formulaic policies are followed.

Policy toward pensions, and particularly policy reform, must depend on the broad economic, social, and demographic situation in a country, on the starting point for pension and related policies, and on where the economy and society are likely to go. Although many of the examples in the book draw on experience in the United Kingdom and the United States, reflecting the experience of the authors, there is considerable discussion of other developed and developing countries, notably Chile and China, and the analytical principles they set out so clearly and rigorously can and should guide the formation of pension policy across a very broad range of country circumstances, tailoring, of course, to those circumstances.

It is not possible to summarize the richness of Barr and Diamond’s analysis in a few sentences or paragraphs, but one or two examples may be helpful. First, the authors stress that it is not correct to design pension policy as if the sole purpose were . . .

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