**_PENSiONREFOR&fINLATvNAMERICa_**

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the measure to assess the efficacy of a given level of recapitalization and whether alternative approaches to investing fund balances to generate a higher rate of return may be a proper and useful course of action.

## C. ECONOMI **C** ONSIDERATIONS IN PENSION **REFORM**

The transition to a reformed pension system raises economic issues that have significant impact on the overall economy. The most crucial overarching issue is the sustainability of a pension program. The financial well-being of pension systems depends critically on the economy. Contributions to a pension system decline when real wages fall. Likewise if a pension program establishes large reserves then investment and real wages are likely to increase.

## **Paying for Benefits for Present Retirees**

A fundamental economic issue is intergenerational equity, e.g., which generations will pay the social security benefits that accrue as liabilities. In pay-as-you-go pension systems, workers pay for the benefits of retirees. In moving to a fully funded system, funds are still needed to pay the benefits of present retirees. In pension systems where there are few reserves, and when workers begin contributing to their own individual accounts rather than pay into a public pension fund, the resources will be insufficient to cover the benefits of current pensioners as well as older workers who will soon be retiring. Should the government borrow to finance the benefit and service the debt through current workers' contributions, the cost of this debt can be paid off by present workers or future generations, or pensioners may be asked to bear a higher tax burden. The importance of these intergenerational issues varies with the demographic profile of the country undertaking pension reform.

## **Macroeconomic Effects of Reform**

It is expected that pension reform will bring benefits to the macroeconomy. If this is to take place, the supply of labor and capital needs to increase. Labor supply can be increased by reducing the perceived and effective tax rate on wages. Higher labor earnings result in more national income, more savings, and hence, more capital formation. The intention is to structure incentives in pension reform policies to value savings and work, whereas the present pay-as-you-go systems that impose an effective tax on wages the incentives are tilted towards those who seek to have more limited employment.

# **II.** NEW **DIRECTIONS FOR REFORM**

Several countries in the region are seizing opportunities to reassess the performance of the public pension systems, learn from experience, and identify the characteristics of pension systems that are sustainable. One of the lessons leamed is the need to provide incentives for the efficient provision of old age benefits. Employee contributions must be linked to benefits so contributions are not seen by participants as a tax. It is possible and appropriate to redistribute income to older persons whose lifetime earnings have been too low, poverty while simultaneously maintaining equity within and across generations. At an aggregate level, public funding should not distort labor markets and drive employment into the informal, non-taxed sectors. Finally, public funding should not distort capital markets.

Several principles of reform of pension systems can be articulated. Most broadly, the role of government in pension systems needs to be reassessed -- which may mean a change in the role of the state from the provision of old age security to regulation of pension systems. This means an increase in the role of the private sector in the management of pension funds and in the provision of back-up insurance. More realistic contribution levels are necessary for sustainability which means a shift from defined benefit pay-as-