_Mexico: The 1997 Pension Reform_ _5_ As wages are higher, the percentage of the pension base is reduced. Pensions may never be higher than the average wage a worker received during the previous 5 contributing years.

The old PAYG system appeared to be quite effective in redistributing income to low-income affiliates. However, as in many other theoretically redistributive PAYG systems, there is a considerable difference between promised and actual redistribution (Friedman, 1996; Schmidt-Hebbel, 1994; and World Bank, 1994). In the Mexican case, as a result of the eligibility requirements (10 years vesting period) and the benefit formula, the system was in fact favoring particular groups of affiliates, which were not necessarily in the lower income brackets. This perverse redistributive effect is related to:

- _The eligibility requirements._ To receive a retirement pension, workers had to accumulate at least 500 weeks of contributions (equivalent to 10 years). Women and other affiliates with high rotation could loose all rights to a pension. The redistribution then would go from those workers working less than 10 years to those working 10 years or more. Also, high-income workers who in economic terms contributed less than low-income workers could still receive a much higher pension. This could happen if the rich worker contributed only for the minimum of 10 years, while a low-income worker contributed for more than 20 years.

- _The structure of the benefits and contributions._ The benefit formula in the old PAYG system allowed those people who worked for more than 10 years to receive relatively higher pensions. However, there were incentives for some workers to either work for only 10 years (since the largest part of a pension would be gained by only working this minimum time), or to belong to the formal sector for only the minimum of 10 years. In these cases, workers with longer periods of contribution subsidized workers contributing for only the minimum period required, regardless of their income. The benefit formula also created incentives to under-report income, allowing high-income workers to contribute the same as some low-income workers, and upon retirement, to receive the same pension.

# **_The Rationale for Pension Reform_**

Beginning in the early 1 990s, a consensus began to develop that the social security system, and in particular the IMSS system, needed to be reformed. A long debate ensued on the options for reform and the depth of the measures to be implemented. The three critical reasons for pension reform were that despite the relatively young population (nearly half is under the age of 25) the Mexican pension system was plagued by financial disequilibrium, inadequate pensions, and high evasion. These factors are the most common instigators of pension reform throughout the developing world where populations are still young, public PAYG system finances are on a downward trend, and informality and poverty are widespread (World Bank, 1994; James, 1996; and Demirguc-Kunt and Schwarz, 1996).

# **Demographic Trends: Avoiding Future Shocks and Taking Advantage of Present Opportunities**

In 1960, Mexico's population structure was relatively young. Of 35 million inhabitants, only 5.6% were older than 60 years, while 55% of the total population was below 20 years of age (Figure 1 a). Over the next several decades Mexico's population structure began to shift as the rate of population growth decreased and life expectancy began to rise (Figure lb). By 1990, Mexico's population had more than doubled at more than 81 million inhabitants.