2 1698 DEVELOPMENT BRIEF Number 57 The World Bank August 1995 inefficiently choose to stop working Support for the aging when retirement funds become available. Others who would ratio- Governments of all types conclude that improvident nally stop working won't do so be- citizens leave them no choice-they must get involved cause of limited access to their in pension schemes. That leads to debate over what accumulated funds. It isn't easy to of plan is est. The aswer is tha no singleadjust the tradeoffs. Moreover,a sort of plan is best. The answer is that no single uniform retirement age also has system suits every country. What's critical is a some inefficiency. Life expectancy practical design adapted to a particular economic can vary by sex, income, and educa- and political situation tion. People with short life expect- ancies mLight be acting rationally if I n the complex discussion of in- zerland, might help, but that's po- they choose lower savings and ear- come plans for the elderly, litically and administratively diffi- lier retirement. there are few points of univer- cult. Allowing withdrawals from sal agreement and possibly fewer mandated savings for a variety of Earmings or contributions? still that are not ambiguous. But purposes, as in Singapore, is also Central to any discussion of plan- most policymakers agree that many possible. The higher the mandated ning for retirement is the distinction people, left to themselves, would savings rate, the stronger the between a defined benefit plan (as not save enough for their retire- in the United States), which relates ment. So governments conclude retirement income to earnings his- that they have no choice but to get tory, and a defined contribution involved. Beyond that lies wide- Forcing all people plan (as in Chile), which ties pen- spread debate over what's best and t sion income to a history of contri- what's practical.* to commit their butions. Differences and policy Nothing is simple. Take the issue savings to choices can go well beyond the of how much people should be method of accumulation, however. forced to save for retirement. As- retirement has For example, all plans need a sume, for example, that some mechanism to convert savings into people save rationally while others some inefficiency flows of retirement income. save nothing. Forcing people to Chileans have two options at re- save would provide a welfare gain. . . . so does a tirement age, whether they stop The myopic will have something at u f retirement working or not. One is to elect the end. And if the mandated rate monthly withdrawals that are sub- isn't too high, there's probably little age ject to a monthly maximum. A re- effect on those who would have tiree then runs the risk of outliving saved anyway. But forcing all economic (and political) case for the accumulation and having to fall people to commit their savings to multiple uses. But a lower level of back on the government-provided retirement has some inefficiency. forced savings just for retirement minimum pension. The other is to Before worrying about retirement, a must be balanced against the risk of use savings accumulated under the rational person might first save for excessive early withdrawal for plan to purchase an indexed life- a home or to educate the children. other uses. time annuity. The United States Varying savings by age, as in Swit- Beyond those issues are the ques- generates an annuity differently. A _________________________________ tions of how and when savings get legislated benefit formula recog- 'For more details, see Peter Diamond, "Economic Support in converted into retirement income. nizes only a 35-year average of in- Old Age," apaperpresented atthel995 Annual BankConfer- Lump sum or a flow of income? dexed earnings and the age at ence on Development Economics, World Bank, Washington, DC, May 1-2. And at what age? Some people will which the benefit flow starts. The benefit formula changes over time, Risks and choices * The future course of mortality but it is the same for everyone in a No retirement system is without is a major social risk that must be cohort. risks, choices, and anomalies. Some borne by some group no matter Another marked difference be- to be considered: how retirement incomes are orga- tween Chile and the United States * Given the differences in life nized. Similarly, the futures of wage that is not related to accumulation expectancies, systems that provide growth and interest rates are large, method is treatment of early death. uniformly defined benefits at a fixed societywide risks. Different systems In Chile a savings accumulation age redistribute income from male to spread these risks differently, but goes to the worker's estate if he or female workers. the risks remain. she dies before retirement age. In * Many economists see indexed * If workers do not save on their the United States there are some annuities as an appropriate form of own, neither taxes paid nor prom- benefits for specific survivors, but retirement income. Workers might ised future benefits affect savings. not for the estate. Those who die correctly conclude that indexing Consumption is simply transferred early generally help finance the lowers initial benefits to finance from the young to the old. If there benefits of those who do not. later ones. are rational savers, however, cur- While there are many ways in rent savings are reduced in re- which a plan accumulating taxes sponse to expected future benefits. differs from a plan accumulating Both types of savers are present in earnings, there are also options that No retirement all countries. The question is in allow adjustments that effectively i what ratio. reduce the differences. A defined system Is without . An investment of retirement benefit system, for example, tends risks choic s and funds in private assets can contrib- to redistribute to early retirees. But ute to the development of capital administrators can alter the distri- anomalies markets, as it has in Chile. But in- bution pattern by adjusting the dustrial countries have little to gain. benefit formula as the earnings his- And some developing countries tory lengthens or the financing of * Defined contribution systems might not have the regulatory abil- the system changes. A defined con- don't insure against a shortened ca- ity to carry out the necessary capital tribution system can make similar reer due to unemployment, declin- market reform. redistributions to early retirees by ing industries, or poor health. A * Actual markets work differ- adding government debt to their defined benefit system can do this ently than idealized models. While accounts. (Chile did just this when by decreasing benefits for early privatization is thought to be a it shifted from a defined benefit to a retirement at a rate less than is route to greater efficiency and lower defined contribution system.) required for a full actuarial adjust- costs, a surprising aspect of the Without alteration, the two sys- ment. But that buys insurance at the privatized Chilean retirement sys- tems also respond differently to cost of an implicit tax on work in tem has been its high administra- such changes as increased life ex- later years. tive costs. In the United States the pectancy. If the mandated savings * A plan that helps those forced Social Security Administration re- rate is no longer appropriate, a de- to retire early also redistributes in- ports administrative costs of less fined contribution system will not come to those who voluntarily stop than 1% of annual benefits. Private function as well, but it will con- working before normal retirement U.S. life insurance companies have tinue to function. With a defined age. Since higher-earning workers costs that run to 12-14%. benefit system, benefits and taxes often have opportunities to work * A good defined contribution must be realigned by legislation in longer, such plans can redistribute system can look easier to design. the face of demographic change. funds from full-career workers to But good and bad versions of all Whether repeated legislation in re- lower-income earners. Yet those schemes exist. Design and, above sponse to changing circumstances with higher incomes can afford to all, what's politically possible are is good or bad depends on the retire early. If they do so, the redis- everything. quality of the legislative process. tribution reverses. Development Briefs are issuedby the World Bank to inform the media, business, academic, and government policy communities about development policy analyses and results from the Bank's research activities. They are drawn from the work of individual Bank researchers and do not necessarily represent the views of the World Bank and its member countries-and should not therefore be attributed to the World Bank or its affiliates. Briefs are issued periodicallyby the Research Advisory Staff, Development Economics Vice Presidency, The World Bank, 1818 H Street, NW, Washington, DC 20433. Tel: (202)473-3984, Fax: (202)477-0955. Brefs are not copyrighted and may be reproduced with the appropriate attribution.