Social Pensions

World Bank Core Course

Robert Palacios April 2013

Motivation

• Coverage in contribution-based pension schemes has remained low for decades in developing countries

• Social pensions are increasingly proposed as a way to address the ‘coverage gap’

• Many countries have recently introduced new schemes or expanded existing ones and others are considering

• Some of the policy questions: • Are they affordable and what are the tradeoffs?

• Do they create distortions for savings and labor supply?

• How do they affect the contributory scheme?

• How do they fit with social assistance? 2

Contributory pension coverage

3

Large social pension programs in 1990

Maldives

Mauritius

Cape Verde

Timor

Large social pension programs in 2013

Has risen from 6 to 23

Options for non-contributory support to the elderly

• Universal social pension • Targeted social pension • Inclusion in general social assistance

• Note: Each of these options can separate

redistribution/poverty alleviation from insurance/savings as suggested in “Averting the Old Age Crisis”, (World Bank 1994)

Universal Social Pensions

• Advantages:

• Eliminates need for targeting

• Fewer issues of disincentives for labor supply and savings, especially pension contributions

• Political economy favorable

7

Universal Social Pensions

• Disadvantages • High cost for reasonable benefit adequacy

• Kakwani and Subbarao 2004: 70% of poverty threshold to those above 65 in 15 African countries – ranges from 0.7% of GDP in Madagascar to 2.4% in Ethiopia

• Most countries spend 0.5-2% of GDP on ALL targeted transfers

• Projected spending can rise much higher with aging

• Given fixed budget envelope, targeting can allow lower eligibility age and/or higher benefit

• Administration still requires key processes including identification, enrolment and transactions/payments (Nepal example)

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Some empirical evidence supports the intuition that the life expectancy differential by income level is greater in LICs (Bannerjee and Duflo (2005) and Pal and Palacios (2010))

10

Targeted Social Pensions

• Advantages: • Significantly reduces overall cost (even taking into

account targeting cost) • At same cost, benefits can be higher or eligibility

age lower

• Disadvantages • will result in errors of inclusion and exclusion • Increased distortions, in particular to save for

retirement in voluntary or mandatory schemes

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Integration with General Social Assistance • Advantages:

• Compared to separate safety net scheme, minimizes administrative costs, avoids duplication of functions

• Likely to maximize poverty reduction impact for given budget envelope

• In high co-residence situations, the two targeted approaches should converge

• Disadvantages, other considerations • Concerns over disincentives for labor supply and

savings may be different

• Re-certification/graduation issues may differ

• Intra-household distribution may not be desirable

12

Are elderly households poorer?

13

Some elderly

Old

Not Old

Poverty Line

Even where the old are poorer than average, there are

many poor who are not old, and old who are not poor.

Simulated poverty impact

15

Based on HH survey data in

two regions of Zambia

(Watkins 2008)

Co-residence higher in LICs

16

Other impacts of social pensions • Large schemes with no or limited targeting shown

to reduce elderly poverty significantly (but question is whether that is best potential poverty impact)

• Targeted schemes vary widely in targeting outcomes

• There is evidence of indirect behavioral effects of larger schemes including: • Reduction of labor supply of coresident workers • Reduction of private intergenerational transfers • Permanent income increased due to investment • Better health indicators for children in pensioner

households

• Practically all of this based on handful of studies of Bolivia, Brazil and above all, South Africa

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“it has been held

that the prospect of

a pension for their

closing years will

disincline the poor

to make or continue

the exertions that

many of them make

at present for their

own support and

that the

considerations

which induce to

industry and thrift

will cease to operate

in future.”

Contributory pension incentives

• All of the options may lead to lower savings if people feel that they have a minimum old age income guaranteed – in some models, this is the justification for the mandate (Kotlikoff 1987)

• Means-testing should discourage savings most and this includes contributions to pension schemes, but with low contributory coverage, ability to ‘game’ the system will be negligible

• In medium coverage countries, design is much more important – examples of Mexico vs Chile 19

20

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

1 2 3 4 5

Quintile

% o

f e

mp

loy

ed

co

ntr

ibu

tin

g

Uruguay

El Salvador

India

Contributory pension incentives

Some criteria

Introduction or expansion

of SPs

Contributory scheme

coverage

Social Assistance

Poverty ratio elderly/non-elderly HH

Other social indicators*

Supporting Low Limited or non-existent

High Better

Detracting High Broad; high spending ratio

Low Worse

Concluding Remarks • Social pensions may be part of the answer to the

coverage gap in pensions but scarce resources mean there are tradeoffs

• Large SP schemes may be redundant if there already exist broad social assistance programs or if coverage is high in the contributory scheme

• Universal vs targeted can be considered as a continuum – the tradeoff is between targeting errors and the ability to pay more to the poor. This is an empirical question but failure to deliver benefits is not only due to poor targeting but also the other processes involved

• Incentive issues with contributory scheme greater to the extent there is an overlap of households covered which is more likely in middle income countries

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Thank you