opportunity to generate long-term savings, unintended intergeneration transfers (often to higher income groups that live longer), and the growth of a large implicit pension debt and financing gap in the face of aging population.<sup>6</sup> To address the short-term and long-term fiscal viability problem as well as economic and distributive concerns, the World Bank (1994) has been recommending and many countries (including China) have been moving toward, multipillar systems that contain the following provision:

- A mandatory, tax-financed and publicly managed pillar for redistributive and coinsurance objectives;

- A mandatory, fully funded, defined contribution and privately-managed pillar (individual accounts) for savings;

- A voluntary, fully funded pillar funded via personal savings or commercial insurance for people who would like more protection for old age.

The multipillar pension system is defended by three main theoretical arguments that are supported by limited empirical evidence. First, it is often argued that the multipillar pension system will facilitate economic efficiency and growth, through removing labor market distortions and by providing better incentives, increased savings, and better allocation of resources (James 1999). For example, a high payroll tax could cause workers and employers to shift from the formal to the informal sector, thereby hurting productivity. Corsetti and Schmidt-Hebbel (1997) show that a payroll tax of 20 percent could lead to a 47 percent shift to the informal sector and reduce the economy-wide growth rate by more than 1 percent a year. Thus, a fully funded, defined contribution pillar would reduce this distortion: following Chile pension reform, the share of informal employment actually dropped, unemployment fell and wages rose between 1980 and 1990. Evidence is not conclusive on whether pension reform leads to a rise in national saving. Haindl Rondonelli (1996) indicates that Chile pension reform accounts for 6.6 of the 9.9 percentage point increase in the national saving rate, from 16.7 percent of GDP in 1976-80 to 26.6 percent in 1990-94. However, the fiscal cost of financing the pension transition initially may have canceled out the positive effect on private saving (Agosin et al 1996, Holzmann 1996). On the other hand, there is strong evidence of the positive effects of a fully funded second pillar (individual accounts) on financial market development, and hence on resource allocation and growth. (See, for example, Holzmann 1997a, Schmidt-Hebbel 1998, Vittas and Iglesias 1992, Vittas 1995.) Another argument for the multipillar system is that it enhances the financial sustainability of the pension system and thereby provides better long-term protection for the elderly. Further, a multipillar system has a redistributive impact and, in particular, could improve intergenerational equity (James 1999). In principle, the entire population should have access to some old age income, at a minimum to a level above the poverty line, and all workers should have a portion of their earnings replaced, consistent with their work history and contribution. The pay-as-you-go system, however, cannot ensure the protection of the elderly and leads to unintended income transfers from the poor to the rich (who live longer). Overly generous benefits in some countries have led to unfair intergeneration redistribution, putting a heavy burden on future generations.

How have countries reformed their pension systems? Schwarz and Demirguc-Kunt (1999) provide a typology of pension reforms around the world. According to their classification, some 82 countries have carried out reforms, of which 21 implemented a major structural reform. Among major reformers, 10 countries are moving toward fully funded individual accounts (the Latin America model), three OECD countries are adopting an employer-sponsored, defined contribution system, and three countries (Latvia, Poland, and Sweden) are using notional defined contribution systems. Several other developing countries are moving in an opposite direction, from defined contribution provident funds to the PAYGO defined benefit system (Figure 1).

6 These problems were recognized and analyzed by many seminal work on pension systems, for example, Aaron 1977, Atkinson 1987, Auerback and kotlikoff 1987, Feldstein 1974, Feldstein and Samwick 1992, Seidman 1986, Arrau 1990, Kotilkoff 1995 and 1997, Holzmann 1988, James 1992 and 1994. See World Bank 1994 for a literature survey. See also Holzmann 1999 and other studies on _Pension Reform Primer_ at www.worldbank.org/pensions.

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