General Guidelines for a Comprehensive Reform Program
(for example, 3 percent a year). Contributions that are invested in financial instruments, as opposed to “human capital,” as in a pay-as-you-go scheme, can receive higher rates of return, at least over the long run. Given that the rate of return on contributions ultimately determines the level of the pension (that is, the affordable replacement rate), increasing the level of funding of the pension scheme can be a mechanism for offering higher pensions. Clearly, higher rates of return are also associated with higher risks. A well-diversified portfolio of investments, however, needs to include assets with various levels of risk. Higher funding can thus encourage better diversification of the sources of savings for retirement.
National Savings The impact that higher funding in mandatory systems has on national savings depends, in part, on the government’s strategy to finance the transition (for a discussion, see also Bailliu and Reisen 2000 and Bosworth and Burtless 2003). If current unfunded liabilities are financed through debt, the short-run impact will be neutral, as the implicit debt of the pay-as-you-go system is simply transformed into an explicit liability. If, however, this transitional cost is financed via adjustments in the budget for items other than pensions, through either increases in taxation or reductions in other expenditures, national savings may increase. In particular, in the presence of credit constraints, or if current savings are motivated by precautionary rather than life-cycle reasons, agents will be unwilling to reduce their savings in response to a transition tax. In the case of voluntary complementary pensions, the effects are more uncertain. Simply replacing one form of voluntary savings with another is unlikely to affect aggregate savings. Even if pension funds offer greater (long-term) returns than other savings instruments, it is well known that the effect of a higher real return on savings is ambiguous, as the income effect might offset the substitution effect. Furthermore, if the government decides to encourage voluntary contractual savings plans through income tax incentives, the impact on national savings would depend primarily on the government’s fiscal stance. A positive effect on aggregate savings would require that the reduction in income tax revenue be compensated through either higher taxes or lower expenditures. The most recent empirical studies regarding the impacts of mandatory funded systems on national savings suggest a positive relationship, on average (for a cross-country empirical assessment, see López-Murphy and Musalem 2004). Within a given country, however, institutional factors ultimately can stimulate or preclude a positive effect on national savings rates (for a discussion, see Bosworth and Burtless 2003). In Middle East and North African countries, due to their frail fiscal position,
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