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Population ageing
and pension
systems in
Latin America

Jorge Bravo

Population Division, This paper will examine the effects of population ageing on
Latin American and
the medium- and long-term evolution of pension systems in
Caribbean Demographic
Centre (CELADE ) Latin America and the Caribbean. It is organized into six
Economic Commission
sections. After the introductory section, section II provides
for Latin America and the
Caribbean (ECLAC) information on ageing and pension system trends in the Latin
jbravo@eclac.cl
American countries, with some references to the interna-

tional context. Section III gives indicators, data and meth-

ods of analysis, and examines the effects of ageing popula-

tion structures and rising life expectancy on pension system

variables: spending on pensions, the financial position, pen-

sion liabilities and the implicit rate of return; it also includes

a critical analysis of the criteria that are generally used to

evaluate the sustainability of unfunded systems. Next, sec-

tion IV provides a more systematic introduction to the con-

cept of and indicators used for implicit pension debt, gives

estimates of the scale of the pension liabilities that have to

be made explicit when the switch to a funded system takes

place and analyses the effects of the age structure and adult

mortality rates in the Latin American countries. Section V

looks briefly at the fiscal transition costs that have to be

coped with when this type of reform is applied and, lastly,

section VI contains a summary and conclusions.

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I
Introduction

Over recent decades, the Latin America and Caribbean except for some references made in relation to
region has undergone substantial demographic changes associated topics. Many aspects that have given rise to
that have altered the population base and the workings major debates, such as the relative merits of funded
of the institutions that transfer resources between and unfunded schemes, and of State-run systems and
generational groups. One particular manifestation of privately managed ones, are touched upon only insofar
these demographic changes, population ageing, is as they contribute to an understanding of the
directly linked to developments in social security relationships with which this article is particularly
systems, and as the tendency towards ageing intensifies concerned.1 The effects of gender differentiation, which
its effects will increase in scope and scale, as is shown become more important as populations age, are another
very clearly by the historical experience of the more relevant subject not addressed here (see Arenas, 2000;
developed countries. Cox, 1999 and Bravo, 1999).
This is the essential standpoint of this paper, which The more specific approach taken here, however,
examines the effects of population ageing on medium- does open the way to a clearer presentation and
and long-term developments in pension systems. This understanding of the effects of demography on different
synthesis is based on studies carried out in recent years aspects of pension systems. Accordingly, the paper is
at CELADE and in collaboration with the Development organized as follows. Section II provides background
Finance Unit of ECLAC that deal with the demographic information on ageing and pension system trends in
and financial aspects of the region’s pension system the countries of Latin America, with some reference to
reforms. the international situation. Section III explains the
First of all, the analysis focuses on the effects of reasons for the analytical model approach used and
changes in the age structure and in the mortality rates examines the effects of ageing population structures
of the adult population on certain indicators of unfunded and greater longevity on four important variables of
systems. It then deals with the transition from unfunded unfunded systems: spending on pensions, the financial
systems to funded ones, and in particular with the position of the system, pension liabilities and the
influence of demographic variables in determining implicit rate of return of the system. This section also
pension liabilities and the fiscal costs of transition. In includes a critical analysis of the criteria used to assess
so doing, the paper brings together and analyses a the sustainability of unfunded schemes.
variety of facts and results brought to light by applied Section IV provides a more systematic introduction
research and uses medium- and long-term forecasts to to the concept of the implicit pension debt and the way
consider how far these relationships may extend. this is measured, and gives estimates for the scale of
Every effort has been made to examine these issues the liabilities that have to be made explicit when the
systematically, but there are many important matters transition is made to a funded system. It also analyses
that are not addressed in this presentation. For example, the effects of the age structure and adult mortality in
it does not deal with general equilibrium relationships, the Latin American countries. Section V briefly
examines the transitional fiscal costs that have to be
met when this type of reform is carried out, and section
VI contains a summing up and closing remarks.
The original version of this article was prepared while the
author was principal consultant to the ECLAC-CELADE/IDB programme
AT N / T F -5827- RG attached to the Institut national d’études
démographiques (INED) in Paris, France, from 15 December 1998
to 15 February 1999 under the international relations programme 1 A useful contribution to this debate would be a comprehensive
of that institute. It was revised at ECLAC and thanks are due for the analysis of the most important advantages and limitations of the
valuable observations of Didier Blanchet, Georges Tapinos, Antoine different schemes, including the numerous demographic, economic
Bommier, Andras Uthoff, Juan Chackiel, Carmelo Mesa-Lago, and political issues involved and the development strategies of the
Mario Marcel and two anonymous readers from IDB . The author countries where the assessment is to be applied. This is far beyond
bears sole responsibility for any remaining errors or deficiencies. the scope of the present study.

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II
Population ageing and
pension systems: Latin America
in the international context

Having passed through the early stages in the are at intermediate stages in the demographic transition
demographic transition, in which child mortality fell and are projected to age significantly over the next few
and fertility was sharply reduced, the population of decades (including the two most populous ones, Brazil
Latin America is beginning to age. Over-60s make up and Mexico), while in a few countries ageing is already
the fastest-growing population group in the region: their fairly advanced, such as Argentina, Uruguay and some
numbers, currently around 40 million, are expected to of the Caribbean countries. In countries such as Chile,
double within 20 years. The proportion of the Costa Rica and Panama ageing is only slightly less
population aged 60 and over is still modest by advanced, with low mortality not yet being matched
comparison with the more developed countries of the by such low fertility rates. Cuba is a special case, as in
world: it now stands at just under 8% in Latin America, no other country of the region has fertility declined
compared to about 16% in the United States, 20% in faster or more sharply since the 1960s, so that in just
Europe and almost 23% in Japan (United Nations, over a decade the ageing process will be more advanced
1998). Nonetheless, mortality in the region has been there than in any other country. Ageing also varies
falling substantially over the course of this century, and within countries, between socio-economic groups and
is now fairly low in many countries; average life by gender. As has been documented in detail elsewhere,
expectancy at birth has now reached the 70 mark, and the specific social context, and the particular sequence
life expectancy at 60 is almost 20 years (ECLAC/CELADE, of events during the demographic transition, also vary
1998) in the region as a whole. In virtually all the from one country to the next (Guzmán, 1996 and Cosio-
countries of the region, reductions in national fertility Zavala, 1996). The different demographic contexts will
rates have tended to follow reductions in mortality after be taken into account in the discussion that follows, to
a relatively short time lag, in most cases less than two the extent that they affect ageing patterns.
decades (Bravo, 1992). Taken all together, these trends As regards the formal public pension systems that
imply that ageing, as measured either by the “old” are analysed here in relation to population ageing, these
proportion of the population or by the old-age are not at all times and in all places the most important
dependency ratio, is going to accelerate over the coming means of providing economic support to the elderly.
decades, and is going to do so at a much faster rate Intergenerational transfers, effected through family/
than was seen in the populations where ageing is now community or market mechanisms (Sauvy, 1953 and
most advanced. Changes in these indicators which took Lee, 1995), have historically been important in both
from six to ten decades to come about in the developed developing and developed countries, and still are.3 In
countries are expected to take only two to three decades Latin America, some countries began to institutionalize
in most of the Latin American countries.2 their pension systems in the early twentieth century
As is the case with almost all socio-economic and (examples being Argentina, Chile and Uruguay), but
demographic variables in the region, there is great
diversity between countries as regards ageing: some
(for example Bolivia, Honduras and Nicaragua) still 3 The evidence reviewed by Lee (1995) indicates that in traditional
have fairly young age distributions and will continue societies intergenerational transfers are “downward” overall, i.e.,
to do so for many years to come. A number of countries they pass from the older members of the population to the younger
ones. This also holds true for family transfers in developed countries
today. It is the strong “upward” movement of transfers channelled
through saving capital accumulation and the public sector
2 For more extensive analyses of ageing tendencies in the region, (including pensions) that has produced the net upward direction of
see Chackiel (2000) and Villa and Rivadeneira (2000). intergenerational transfers in more developed societies.

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most national systems became more comprehensive in In Latin America, by contrast, the overall level of
the post-war period. Since their inception, these systems pension spending is similar to that of Asia,5 averaging
have expanded their coverage and brought major around 2% to 3% of GDP. Comparison of this aggregate
benefits to a significant proportion of the elderly expenditure level with the ageing indicators referred to
population. However, they have also suffered from a earlier shows that there is a large gap between the Latin
number of problems. They have had difficulty in American countries and the more developed regions
achieving the ideal of universal coverage, ensuring full and countries, whose ageing indicators are double or
and timely collection of contributions, protecting the treble those of Latin America, but which spend four or
real value of reserve funds and making the contribution five times as much on pensions as a proportion of GDP.
and benefit adjustments that have become necessary as We shall analyse these differences further in the
population structures have changed and systems have following section.
matured (Mesa-Lago, 1985 and Uthoff, 1997). These Before turning to a more thorough evaluation of
problems have built up over the years and have been the effects of ageing, it is worth glancing at the global
compounded by the regional economic crisis of the implications of this phenomenon in the coming decades.
1980s, which brought administrative and financial As figure 1 shows, the adult ageing process (measured
shortcomings more clearly to light. These factors by the old-age dependency ratio) is expected to
weighed heavily in the pension scheme assessments and accelerate in all regions of the world over the next few
proposals for reform that were made in that decade and decades, even in Europe and North America where
put into effect in the 1990s. In the following sections ageing is already well advanced. These changes are
we shall examine some of the reform issues from the quite substantial: whereas in 1990 the old-age
point of view of population ageing and its implications dependency ratio (population aged 65 and over in
for financing and intergenerational distribution. relation to the population aged 15 to 64) varied from
In the Latin America region, as in the rest of the 6% to 18% in different regions (the world average being
world, most public pension systems are unfunded and 10%), it is forecast that by 2030 all regions except Africa
are backed by relatively small reserves. 4 Public will have dependency ratios of between 16% and 35%
spending on pensions has grown steadily worldwide (with a world average of 17%).6
and now averages between 8% and 10% of GDP in the The chart shows that the population of Latin
Organisation for Economic Co-operation and America and the Caribbean will age faster than the
Development (OECD) and the countries of eastern average, as the old-age dependency ratio there is
Europe (World Bank, 1994 and Dumont, 1998). In forecast to reach the world average in 2030, but starting
many industrial countries, social security spending is from a below-average value (8%) in 1990. By 2050 the
one of the two or three biggest government expenditure Latin American ratio will have more than tripled to stand
items; in the United States, social security is now the at around 27%, around three percentage points above
biggest government programme, having overtaken the world average. The strength of this projected trend
defence in the early 1990s. Forecasts by OECD (Leibfritz is only surpassed by longer-term projections for the
and Roseveare, 1995) predict that over the twenty-first European and OECD countries, which show the greatest
century pension payments could range from 5% to 20% ageing effects on pension systems hitherto estimated
of GDP and that deficits could be from 0% to 10% of (Roseveare and others, 1996 and Calot and Chesnais,
GDP, unless substantial adjustments are made over the 1997).
coming years. The main factors influencing these When these changes occur in situations where
forecasts are the long-term trend towards population pension systems are maturing, and where there are
ageing and the fluctuations predicted in the age structure
of the population as a result of the baby boom in the
early 1960s. 5 There are a number of differences between the two regions,
however: in Asia, public systems are generally of more recent
creation, and tend to cover a smaller proportion of the workforce
4 A notable exception is the United States, where the important old and the elderly (Kinsella and Gist, 1995).
6 A simple interpretation of this tendency in terms of pension system
age, sickness and death insurance (OASDI ) fund will carry on growing
for at least another decade to provide for the retirement of the large variables is that, simply as a result of population ageing,
baby boom cohorts. There is considerable controversy, however, contribution rates would have to increase by around 70% over this
over the liquidity and real economic value of the assets making up period to prevent the financial position becoming worse than it
this fund. was in 1990.

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FIGURE 1 unsustainable, and that they are bound to lead to


World ageing outlook, by region, 1990-2050
“bankruptcy” or an insurmountable crisis. Countries
(Population aged 65 and over/population aged 15 to 64)
can supplement existing government-run unfunded
50 systems with privately managed funded schemes or
45 Europe other (mixed) components, as some are now doing.
Pop. 65+/Pop. 15-64, %

40 However, numerous studies and different country


35
Northern America
experiences throughout the world make it plain7 that
30 Oceania the demographic tendencies referred to here do not
25 Latin America & Caribbean show that full funding is the sole or necessary solution,
20 W orld or the most desirable one, for the problems of pension
15 Africa
Asia schemes, as some observers believe. Most analysts now
10 agree that thorough policy studies and assessments
5 should consider different options, including varying
0 degrees of public/private mix and funding, benefit- and
1990 2000 2010 2020 2030 2040 2050 contribution-defined schemes (Mesa-Lago, 1994;
Year ECLAC, 1998; Thompson, 1999; Orszag and Stiglitz,
1999 and Holzmann, 1999), taking into account the
Source: United Nations (1998).
different demographic, economic and political
conditions obtaining in different countries.
The following sections of this paper will look at
restrictions in the labour market that manifest medium-term trends in these systems from a broad
themselves in high unemployment and low earnings demographic point of view. First of all, a range of
growth, it is clear that these demographic trends will pension system indicators, and their relationship with
compound the adverse economic effects and the ageing, will be analysed. Attention will then turn to
existing structural problems affecting public systems. unfunded pension liabilities and the influence on these
As will be seen in the following sections, however, it is of the population age structure and old-age mortality.
certainly wrong to interpret such difficulties as evidence The paper will then go on to consider the fiscal costs of
that demographic trends are making these systems unfunded-to-funded (U-F) transitions, after which it
will conclude with some final remarks.

III
Pension system indicators over
the course of the ageing process

1. Indicators, data and methods of analysis debt8 and iv) the implicit (or internal) rate of return of
the system, as represented by flows of contribution
Almost all pension system indicators are influenced payments and sums disbursed by way of pensions
by demographic variables, and particularly and most during the lifetime of a cohort. Appendices 1 and 2 give
directly by population ageing. For this paper we have
chosen four variables to illustrate our analysis of the 7 See, among many others, Blanchet (1990), ECLAC/CELADE (1996),
effects of ageing on different aspects of unfunded Chand and Jaeger (1996), Conseil d’analyse économique (1998),
pension systems: i) annual expenditure on pensions, Conte-Grand (1995), Reynaud, coord. (1998) and ECLAC (1998).
8 As is explained in more detail in section IV below, there are a
expressed as a percentage of GDP ; ii) the annual
financial balance of the pension system, i.e. revenue number of possible ways of measuring pension liabilities in
unfunded systems. In this study we shall use the present value of
minus outgoings, which can be expressed as a the future pensions that will be received by pensioners and of the
proportion of system revenue or of GDP; iii) the implicit contributions already paid by the economically active population
pension liability, also known as implicit pension at a given point in time, expressed as percentages of GDP .

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more details about the concepts, measurements and data FIGURE 2


Latin America and the Caribbean (selected countries):
used to calculate these.
Pension system expenditure and financial balance, by
The most standard indicators, such as annual degree of population ageing, 1990-1993
pensions spending or the financial balance of the
system, are periodic measurements (i.e. annual flows) A. Pension expenditure and population ageing
which can be used to quantify the burden of the pension
system on the national economy, but which provide little 10

GDP
Cuba
information about the medium- or long-term financial 8

Expenditure as % of
Chile
sustainability of the system or its distributional 6 Panama
performance, especially in different generational 4 Argentina

groups. These aspects are captured better, although still 2


only partially and imperfectly, by other indicators that 0 Jamaica Barbados
Jamaica
summarize contribution and benefit flows over the life -2
Nicaragua
cycle. Two of these are implicit pension debt and
implicit system rate of return, which are analysed in 0.00 0.05 0.10 0.15 0.20
the following sections. We have chosen d, the old-age
Proportion of the population aged 60 and over
dependency ratio,9 which from now on we shall simply
call the dependency ratio, as the population ageing
indicator to be used for analysing the pension system B. Financial balance and old-age dependency ratio
indicators selected. Historically, ageing of individuals 3
or population cohorts, as measured by rising life
2
expectancy, tends to precede and then overlap with Chile
1
changes in d, although the correlation between these
two forms of ageing is not a strict one and their 0 Cuba
.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35
consequences for pension systems differ in nature and -1
extent, as will be shown in the following sections. -2
Panel A of figure 2 shows observed pension Chile
-3
Cuba
expenditure values as a percentage of GDP, estimated
-4
on the basis of data compiled by ILO (1997) on national
social security expenditure in the period 1991-1993.
Includes State contribution
These estimates relate to old-age, survivors’ and
Excludes State contribution
invalidity pensions in the public and private sectors and
exclude transfers to other schemes. They are to be Source: Author’s estimates based on ILO (1997), ECLAC /CELADE
treated merely as an indication of magnitude, since the (1999) and United Nations (1999).
exact figure may vary depending on the specific
measurement criteria being used. Again, no information over 8% in Cuba, with countries such as Argentina,
is available for Brazil, Mexico, Peru and Uruguay, four Chile and Panama being at an intermediate level. Taken
very important countries in the region. all together, these data reveal spending levels that are
Nonetheless the data, plotted against the proportion low to medium by international standards. Secondly,
of the population aged 60 and over, suggest a couple of although a number of the countries with high spending
things. Firstly, as had been predicted, the spending of are in the medium to high ageing categories by regional
many countries is of the order of 2% of GDP or less, standards, there is no obvious sign of a close
among these being an appreciable number of Caribbean relationship between the degree of ageing and pension
and Central American countries, Bolivia and Ecuador. expenditure. This partly reflects problems with the
The expenditure of the remaining countries ranges from comparability of expenditure data, but also, and
a low of around 3% of GDP in Colombia to a high of probably more importantly, differences in the
population coverage of pension schemes, contribution
and replacement rates, eligibility criteria and the degree
9For the purposes of the present paper, this ratio will henceforth of system maturity.
be between the population aged 60 and over and the population These two types of limitation make themselves felt
aged 20 to 59. to at least the same degree when the financial balance

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of the system is analysed. There are comparability range of ageing levels (outside the range observed
problems not just with expenditure, as before, but also hitherto in Latin America) and examining other important
with revenue, which is affected by international system variables, such as pension liabilities and the
differences in the way system components and system’s internal rate of return, which are extremely
programmes are defined and in accounting conventions, difficult or impossible to calculate directly when existing
particularly as these relate to the treatment of transfers data are the only basis used.
from other programmes and to State contributions net
of the contribution made by the public sector as an 2. Effects of ageing on the expenditure and financial
employer (appendix 1). Bearing these caveats in mind, balance of the system
the estimates for the financial balance of pension
systems given in panel B of figure 2 suggest that a Figure 3 illustrates the general tendencies forecast for
surplus is the norm, particularly in countries whose these two variables as the population ages. The figures
schemes are of more recent creation. The exceptions shown assume fixed values for the contribution rate
are the small deficit of Panama and the more substantial (c = 12.2%), wages as a share of GDP (s = 34.3%) and
ones of Chile and Cuba.10 These last two countries are the number of workers covered by the pension system
special cases: the revenue and expenditure accounts of as a proportion of all waged workers (k = 0.76), these
Chile are strongly affected by the transition deficit being the averages for the Latin American countries
resulting from the move towards full funding, and those around 1990. In the case of the financial balance, it is
of Cuba by the fact that the State absorbs the primary further assumed that no debt or reserve fund capable
imbalance, so that the country’s system is precisely in of offsetting periodic imbalances has been set up; in
balance when the State contribution is included. The other words, our definition of balance reflects the
transversal relationship observed between the primary surplus or deficit.
demographic dependency ratio and the financial Figure 3 isolates the demographic effect in the
balance is even weaker than in the case of spending, usual way by setting the value of other accompanying
for reasons similar to those already adduced. factors and examining the change in the indicators that
To sum up, the data just analysed provide useful concern us within a plausible range for our ageing
general information on the indicators and relationships variable, d. Four reference points are graphed for each
we are concerned with, but offer rather limited system indicator. The first two points, from left to right,
possibilities for more detailed and specific study.11 For are obtained from the demographic profile (adult age
the purpose of isolating and analysing the effects of structure and mortality schedule) of Nicaragua in 1990
ageing on pension systems, a more viable and productive and Uruguay in 1990, these being the countries that
approach is to use individual country models, broken have the youngest and oldest age structures in the
down by age, that take account of the key parameters of region, respectively. In addition, to provide an idea of
the system. The following model, which has had to leave the way pension system indicators may change over
out a number of the details and peculiarities of pension the longer term, the third point corresponds to the
systems (appendix 2), gives rough orders of magnitude demographic profile of France in 1990 and the fourth
for the indicators we are concerned with, and not exact one to the profile projected for France in 2050 (Dinh,
calculations.12 The drawbacks of simplification are 1995 and Meslé and Vallin, 1998).
compensated for by the possibility of studying a wider Panel A of the chart shows the linear relationship
between pension system spending and ageing (indexed
by d), other things being equal, that is embedded in the
10 Argentina and Uruguay also had sizeable social security deficits model conditions. The values for the data confirm the
in the late 1970s and early 1980s (Mesa-Lago, 1991, table 9). fact, already documented in section II of this paper,
11 In theory, another approach would be to carry out longitudinal

analyses on countries with reliable chronological series of spending


that when systems cover a fraction of a demographically
and revenue data. This requires consistent, complete statistical series “young” working-age population, pension spending
covering at least four or five decades so that substantial changes may be just 1% or 2% of GDP, but that this can reach
arise in the indicators of ageing, something that limits yet further levels of close to 10% when the country’s population
the scope for carrying out this kind of analysis in the case of most reaches an advanced state of ageing, even if coverage
Latin American countries.
12 The calculations are strictly valid if the rules of the system, labour remains as incomplete as it is at present in Latin America
force participation, coverage rates and the degree of compliance as a whole (about half the workforce). Spending levels
with contribution liabilities are constant in each country. can be even higher in practice when coverage is wider

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FIGURE 3 or universal: pension spending in Italy is already about


Simulation of pension system expenditure and financial
15% of GDP and, as has already been noted, it is expected
balance by degree of ageing, in accordance with the model
conditionsa to go even higher than this in some OECD countries over
the twenty-first century.13
A. Ageing and pension expenditure While expenditure levels give an indication of the
weight that pension programmes have in the economy,
10
a better idea of the aggregate financial performance of
GDP

8 the system is obtained from the balance, i.e. the


Expenditure as % of

difference between the system’s annual revenue from


6
contributions and its yearly pension payments. Panels
4 B and C of figure 3 show two possible variants of this
indicator: the balance as a proportion of system revenue
2
and as a percentage of GDP . Both are also linear
0 functions of d, in accordance with the conditions of
0 0.2 0.4 0.6 0.8 the model. These lines suggest that, if the system
variables (contribution rates, replacement rates and
Dependency ratio (pop. 60+/pop. 20-59)
membership conditions) are not adjusted, population
ageing can turn a surplus in the initial balance when
B. Ageing and financial balance of the pension system populations are “young” (d less than 0.3) into
(% of income) substantial deficits, which may amount to as much as
twice system revenue, or 6% of GDP, when population
100
ageing is very advanced (d of around 0.8), given
Percentage of income

50 constant parameters which are the averages for the Latin


0 American systems. This theoretical possibility, however,
0 0.2 0.4 0.6 0.8 has not hitherto come about in the region. In the maturer
-50
and more “aged” systems of the more developed
-100 countries, the system variables (contributions, benefit
-150 amounts or eligibility conditions) are usually adjusted
before such extreme situations arise.
-200

Dependency ratio (pop. 60+/pop. 20-59) 3. Sustainability of unfunded systems and


intergenerational equity
C. Ageing and financial balance of the pension system
It is not always easy to define what a “sustainable” level
(% of GDP)
of pension spending or an “unsustainable” deficit level is,
4 since in practice this involves many simultaneous variables.
2 In public debate, political considerations may lead to a
GDP

0 relatively modest current or projected deficit being


Percentage of

described as excessive with a view to justifying reforms


-2 0 0.2 0.4 0.6 0.8
involving a change in the system, while substantial deficits
-4 may not be regarded as a serious problem if they can be
-6 financed by increasing public debt, which will have to be
-8 coped with by future governments and paid off by future
Dependency ratio (pop. 60+/pop. 20-59) generations of taxpayers.
But even if political considerations are left aside
a As described in section III, part 1. The suppositions and equa-
for analytical purposes, the definition of sustainability
tions used in the model are given in appendix 2. The param-
eters used in this simulation are “typical” ones, i.e. averages
for Latin American pension systems and labour markets, while
demographic conditions are allowed to vary within the range 13 A simulation for typical Latin American pension system
given. From left to right, the points represent the demographic parameters based on the present model (Bravo, 1999) shows that
profiles of Nicaragua in 1990, Uruguay in 1990, France in 1990 with universal coverage spending levels in the region would be
and France in 2050. roughly double those shown in panel A of figure 3.

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is still complex, particularly when it is limited to the be a great help in establishing common ground for
standard indices of the periodic system. For example, policy discussions if they were (Mesa-Lago, 2000).
an extraordinarily high level of pension spending (as Nonetheless, uncertainty about the future, particularly
in Italy, for example) is chiefly a reflection of the fact in the medium to long term, means that in any specific
that the country’s population is currently one of the instance these assessments have to be interpreted with
oldest in the world. It is very natural that, both at the caution, since the accuracy of the results depends
individual level and in society as a whole, the resources directly on the validity of the assumptions made.
used to finance consumption by the elderly should Policy analyses are making increasing use of stock/
increase as people live longer and longer. This cannot lifetime summary measures of system accounts to
in itself be regarded as an “unsustainable” tendency; examine the comparative medium- to long-term
insolvency will only occur if insufficient provision is financial stance of the systems concerned.15 These are
made to finance this increased spending over a discussed in more detail in the following section. One
reasonably long period that is consistent with the time of these stock measures is the implicit pension debt (or
horizon over which the pension system contracts liability), i.e., the present value of unfunded pension
liabilities and pays out benefits.14 system liabilities towards pensioners and active workers
The financial balance (of the period) is more at a given point in time. This indicator, calculated in
informative in this regard, but still falls short of accordance with the model conditions, is graphed in
providing a clear solvency test, since primary financial panel A of figure 4 against our preferred index of ageing
imbalances can arise simply as a result of the different d. It can be seen that it rises in an almost linear fashion
degrees of maturity that systems have reached or of against the dependency ratio within the range given.
temporary economic fluctuations, which do not imply The implicit pension debt is a useful summary
insolvency in the sense just indicated. When there are indicator and, as the following sections show in some
large, persistent deficits (such as the ones projected for detail, is essential for understanding and measuring the
a number of OECD countries over the twenty-first fiscal cost of closing an existing pay-as-you-go system.
century, assuming all variables except ageing remain It does not however tell us directly whether a particular
unchanged) it is more obvious that adjustments are system is “sustainable” or not. As in the case of
needed, but even here a clear distinction needs to be spending, the pension liability rises naturally as the
drawn between the “sustainability” of continuing system matures and expands its coverage and as the
parameter values (contribution levels, benefit population ages. Again, if for example a large implicit
calculation methods, eligibility conditions), which can debt can carry on being “rolled over” to future
be changed, and the viability of the system’s general generations (as happens in a continuing pay-as-you-go
design, which has more to do with its suitability for a system) under conditions acceptable to workers and
particular type of development model and is more a pensioners, then there is not a strong case for deeming
function of economic policy considerations than of the it unviable.16 Furthermore, it is possible for a low
degree of ageing in the population as such. dependency system to have a small implicit debt and, at
Full actuarial analyses that take account of present the same time, a significant permanent deficit, as
and projected system parameters are a more satisfactory demonstrated by the model estimates for El Salvador
way of assessing the solvency and the medium- to long- and Guatemala (not shown here). In fact, Nicaragua, a
term sustainability of systems. Indeed, if there were country with a low pension debt, had a modest
certainty about the current values and future trend of operating deficit in the early 1990s. The opposite
the different system variables, the actuarial balance situation can also occur: countries with a high pension
would be an excellent summary measure of solvency debt and a relatively aged population that can show
(in the medium term). Many developed country systems sustained financial balance or even a budgetary surplus
have well-established actuarial assessment practices.
In most of the Latin American countries, unfortunately,
analyses of this kind are not carried out consistently 15 See Franco (1995) for a good critical discussion of the different
(see Mesa-Lago, 1985 and 1991), although it would indicators.
16 From a macroeconomic point of view, a valid criterion, particularly

for highly indebted countries with relatively mature systems, is the


14 Baldacci and Tuzi (1999) provide an interesting analysis of increase in public-sector liabilities (including those of the pension
demographic and labour market changes and the sustainability of system). Chand and Jaeger (1996) provide an excellent discussion
the Italian pension system. along these lines for a number of industrialized countries.

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128 CEPA L R E V I E W 7 2 • D E C E M B E R 2 0 0 0

FIGURE 4 In many theoretical and real-world situations, though,


Simulated values for implicit pension debt and implicit the indicators referred to do not permit of an
rate of return of the pension system, in accordance with
unambiguous interpretation, which supports the idea
the model conditionsa
that there is no generally applicable rule to justify the
A. Implicit pension debt and ageing need for one particular type of reform on the basis of
ageing trends alone.17
250
Another way of approaching the problem is to ask
debt as % of GDP
Pension system

200 how the system affects different generational groups.


150 In fact, one increasingly widespread approach to
100 determining the sustainability of public policy or a
50 particular government programme, which is what we
are concerned with here, is to consider that a system or
0
0 0.2 0.4 0.6 0.8 policy suffers from intergenerational inequity if it
provides benefits to current generations at the expense
Dependency ratio (pop. 60+/pop. 20-59) of the economic welfare of future ones. In extreme
cases, a particular programme or policy may prove to
be more absolutely unsustainable if it requires future
B. Pension system rate of return and ageing
generations to bear an excessively large net lifetime
7 tax burden. An example of this situation is provided by
6 Gokhale (1995), who uses generational accounts for
Percentage return

5 the United States to calculate that if current government


4 economic policies were continued, future generations
3 would have to bear a net tax burden 35 percentage points
2 higher than that borne by current generations, yielding
1 the obviously inconceivable figure of 80% of lifetime
0 income.
0 0.2 0.4 0.6 0.8 Panel B of figure 4 plots the implicit rate of return
Dependency ratio (pop. 60+/pop. 20-59) of the pension system (r), which reflects the net lifetime
benefit of participating in the system for a given
a As described in section III, part 1. The suppositions and equa- individual or cohort. What r measures is the excess
tions used in the model are given in appendix 2. The param- proportionate present value that the individual or cohort
eters used in this simulation are “typical” ones, i.e. averages
for Latin American pension systems and labour markets, while
obtains in pension benefits over and above the value of
demographic conditions are allowed to vary within the range the contributions paid into the system over their working
given. From left to right, the points represent the demographic life, an indicator analogous to the one used to measure
profiles of Nicaragua in 1990, Uruguay in 1990, France in 1990 the rate of return on financial investments.18 As in the
and France in 2050. case of the variables plotted previously, this indicator
is calculated in accordance with the general
(for example, the model estimates for Chile and assumptions of our basic model, with two alternative
Uruguay). Costa Rica, a relatively high debt country, scenarios now being considered: firstly, the case
had an operating surplus in the early 1990s; a more where the system variables remain constant
extreme case is that of the United States, which has a throughout the ageing process and the general
large pension liability but a substantial periodic balance
surplus. A number of other OECD countries have even
greater pension liabilities but operate with modest 17 See Blanchet (1990 and 1998) for a fine, nuanced discussion of
deficits or balanced budgets. the relative merits of funded and unfunded systems under changing
In some cases, a more consistent diagnosis can be demographic conditions in a context of general balance, which
obtained when spending, the financial deficit and the refutes some common misconceptions about the subject.
18 See Bravo (1996) for a more detailed discussion of the implicit
pension debt are all substantial, as for example in
rate of return and the way this is affected by different factors and
Argentina and Uruguay during the 1980s. When all the policies. Related effects on lifetime wealth are studied in Auerbach
indicators point in the same direction, the need to make and Kotlikoff (1987), Arrau (1991) and Cifuentes (1995) in the
major adjustments to the system becomes more obvious. context of general-equilibrium, overlapping-generation models.

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