Old-age pension reform and modernization pathways: Lessons for China from Latin America

Abstract

While numerous Western countries first experienced cultural rationalization, next economic modernization, and then faced the challenges of population aging and pension policy reform, both Latin America and China, in contrast, are dealing with these challenges in the context of much less developed economies and stronger traditional cultures. In this article we analyze old-age pension reform efforts in eight Latin American countries that have introduced funded defined contribution schemes with individual accounts. We are searching for insights about the potential success of similar reforms being implemented in China. All of these societies are organized primarily around the principles of family, reciprocity, loyalty and poverty. Our analysis suggests that these distinctive characteristics have important implications for the likely success of the reforms currently being implemented in China, particularly in four interrelated areas: coverage, compliance, transparency, and fiscal stability.

Introduction

Latin America is a pioneer with respect to the shift from old-age pension schemes based on pay-as-you-go (PAYG) defined benefit models to schemes based all or in part on funded individual accounts. In 1981 Chile became the first nation to make the shift with the introduction of mandatory fully-funded privately managed individual retirement accounts (IRAs). Today there are 12 Latin American countries that have shifted to schemes influenced by the Chilean model (Gill et al., 2005, Kritzer, 2005).

On the opposite side of the earth, China is following a similar path, though the Chinese IRAs are currently publicly managed and remain largely unfunded (Jackson & Howe, 2004). Since 1995 China has introduced a number of reforms, the most important of which were promulgated in 1997 and 2000. By 2025, one quarter of the world's population aged 60 and over will be living in China (United Nations, 2005). For this reason the success or failure of the reform of China's old-age pension system will affect a major proportion of the world's elderly population (Williamson & Shen, 2004).

In many respects the reforms in China have not been working out as had been intended. The major problems faced by the old-age pension reform in Latin America appear again in the newly introduced reforms in China. These problems include low coverage and compliance rates, poor transparency, and serious fiscal difficulties.

Our analysis tries to obtain insights about the potential consequences of reforms currently being introduced in China based on evidence from eight Latin American countries – Argentina, Bolivia, Chile, Colombia, El Salvador, Mexico, Peru and Uruguay – that introduced some form of funded IRAs (partial privatization) between 1981 and 1998. Four other countries – Costa Rica, the Dominican Republic, Ecuador, and Nicaragua – are not included because their reforms are so new, because they are not yet fully implemented, or due to the lack of information.

Many differences can be found between the Latin American countries, and perhaps even more between them and China. For example, Latin American countries have undergone a variety of political regimes, but none of them has been close to Chinese communism. Differences acknowledged, our analysis emphasizes the major cultural and economic factors shared by the countries analyzed. We argue that the eight selected Latin American countries and China are strong traditional cultures and low-income economies characterized by the centrality of: (1) the family, (2) reciprocal relationships, (3) rules of loyalty, and (4) poverty. Our analysis highlights the role of these factors in shaping the unfolding of the pension reform process with respect to four areas: (1) coverage, (2) compliance, (3) transparency, and (4) fiscal stability. The role of the cultural and economic factors considered in this article has been largely overlooked in the literature on pension reform. Much of this literature focuses on political factors, such as the welfare state, communism, and the World Bank policies (e.g. Esping-Andersen, 1996, Fox, 1997, Frazier, 2004, Myles and Pierson, 2001).

In this article our focus is on Latin America and China, but we find it essential to make some comparisons with the Western European nations. The latter will be characterized as rationalized cultures and affluent economies displaying centrality of: (1) the institutions supporting elderly, (2) individual financial planning, (3) legality, and (4) wealth. Although a detailed analysis of Western European countries is beyond the scope of this paper, the comparison has important advantages. A comparative perspective calls attention to the factors shared by Latin America and China. In addition, the Western European nations constitute a reference point that can be used to provide all observers with a common frame through which to assess the pension reform in Latin America and from which to speculate about some of the challenges China will face in connection with pension changes currently being implemented. But above all, the comparison to Western European nations helps to uncover some of the underlying assumptions of these pension reforms that do not entirely hold for Latin America and China. In a somewhat oversimplified formulation, these assumptions are: (1) preeminence of formal-institutional support systems of the elderly, (2) emphasis on individual responsibility for financial planning, (3) zealous attachment to the law, and (4) perception of old-age poverty as an isolated problem. Formulated in a more general way, we will argue that the reforms fail to account for some of the major cultural and economic characteristics shared by Latin America and China.

Fig. 1 and Table 1 provide a brief summary of a number of key points that we have briefly introduced above, but more importantly they also serve as guide to much of the analysis which follows.