_Mexico: The 1997 Pension Reform_ _8_ increased. This led to an increasing asset-liability mismatch. According to Government calculations, IMSS' actuarial deficit (141 % of 1994 GDP in present value and for a time horizon of 75 years) was expected to result in a cash deficit by the year 2007. This would have required either a trebling of contributions or an increase in Government contributions amounting to 1% of GDP in the year 2000 and 3.75% of GDP in the year 2030.

# **Evasion, Inequality, and Poverty**

In the PAYG system, high rates of evasion are associated with three main factors: the weak relationship between contributions and benefits, high inflation, and short vesting periods. There is almost no relation between benefits and lifetime contributions, which encourages evasion, underreporting of wages and informality in the labor market. First, on average, the IMSS pays each insured worker a pension for a period of 18 years and the corresponding widow's pension for 12 more years. Together, this amounts to an equivalent pension of 30 years while in some cases the worker may have contributed to the system for only 10 years, the required vesting period. After only 10 years of contributing as little as 4% of wages, a worker becomes eligible to receive a stream of benefits equal to 17 years at not less than 100% of the minimum wage, and up to 100% of the average salary of the last _5_ years. If the affiliate leaves the formal work force before pensioning, he can loose all his rights for pensioning and years of contributions unless he returns and contributes again for a year.

Second, the reference base salary to calculate the pension is based on the average of the wages earned in the last five years divided by the current minimum wage and not on the earnings for all years of service. Third, indexation of benefits to the minimum wage (rather than the general price index) introduces political risk via lags in the adjustment of the minimum wage in times of accelerating inflation. Moreover, this indexation scheme penalizes a government that adopts tough anti-inflationary policies since minimum wages can increase in real terms and result in large increases in public pension obligations. These types of problems have been documented in other countries (See Valdes, 1994 and World Bank,1994). The high inflation of the 1980s led to a significant drop in real wages, which fell by 60% between 1980 and 1994. Contributions to the IVCM system began to tail off with the fall in real wages and the real value of pensions eroded. In most cases (80% of pensioners), this has reduced pensions to the guaranteed minimum benefit, which is equivalent to the minimum wage (approximately US$90 per month).

Not surprisingly, workers have perceived the pension scheme as a payroll tax. This situation has created strong incentives for both employers and employees to avoid affiliation and under-report earnings to qualify, and over-report them to receive benefits. It has also acted as a deterrent to attract informal sector workers, who comprise mainly the poor.

# **II. THE 1992 SAR REFORM: HOW A PENSION REFORM SHOULD** NOT BE **DONE**

# **_The Second Pillar: Individual Retirement Accounts in the SAR_**

In a partial effort to address growing deficiencies in the first pillar, the Government introduced the SAR in May 1992 as a mandatory fully funded savings scheme based on individual accounts. It was designed to complement the first pillar' and consisted of two sub-accounts: IWhile there are as many as 8,000 voluntary occupational plans, most of these funds are concentrated in 30 to 35 enterprises - foreign multinationals and the large parastatals - and combine a severance payment obligation (defined under