[Marxism] Individual Accounts: Lessons from International Experience (Social Security article from Science)

[Les Schaffer <schaffer@xxxxxxxxxxxxx>]

from this week's Science online, snippets only, for econ types. i can
just barely make sense of the details and would welcome explanation/debate.

les schaffer




Science, Vol 309, Issue 5732, 250-251 , 8 July 2005

ECONOMICS:
Individual Accounts: Lessons from International Experience
J. Michael Orszag and Peter R. Orszag*

The United States is undergoing a debate over whether part of its Social
Security system should be replaced with individual accounts. Advocates
of this approach, including the Bush administration, have cited
international experience as demonstrating its advantages (1). However,
every country adopting individual accounts has encountered significant
problems.

[snip]

To evaluate the experience of these countries with accounts, we examine
the three key stages of individual account systems: participation and
contribution rates, asset accumulation, and payout.

Participation and Contribution Rates
In voluntary account systems, participation and contribution rates have
often posed surprising problems. (In mandatory systems, participation
and contributions can be set by policy fiat.) Part of the problem is
that people do not appear to behave as rationally as is often assumed in
economic models. The introduction in 1988 of voluntary individual
accounts in the United Kingdom, for example, was followed by a wave of
aggressive sales practices by financial intermediaries. The result was
the so-called mis-selling scandal, in which individuals were frequently
induced to choose an inappropriate account (9). In response to what has
been called the "biggest financial scandal in the United Kingdom," the
government forced the financial services industry to pay more than 12
billion pounds in compensation to the individuals involved (10).

The lack of fully rational individual behavior in the mis-selling
example is widely replicated in other settings. For example, in the
United States, a significant minority of households is not saving
adequately for retirement. Yet research has demonstrated that such
under-saving could result in large part from inertia. For example, if
workers are automatically included in a 401(k) plan unless they choose
not to participate, participation is much higher than if workers must
affirmatively sign up for the plan (11, 12). Similarly, workers are more
willing to make larger contributions if they had previously committed to
doing so (13). In Sweden, the overwhelming majority of new participants
in the individual accounts choose the default fund (14). Clearly the
reality is different from conventional economic theory, which suggests
that in the absence of switching costs, individuals will make fully
rational decisions unaffected by the presence of a default (15).

Asset Accumulation
Assets within an individual account available at retirement are
determined by contributions, financial returns, and administrative
costs. The higher the net return on the account, all else being equal,
the larger the payout at retirement. In the United States, the geometric
average annual equity return (adjusted for inflation) between 1900 and
2000 was 6.7% (16). The historical experience in the United States,
however, is atypical. Equity returns internationally have been
substantially lower (17). Furthermore, the higher expected return on
equities compared with safer investments reflects their riskiness.
Stocks are consistently associated with risk: 15-year returns in the
United States have ranged between -2% and 13% since 1885 (18). These
risks are often exacerbated by poor investment decisions (19).

Administrative costs also affect asset accumulation: The relevant return
for an individual is after fees and expenses have been subtracted. In
most individual account systems, these administrative costs historically
have proven to be high. In the United Kingdom, administrative costs were
on track to reduce account balances at retirement by more than 30% (20)
before the government recently introduced fee regulations. In Australia,
administrative costs amount to more than 1% per year (21), which would
reduce account balances at retirement by about 20%. By some estimates,
administrative fees have been somewhat lower in Sweden, in part because
the system is centralized and government-run and in part because
individuals are not charged the entire cost of administering the
accounts (22).

[snip]

Payout Phase
Because individual accounts in most countries are relatively new, very
few are currently paying out significant sums to retirees. Policy-makers
have therefore not yet faced some of the serious challenges associated
with the payout stage, which can become particularly complex (24). In
defined benefit systems, pensions are often payable for life. In
individual account systems, individuals can purchase life annuities upon
retirement, but such purchase is not mandatory in most countries. Where
purchase is not compulsory, take-up is low, and therefore, annuities
markets are small; indeed, in the United Kingdom, which has compulsory
annuitization, the annuities market is larger than the rest of the
world's combined (25). Mandatory annuitization, however, may not be
sustainable, in part because of political pressures to allow accounts to
be bequeathed (annuitizing an account means that the funds cannot be
passed to heirs). Another major issue is whether annuity pricing should
be uniform, given significant mortality differentials across
socioeconomic and other population subgroups. If annuitization is not
required, however, take-up tends to be low, meaning that many workers
are exposed to the risk of outliving their assets. This risk may be
exacerbated by uncertainties over future life expectancy improvements,
the degree of which has been the subject of serious disagreement among
demographers (26, 27).

Conclusion
As demographic trends have increased costs in traditional defined
pension schemes, policy-makers have sought new approaches to cope with
an aging population. About 20 years ago, countries started experimenting
more actively with individual accounts. At the time, such accounts
seemed attractive, perhaps because there not yet had been any
significant negative experiences (or significant positive ones, for that
matter). It has since become apparent that individual accounts have
entailed significant problems in every developed country that has
implemented them. These problems indicate that more work is needed both
in practice, to make accounts work better, and in research, to achieve
better alignment between economic theory and observed behavior.


http://www.sciencemag.org/cgi/content/full/309/5732/250

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