12 47. In countries that exhibit this type of political behavior, a pension system based on competitive selection of pension management companies by individual members can insulate trustees from many of these pressures. Since each pension management company must compete for clients, this competitive process punishes those companies that indulge in concessions to politicians. For example, if powerful politicians request that pension management companies buy a low-yielding debt from a state-owned enterprise, the company resists this pressure will exhibit higher retums and will be rewarded with more customers and higher profits, as seen in a recent Chilean episode (Godoy and Valdes-Prieto, 1994). It is important to note that these benefits will obtain with more certainty if the supervision agencies help to support the political independence of the members of the boards of trustees.

48. Therefore, in all cases where the political development of a small country has not reached a stage where vulnerability to such pressure can be confidently ruled out, and human capital is too scarce to supervise thousands of employer and union-run boards of trustees, the best option is individual selection of pension management companies. This proposition has received empirical support. A recent study by Mitchell and Hsin (1996) about the financial performance of 130 occupational pension plans for public employees at the state and county levels in the United States, where the sponsor is a political entity, finds that the presence of elected pensioner representatives, usually linked to unions, on the boards of trustees reduces the rate of return of the pension fund.

49. A recent study by the World Bank,<sup>8</sup> about the rate of return obtained by provident funds (single, government-managed pension funds) in 14 countries, found that all of them performed worse than privately managed pension fund management companies, and many had returns below negative ten percent per year for five years. A study by Mesa-Lago (1991) compares the financial returns of the funds invested by half-funded conventional social security systems in 8 Latin American countries and comes to similar conclusions.

_50._ In light of this experience, small developing countries may wish to choose a design with privately owned competing pension trustee companies, supervised by a specialized government agency -- a superintendency. (The exceptions, where other trustee arrangements might be better, would be countries that have enough human capital to supervise tens of thousands of employers and unions, and have a high degree of political development and stability.) However, the arrangement with privately owned competing pension trustee companies may be rendered suboptimal if this market turns out to be concentrated. This is because a tight oligopoly of pension trustee companies would have too much power in the domestic securities markets, where international capital mobility is not significant, thus increasing the risk that these firms would be misused by politicians. Section C below discusses the possibility that concentration in some types of financial services rendered to flows (e.g., collections, payments of benefits) may lead to concentration in the pension trustee market (i.e., services applied to stocks).

# **C. Competition in the Supply of Some Pension Services**

51. The paragraphs that follow assess the degree to which each pension service is characterized by monopoly. In each case, specific options are described for the provision of that service.

_!I_ See James et at. (1994), Chapter 3. paras. 93-6 and Figure 3.7 and Chapter 6, Fig. 6.3.