The research department of BBVA Bancomer, Mexico's largest bank (Spanish-owned) has published a report on Mexico’s pension arrangements. As might be expected, the authors praise the private administrators of Mexico's reformed pension system, and do not address the complaints of many that the fees are high.
In 1997, Mexico followed the example of Chile, creating a system of pre-funded, individual accounts managed by private firms known as Afores (Administradoras de Fondos para el Retiro). PensionReforms has reviewed a number of reports that have identified problems with Mexico’s arrangements – for example see here, here and here.
This 2014 report sets up a model to project pensions to the year 2050. The authors restrict their coverage largely to contributory pensions, and then to a single institution - IMSS (Mexican Social Security Institute) - but the IMSS covers nearly all Mexican workers who participate in a contributory pension plan, so this is not such a handicap as it might appear to be at first glance.
The report acknowledges the continuing problem of the low coverage of contributory pensions, especially for the poorest Mexicans:
“The reform of the IMSS pension system in 1997...has had favourable macroeconomic effects for Mexico, as it has significantly increased financial saving, encouraged the development of local financial markets and led to the creation of new asset classes in which Afores invest pension savings. However, the coverage and replacement rates of this pension system are far from ideal, due to problems exogenous to the pension system, such as low contribution rates, low contribution densities and informal labour markets.”
In the covered group, about 47% hadn’t contributed for long enough to qualify for the minimum pension (currently at least 24 years).
From 2035 the first workers of the Afore generation begin to receive pensions funded with the individual accounts under the current (1997) law. Their replacement rates will be lower compared with the 1973 law, “…due mainly to factors exogenous to the pension system, such as low contribution rates and low contribution densities.”
The fiscal costs of transition include the PAYG pensions, the minimum guaranteed pension, the Cuota Social and other government contributions to the individual accounts of active workers. The most expensive component of this cost is the pension for transition workers, who can retire under the rules of the 1973 law.
“The baseline scenario projections show a difficult future for the protection in old age. In this case, one of the most important factors are the negative consequences of having an informal labour market on the conditions of contributions and thus on the possibility of obtaining adequate pensions. The situation is dramatic among the young and those with low incomes, due to their limited capacity of accumulation.”
In 2012, of the 48 million pension accounts administered by Afores "only 21 million received at least one contribution in the last three years". The authors generously label the owners of these accounts as "regular contributors". Another 16 million accounts have been inactive for many years, with no recorded contributions since 2005. The report realistically does not allow for any change in this dismal record of contributions.
The report’s main concern is the fiscal cost of pensions, which, they project, "…hits a maximum of 1.4% of GDP around 2045, and then begins to fall, as the pensioners belonging to the transition generation die". It includes the full cost of the 1973 PAYG pensions in this calculation. PensionReforms thinks it is unclear why that is so. Under the 1973 law, the 6.5% contribution that used to go to social security now goes to private accounts. Pay-as-you-go has been transformed into pay-pay-pay to cover pensions of the transitional generation. This "transition cost" of moving to a pre-funded system is somewhat misleading, however. Suppose that the Afores invest only in government bonds. (This was true in early years, and partially true even today.) Then, increased borrowing (by the state) replaces the lost payroll contributions. The only thing that happens is that implicit pension debt is transformed into explicit debt. Visible public debt increases, but public liabilities (including pension promises) remain unchanged.
The report has seven main recommendations. PensionReforms suggests that the net result of their implementation would be a higher fiscal cost with little if any improvement in coverage. Here, briefly, are the proposed reforms.
1. Increase the present contribution rate of 6.5% gradually, reaching 11.5% by 2017. This can reduce fiscal costs by increasing the size of pensions, with less need for government to fund minimum guaranteed pensions. But it would very likely also increase informality, with fewer reaching the 1,250 weeks of contributions required to access a pension under the reformed system.
2. Eliminate the option for early retirement at age 60, when the State Pension Age age is 65. At present, 95% of workers in the transitional generation choose early retirement if they have the required record of 500 weeks of contributions. Forcing them to contribute five additional years to private accounts would save government money, because the account balances are turned over to government when a contributor retires under the old (1973 law) rules.
3. Assuming that the non-contributory federal pension remains at 525 MXP ($US40) a month, and continues to go only to those 65 and older who have no other pension, the fiscal cost of the programme is $US3.5 billion in 2013 and the report suggests that would increase to more than $US10.2 billion by 2050. Annual expenditure averages 0.28% of GDP over the period 2013-2015. This ignores a promise of the current President to double the size of the social pension, to the cost of enough food to keep a person reasonably healthy, and link it to increases in the cost of this food basket. Nonetheless, the report proposes to pre-fund these social pensions “…so the government contributions could be made into a fund, run by financial institutions, in order to guarantee transparency in the management of the funds and to obtain financial returns that reduce the total fiscal cost". If pre-funding could reduce the cost of government expenditure, why not pre-fund everything, such as expenditure on schooling, healthcare, defence, police, maintenance of highways, etc.? PensionReforms suggests that pre-funding cannot reduce fiscal costs.
4. The government already has in place a matching contribution system known as social quotas. The report recommends adding a second system to this, directed to young workers, so that they can learn the importance of saving for retirement at an early age. More precisely, the government would make the entire contribution - 6.5% of pay - for workers aged between 14 and 20 years. The proportion of the contribution made by government would fall gradually to 0% at the age of 30. There is no mention of social quotas, but presumably these would remain in effect. This implies that a young person (aged 14-20 years) earning a minimum wage would receive, thanks to the government, savings equal to 13.5% of pay, money that he or she could access on reaching the retirement age of 65 years. This is designed to reduce informality in labour markets. It would be a costly experiment, and it is doubtful that informality would fall appreciably as a result of these worker subsidies.
5. Reform the pension systems for employees of states, municipalities and state-owned companies, converting them from Defined Benefit schemes "…into sustainable systems with full portability of pension benefits amongst them". This is code for pre-funded, private accounts. The federal employees’ social security system already made this reform, in 2007, but other public pension systems have not yet followed the federal example.
6. Force the self-employed to contribute to the mandatory savings accounts, with matching contributions from taxpayers to provide incentives for participation. The report does not estimate the effects of such a measure, "which is beyond the scope of this work".
7. Increase tax incentives for voluntary savings. Since only high-income workers (earning more than $US30,769 a year) pay income tax in Mexico, it is not clear how increased incentives could affect retirement saving. Even when incentives work, the main effect is usually to change the form of saving (to maximize tax subsidies) rather than the amount of saving.
PensionReforms thinks that the proposed reforms will create more business for the Afores but will not address the fundamental problems associated with compulsory Tier 2 schemes in a country where governance standards are, at best, patchy. More pre-funding is no solution for either governance or fiscal problems.
However, the biggest shortcoming is the lack of attention given to the real issue – poverty in old age. That is a present problem and one that can only be addressed by direct, central government action of the kind implemented by Mexico City – see here. Only three paragraphs of this 34-page document discuss - very superficially - non-contributory social pensions. The report correctly notes that private accounts have failed to increase pension coverage and poverty in old age, but does not address the need for improved social pensions. (File size 472 KB; 36 pp) 704