The Political Economy of Pension Reform in Brazil

1
The Political Economy of Pension Reform in Brazil

• Vinícius C. Pinheiro, OECD
• (vinicius.pinheiro_at_oecd.org)
• Washington, December 2004

2
Structure of the Pension System

• General Regime for Private Sector Workers
  mandatory public PAYGO social subsidies
  ceiling US 800 (95 of workers earn above this
  limit), minimum US 87 managed by the National
  Institute of Social Insurance (INSS).
• Civil Servants mandatory decentralised mostly
  PAYG (partial pre funding in some cases) managed
  by federal, state and municipal administrations
• Military special career-based scheme
• Complementary Regime voluntary private fully
  funded managed by occupational pension funds
  (closed) or banks and insurance companies (open)
  18 of GDP in assets

3
Brazil Pension Deficit as of GDP - 2003
4
of population over 60 years old Brazil (2000
2050), other countries (2000)
France, 2000
Argentina, 2000
Russian Fed, 2000
Germany and Japan, 2000
USA, 2000
Paraguay, 2000 5,3 Bolívia, 2000 6,2
Source IBGE e United Naiions Population
Division
5
Brazil - Labor Market and Coverage- 2001 (in
million ha)

• TOTAL POPULATION 169.4
• Economic Active Population 83.2
• - Unemployed 7.7
• Working population 75.5 (100)
• Public Sector - 4.9 (6.5)
• Private Sector- 70.6 (93.5)
• Contributors to the General Regime 29.9
  (39.9)
• Non Contributors - 40.7 (53.9)
• Informal Employment- 12.3 (16.3)
• Self-employed 14.3 (18.9)
• Domestic 4.2 (5.6)
• Employers 1.3 (1.7)
• Non paid workers and
  subsistence economy 8.4 (11.1)

6
Brazil Population over 60 years old receiving
social security benefits (1992 1999)
Source MPS-Brazil and IBGE
7
Brazil Social Security and Poverty - 1999
Source MPS-Brazil and IBGE
8
Brazil Povery line by age group - 1999
Source MPS-Brazil and IBGE
9
Population below poverty line by age group in
selected Latin American countries - (1998)
Source Gill, I. Packard, T. and Yermo, J (2004).
Keeping the Promise of Old Age Income in Latin
America A Regional Study of Social Security
Reform
10
Brazilian Pension Reform Strategy

• Adjust PAYG general scheme and increase coverage
• Develop complementary private pension scheme
• Homogenise the rules for public and private
  workers

11
BRAZILIAN PENSION REFORM PROCESS
PAYGO CONSTITUCIONAL REFORM OF ALL SOCIAL
SECURITY SYSTEM
1st phase (1995-1998)
PRIVATIZATION DEBATE (97-99)
2nd phase (1999 2001)
PUBLIC SERVANTS (Blocked)
PRIVATE WORKERS REGIME CHANGE IN THE BENEFIT
FORMULA AND INCENTIVES TO ATRACT NEW CONTRIBUTORS
COMPLEMENTARY REGIME LAWS ADRESSED TO IMPROVE AND
EXTEND COVERAGE
STOCK ADJUST CONTRIB AND RETIREES CONTRIB. (JAN
99) BUT DEFEAT BY SUPREM COURT (SEP 99)
FLOW PRIVATE SECTOR RULES
Civil Servants Regime Constitutional Reform
Flow Similar rules to private sector (but
different system) Stock Adjust PAYG variables
3rd phase (2003)
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Pension reform Political Costs and Benefits
13
1st Phase PAYGO Reforms Concentrated Costs and
Diffused Benefits

• Measures Adjustments in contributions and
  replacement rates, eligibility conditions (age,
  length of contribution, tenure), restriction to
  special regimes
• Costs Restrictions to specific groups
• Benefits Actuarial and financial balance for
  future generations (public good)
• Result General political trend to block the
  reform

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1st phase PAYGO Reform What do you really want?
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Structural Reforms Diffused Costs and
Concentrated Benefits

• Measures Transition to fully funded schemes
• Costs Paid by all society (including future
  generations), depending how transition costs are
  financed
• Benefits More concentrated in specific groups
• Financial sector - market development
• Employers - lower contribution rates
• Unions - possibility to intermediate the
  establishment of Pension Funds
• Result Organized groups supporting the reform

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Brazilian Pension Reform Options considered for
the 2nd phase

• Proposal 1 - Multipillar model
• First pillar 1 to 3 minimum wages - basic,
  mandatory, public, national, PAYGO, flexible
  contribution
• Second pillar 3 to 10 minimum wages - mandatory,
  private, fully funded, defined contribution
• Third pillar up to 10 minimum wages - voluntary,
  private, fully funded
• Proposal 2 - Notional accounts
• First pillar 1 to 10 minimum wages - basic,
  mandatory, public, notional defined contribution
  scheme
• Second pillar up to 10 minimum wages -
  voluntary, private, fully funded

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Macroeconomic Crisis Calendar

• March 1994... Stabilization Program - Real Plan
• September 1998 Russian crisis -gt interest rate
  raised to 45 per year
• December 1998 IMF, World Bank, IADB loan -gt
  Fiscal adjustment program to reach 3.1-3.25,
  3.15 of GDP primary surplus in 1999-2001 in
  order to stabilize the ratio Public Debt/GDP in
  46,5
• January 1999 Brazilian currency devaluation and
  transition to floating exchange rate regime
  pressuring public debt and fiscal policy

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2nd Phase Option 1 - How to finance the
transition costs to a fully funded system in a
context of fiscal crisis?

• WORLD BANK (1998) 205 GDP
• ECLAC (1999) 201.6 GDP or 6 x 40 years
• FIPE/USP (1997) 255 GDP
• IBGE/IPEA (1997) 218 GDP
• FGV/RJ (1997) 250 GDP
• WORLD BANK (1995) 188 GDP

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2nd Phase Option 2 - Adopting Notional Defined
Contribution Model to the Brazilian Reality...

• Whats the interest rate to be used?
• How to recover the past contributions without
  reliable registrations?
• How to prevent justice claims associated to
  indexation?

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2nd Phase - Brazilian Benefit Formula (fator
previdenciario)

• Notional Individual
• Fund
• W x c x P

X BONUS
Pension
Residual life expectancy at the retirement age
(LE)
W average of the 80 highest wages
between July 1994 and the retirement date P
contribution period c contribution rate
(0,31) RA retirement age LE updated
annually by IBGE
BONUS 1 (RA P x c)/100 (IMPLICIT INTEREST
RATE)
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3rd phase Civil Servants Pension Scheme Main
Measures

• Increase of the minimum retirement age for
  current workers from 53/48 years old for men and
  women respectively to 60/55. Early retirement
  will be permitted with 5 per cent reduction in
  the replacement rate.
• Change of the benefit formula moving the
  reference period for benefit calculation from the
  last salary to the average of all life earnings.
• Benefit adjustment linked to inflation (instead
  of to active workers salaries)
• Reduction of replacement rates for survivor
  pensions from 100 per cent to 70 per cent.

22
3rd phase Civil Servants Pension Scheme Main
Measures

• Retirees contribution
• New workers Private sector ceiling (US 800)
  complementary public pension funds for civil
  servants (pending on legal initiatives of
  federal, state and municipal).

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3rd phase Civil Servants Pension Scheme
Political Strategy

• Gradual and incremental perspective
• 1st year of the government mobilization of post
  election political capital
• Focus on well-defined group (civil servants)
• Build coalition of supporters
• Exclusive political agenda
• Communication strategy
• Different negotiation arenas (not only the
  Congress)

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Conclusions Brazilian perspective on pension
reform

• To strength basic PAYG system and develop
  voluntary/complementary private funded schemes
• Gradualism
• Incremental
• Focused
• Permanent investment on institutional building
  and public awareness