SOCIAL PROTECTION & JOBS DISCUSSION PAPER Public Disclosure Authorized No. 1927 | April 2019 Public Disclosure Authorized The Politics of NDC Pension Scheme Diffusion: Constraints and Drivers Igor Guardiancich, R. Kent Weaver, Gustavo Demarco, and Mark C. Dorfman Public Disclosure Authorized Public Disclosure Authorized © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: +1 (202) 473 1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. RIGHTS AND PERMISSIONS The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: +1 (202) 522 2625; e-mail: [email protected]. Abstract: Nonfinancial defined contribution (NDC) schemes offer governments desirable properties in terms of efficiency, fairness, and financial sustainability and an opportunity to deflect the blame for pension cuts. Yet adoptions of NDC schemes largely ground to a halt and several countries retreated from NDC implementation after legislation. Lack of support from powerful international actors is partly to blame, as is the perceived rigidity of NDC in reducing room for policy maneuver. Correct implementation requires substantial administrative capacity. Less demanding automatic stabilizing mechanisms undercut the appeal of NDC in the European Union. Thus, while being an important option for policy makers and a benchmark against which to measure alternative reforms, NDC is unlikely to become the dominant pension design choice anytime soon. Key words: Nonfinancial Defined Contributions, Policy Diffusion, Policy Reversals, International Organizations, European Union, Automatic Stabilizing Mechanisms JEL codes: H55, J58 2 Acknowledgments This paper is written for Progress and Challenges of Nonfinancial Defined Contribution Pension Schemes, Volume 2: Addressing Gender, Administration, and Communication, edited by Robert Holzmann, Edward Palmer, Robert Palacios, and Stefano Sacchi, to be published by the World Bank in autumn 2019. We are grateful to Bernhard Ebbinghaus, Alexi Gugushvili, and Marek Naczyk for comments and suggestions and to Amy Gautam for first-rate copy editing. A first version of the paper was presented at the NDC III conference in Rome, October 5–6, 2017, and we are thankful to the participants for their comments and encouragement. The views expressed herein are those of the authors and do not necessarily reflect the views of the institutions they are associated with or the views of the World Bank. 3 Abbreviations and Acronyms ASM Automatic Stabilizing Mechanism DB Defined Benefit EU European Union FDC Financial Defined Contribution GDP Gross Domestic Product ILO International Labour Organization NDB Nonfinancial Defined Benefit NDC Nonfinancial Defined Contribution PAYG Pay-As-You-Go OECD Organisation for Economic Co-operation and Development 4 Table of Contents 1. Introduction ....................................................................................................................... 6 2. Definitions and patterns .................................................................................................... 8 2.1. Background information ................................................................................................ 8 2.2. Theoretical perspectives on NDC diffusion.................................................................. 10 3. Innovators ........................................................................................................................ 18 3.1. Sweden ......................................................................................................................... 18 3.2. Italy ............................................................................................................................... 20 4. Adapters: Poland ............................................................................................................. 22 5. Boundary straddlers: Germany ....................................................................................... 25 6. Incrementalists: Slovenia ................................................................................................. 27 7. Dropouts .......................................................................................................................... 29 7.1. Former Soviet Union and Central Asia ......................................................................... 29 7.2. Egypt ............................................................................................................................ 33 8. Conclusions and prospects for NDC systems .................................................................. 34 8.1. Patterns of diffusion .................................................................................................... 34 8.2. Facilitating and impeding conditions for NDC-based reforms .................................... 35 8.3. Prospects for further diffusion of NDC reforms .......................................................... 38 8.4. Sustainability of NDC reforms ...................................................................................... 41 References .............................................................................................................................. 43 5 1. Introduction Proponents of pension reforms based on nonfinancial defined contribution (NDC) principles argue that NDC displays a number of desirable properties in terms of efficiency, fairness, and financial sustainability. NDC schemes influence individuals’ choices to work in the formal labor market and contribute to their own pension (micro efficiency). Inclusion of life expectancy in the benefit calculation encourages participants to work longer, as postponing retirement is rewarded. If these incentives work, then the supply of a country’s labor and thereby gross domestic product (GDP) increase (macro efficiency). NDC schemes guarantee both intragenerational fairness – i.e., that each monetary unit contributed yields one unit in benefits (plus an imputed interest) – and intergenerational fairness by guaranteeing that each generation pays the same percent of income in contributions. The NDC approach facilitates financial sustainability as do financial defined contribution (FDC) schemes, but without the burden of financing the transition costs. NDC-based reforms have at times enjoyed support by powerful international actors like the World Bank. Reversals of some FDC reforms (Holzmann 2013) and growing awareness of the associated financial and market might also create further openings for NDC reforms. The NDC design offers potential political advantages to policy makers, notably eliminating or lowering the need for repeated ad hoc pension retrenchment measures that may be politically costly to officeholders who impose them (Brooks and Weaver 2006). Repeated ad hoc reforms may also have negative impacts on the legitimacy of and trust in pension systems. Despite these potential advantages, the diffusion of NDC pensions was limited in recent years. A first cluster of NDC pension system adoption occurred in the 1990s in Sweden, Italy, Latvia, and Poland. Where implementation was fully successful, such as in Sweden, only minor adjustments followed (Weaver 2016). In countries where implementation was more problematic, such as in Italy, interventions were more profound, but they seldom 6 directly clashed with the NDC logic (Jessoula and Raitano 2017). Ultimately, Italy’s NDC scheme was tightened up with the 2011–2012 Fornero reform. This relatively successful first wave was not followed by massive adoption elsewhere. Around the turn of the century, a number of reforms followed in places such as Kyrgyzstan and Russia, but they were either never properly implemented or, as in Russia, were reversed. In 2009, Norway introduced an NDC pillar and stuck to it. In the 21st century, and especially since the global financial crisis of 2008–2009, adoption of more limited automatic stabilizing mechanisms (ASMs), often accompanied by incremental retrenchment mechanisms and sometimes by the creation of small FDC tiers, largely supplanted NDC pension reforms in the policy repertoires of most advanced industrial countries. A balancing mechanism was introduced in Germany, Spain, and Lithuania. Benefits are tied to life expectancy in Finland, France, Portugal, and Spain. The statutory retirement age is tied to life expectancy in Cyprus, Denmark, Finland, Greece, the Netherlands, Portugal, and Slovakia (European Commission 2018, 36). Hence the puzzle addressed in this paper: Why, given that it appears