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Going Broke? Why Pension Reforms Are Needed In Emerging Economies

 April 06, 2012 10:43 PM


By Mauricio Soto

We're all getting older, and there's no doubt that pension reform is a hot topic in the advanced economies. But it's also critical in emerging economies.

Our analysis here at the IMF shows that across emerging economies pension spending is projected to rise as the population ages. On average, these spending increases are not that large. But reforms are needed to increase coverage of the system without making pension systems financially unsustainable over the long term.

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Rising spending

In emerging Europe, we've seen how pension spending has increased from 7½ to 9 percent of GDP over the past two decades. Spending also increased rapidly in other emerging economies—albeit from much lower levels—going from 2 to 3 percent of GDP over the same period. It seems the relatively low spending in emerging economies outside Europe reflects relatively low coverage (generally only those in the formal sector are eligible) and younger populations.

Populations are aging rapidly in the emerging economies. As illustrated in Chart 1, a rather grim picture is developing where we see that the ratio of elderly to working population will more than double in the next four decades. In the future, there will be many more retirees consuming what fewer workers will produce.

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So taking this into account, Chart 2 shows the projected increase in pension spending over the next 20 years is about 1 percentage point of GDP. And these projections assume no expansion of coverage beyond current levels.

Several countries—Bulgaria, Chile, Estonia, Hungary, and Poland—have enacted reforms that will cut public pension spending over the next 20 years. In other countries—particularly in Asia, we see smaller projected spending increases due to lower coverage and spending. For five emerging market economies the fiscal burden will be a lot higher (more than 2 percentage points of GDP).

 Not everyone gets a pension

 In many emerging economies a large share of the elderly population is poor—in part because of inadequate pension coverage.

Region

Percentage of the elderly who receive public pensions

Emerging Asia

26%

Latin America

59%

Emerging Middle East and Africa

68%

Emerging Europe

93%

Expanding existing pension systems to improve coverage would be costly. For example, increasing coverage from 26 to 34 percent in Asia would increase spending by 1 percentage points of GDP. Similarly, in other emerging economies outside of Europe, increasing coverage from 64 to 73 percent would increase spending by 1 percentage point of GDP.

How can pension reform help?

There is plenty countries can do to address burgeoning demographic pressures to public pension systems. The range of measures includes raising retirement ages, cutting pension benefits, and increasing revenues.

Among these options, gradually raising retirement ages has some clear advantages:

  • Promote higher employment levels and economic growth
  • Help avoid cuts in pensions, reducing the impact of reforms on elder poverty
  • May be easier for the public to understand than cutting pensions or increasing contributions.

One possible strategy would be to equalize retirement ages of men and women—in many emerging economies the statutory retirement ages of women remain lower than those of men.

For the emerging economies withlow pension coverage, current systems—which are often generous but cover only a small portion of the population—should be reformed prior to expanding coverage. In addition, countries with very low coverage rates could consider "social pensions" that provide a noncontributory flat pension aimed at poverty reduction.

For countries that havesubstantial pension coverage, such as in Emerging Europe, continued reforms are needed to contain the growth in public pension spending. . They also need to be cautious in diverting additional contributions from public to private systems, which could make the financing of the deficit more challenging in the short run.

Many emerging economies will need to expand their pension systems to reduce poverty among the elderly. Well-designed reforms can help countries meet this objective without going broke.

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