Reforming Social Security: Lessons from Thirty Countries

Studies | Social Security

No. 277
Thursday, June 09, 2005
by Estelle James


Introduction

Since 1980, more than 30 countries around the world have adopted some kind of privately managed plan, usually based on personal accounts, as part of their social security systems. Each has done so in a different way. As the United States considers Social Security reform, including some form of personal accounts, it may be useful to examine options that other countries have implemented. This paper surveys the approaches they have used to resolve key issues, such as how to keep costs and risks low, protect vulnerable groups and make sure that the accumulation in the account lasts for the individual’s lifetime. The experiences of these countries do not offer answers to all our questions, but they do suggest the range of options available to us and some of their potential effects (both good and bad).

“More than 30 countries have reformed their social security systems to prefund some benefits, usually from personal accounts.”

Prefunding Social Security through investments that earn a market rate of return can help make the system more sustainable. It would avoid passing a large debt on to our children, and could help to increase national saving, and therefore productivity and growth. But if the government manages the funds, several dangers emerge that could negate these potential advantages: If invested exclusively in government bonds, the funds may end up increasing government deficits; if invested in the stock market, they may lead to conflicts of interest between government as regulator and as investor; and their use could be subject to political manipulation and the misallocation of capital. These are the main arguments for establishing personal accounts, with private management of the funds.

But private management of social security funds also entails potential problems. Administrative costs may be high, thereby reducing final pensions; financial market risk adds uncertainty to retirement income; some workers may not accumulate enough to keep them out of poverty during old age; retirees may use up their accumulation too quickly; and the transition financing gap may increase the nation’s explicit debt.

How we solve these potential problems determines whether the new system is good or bad and whether it improves or harms the welfare of future workers and retirees. The devil is in the details. Fortunately, we can learn from the experience of others.


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