Contractual Savings In Countries With A Small Financial Sector

**Table 4: Pension annual real rate of return and governance**

||RR|STD|RR/STD|Govemance|
|---|---|---|---|---|
|Rateofreturn(RR)|1.0000||||
|Standarddeviation(STD)<br>p-value|-0.8836<br>[0.0000]|1.0000|||
|RR/STD<br>p-value|0.6746<br>[0.0006]|-0.5456<br>[0.0086]|1.0000||
|Governance|0.4937|-0.4664|0.3787|1.0000|
|p-value|[0.0269]|[0.0382]|[0.0997]||

**Source:** Authors' calculation from Iglesias and Palacios (2000)

Iglesias and Palacios (2000) use this data to compare the return of private pension with the return on public pension funds and inevitably find that public funds have been mismanaged in many countries and that private pensions are one way to introduce discipline in asset management. The interference of governments can be detrimental when investment policies are guided by objectives unrelated to the maximization of return on pensions assets. Low rates of returns on pension contributions induce distortions on the labor market as contributions are increasingly perceived as income tax. As a result, savings are not allocated to the most efficient use. Clearly governments want to overcome a situation of economic impasse by targeting key industries. However, the recourse to coercive regulation and captive source of funds is the short term answer to a credibility problem on the part of the government that prompts investors to impose high risk premia on future nominal interest rates<sup>24</sup> . What is not realized, or probably only underestimated, is that the use of captive source of funds only reinforce investors' expectations and seriously undermines the development of financial markets. When financial markets are not developed financial innovation is hampered and the cost of_capital remains high. Hence, efficient mobilization of savings and allocation of resources are denied. Furthermore, when these captive source of funds involve social security schemes, the provision of adequate pension benefits is undermined; and the implicit debt of the government inflated.

Specific recommendations can be made for small developing countries. In these countries the reduced dimension of institutional relationships, the relative scarcity of human capital, the greater concentration of wealth, and a relatively less independent civil service facilitate concentration of functions, interference by third parties and more generally weak governance. Glaessner and Vald6s-Prieto (1996) argue that in the provision of pension services in small countries, it is essential that the supply of trustee services and governance be maximized. Not only is it important to procure, maybe abroad as previously mentioned, services from highly reputable companies, but it is as important to supply highly independent trustee services. These greatly influence the performance of pension funds by hiring and selecting asset managers, determining investment policies, selecting auditors, and asset custodians. The number of trustees per

> 24 The US social security trust fund can only be invested in non-tradable government securities. However, the credibility of the macroeceonomic policy of the US government is not at stake and this exception to the reasoning before made can easily be explained in this way. Very different would be the situation if fiscal discipline in the US were non-existent as in many developing countries.

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