Academic journal article Journal of Economic Cooperation & Development

Pension Reforms: A Case for Pakistan

Academic journal article Journal of Economic Cooperation & Development

Pension Reforms: A Case for Pakistan

Article excerpt

The study deals with pension system reforms for the Pakistan economy and highlights the current situation and future prospects. The study presents an overview of empirical evidence on pension system reforms, the strengths and weaknesses of the pension system of Pakistan and the institutional development pertaining to pension reforms. Fully funded pension system can help to strengthen the formal channels of retirement savings and can help to get rid of problems prevailing in current pension system. If the decision to reform the pension system is not taken in time then in the near future rising pension expenditure would lead to increase in indirect taxes, reduction in development expenditure and/or increase in government borrowings. Although some efforts to reform the pension system had been made to reduce the government's rising pension bill, yet despite realization of the problem no serious effort had been made to reform the pension system in a fundamental way.

1. Introduction

Pension systems are intended to give income support to those individuals who bear losses in earning capability during old age, incident of disability or death of wage earner in the family. Thus, pension systems aim to reduce poverty among the old individuals and strive to smooth consumption between the working years and the retirement years, in such a way that individuals do not bear a massive drop in living standards when old age and disability reduces their earning ability. The former objective is obtained through non-contributory pension system and the later through contributory pension system.

Most of the systems of old age security are publicly managed schemes and are financed by payroll taxes on a pay-as-you-go basis. This system is under increasing strain throughout the world. Schwarz et al. (1999) and James (1998) pointed out that over the next 35 years, the fraction of world's population that is above 60 would roughly double, from 9 percent to 16 percent. The continuous fall in fertility rates coupled with rising life expectancy leads to a decline in the proportion of children and an increase in the proportion of elderly. The number of pensioners per worker is increasing continuously; hence as a result higher wage taxes are required to provide pension benefits to growing number of retirees. [ James (1998), Sarrapy et al. (1996), Corsetti et al. (1995), Holzmann et al (2005)]. This situation results in high evasion, pushes labor into informal sector and raises the burden on public treasury.

The public pay-as-you-go pension system is expected to become fiscally unsustainable in near future. The most important threat comes from the changing demographic structure, especially fall in fertility rates coupled with rising life expectancy. The resulting increase in the number of pensioners per worker leads to higher wage taxes and/or growth in implicit pension debt coupled with financing gap, thereby making the current pay-as-you-go pension system unsustainable in many countries.

If safety measures are not undertaken in response to aging of population then it is expected that the existing pay-as-you-go pension system will become insolvent in many countries. In order to avoid the dangers associated with pay-as-you-go pension system, the World Bank has recommended a multipillar pension system. These new arrangements contain three pillars [Holzmann (2000), Holzmann et al. (2005), James (1998))]:

* A mandatory, publicly managed, tax-financed pillar for redistribution,

* A mandatory, privately managed, fully funded pillar for savings, and

* A voluntary pillar for people who want more protection in their old age.

The most important of these arrangements is the second pillar. The justification for mandatory fully funded pension system is workers' myopia. A large number of people possibly will be shortsighted, might not save sufficient amount of money for their old age on a voluntary basis, and possibly will turn into a burden on society when they become old. …

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