Thursday, December 07, 2006

How to tackle informal sector pensions

When it comes to the question of pensions for the `organised sector', there is now a considerable consensus on how to proceed. The basic recipe consists of defined contributions; individual accounts; fund management based on the low prices of wholesale market with a big role for passive management (indexation); better returns through exposure to systematic risk factors; variation of risk exposure across the life cycle. These ideas are largely what drives the New Pension System (NPS) in India. I have an article on these issues, done for the inaugural India-and-China conference of the Lee Kuan Yew School of Public Policy (LKYSPP) at the National University of Singapore, titled A sustainable and scalable approach to Indian pension reform.

The key ingredients which make this a feasible recipe is the employer. Collection of contributions is made efficient because of the employer, and there is the rhythm of contributions coming in every month. Neither of these hold for the informal sector.

In the informal sector, the best you can do is to have people step forward to voluntarily contribute into a pension account. Given the high discount rates that most humans have, it is hard to elicit such participation. And, even if you can talk someone into stepping forward, preserving the flow of contributions across long decades is daunting.

I have started seeing glimmers of how this can be made to work. On this theme, I wrote an article How to tackle informal sector pensions in Business Standard yesterday.

The most remarkable success story of this nature is in Mexico, where the foundation was an NPS-style pension system for the organised sector. (In their case, this NPS replaced the EPFO, not the civil servants pension). Once this infrastructure was in place, they linked it up to the Conditional Cash Transfer system, through which transfers are made to poor mothers across the country. This enables the opening of pension accounts by poor people. The government co-contributes with them in order to incentivise participation.

1 comment:

  1. "This enables the opening of pension accounts by poor people. The government co-contributes with them in order to incentivise participation."

    Is there any indication that GOI is moving this way? Or, as I hear often from other commentators, is tax and spend model of social security in US and Europe still in the lead? The first one would be a better long-term sustainable model I'd think.

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