Before undertaking social security reform, governments should try to determine whether such reform will give a significant number of workers more access to the financial system-because this might considerably affect the fiscal costs and the type of safety net programs required to minimize the system's effects on income distribution.
Serrano explores the effects a transition from a pay-as-you-go (PAYG) social security system to a fully funded system may have on income distribution, fiscal policy, and capital accumulation.
He presents a heterogeneous agent model developed to study the transition from a state-managed pay-as-you-go social security system to a privately managed fully funded system. He assumes that agents can differ in their human capital endowments and in their access to the financial system.
He finds that, for some initial distributions, when access to the financial system is restricted for some individuals, income distribution may improve with privati-zation of the pension system.
Where there is complete access to the financial system before reform, however, income distribution deteriorates in all cases.
Regardless of the initial distributions, reform of the type described here increases the level of physical capital in the economy. But the increase will be larger the larger the fraction of the population composed of poor individuals, or the higher their level of human capital.
He also finds that different initial distributions will have different effects on the fiscal policy needed to finance reform. Similarly, different forms of reform financing will have different effects on intragenerational distribution.
In the case in which the government decides to maintain a constant level of debt, generations alive when the reform takes place will have lower lifetime earnings than those born after them.
He also finds that the taxes needed to pay for transitional workers' pensions will be higher when the fraction of the population with access to the financial system in the PAYG equilibrium is higher.
This paper—a product of the Finance, Private Sector, and Infrastructure Sector Unit, Latin America and Caribbean Region—is part of a larger effort in the region to study the design, implementation, and consequences of social security reforms. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Marga de Loayza, room I3-128, telephone 202-473-8902, fax 202-522-2106, Internet address mdeloayza@worldbank.org. The author may be contacted at cserrano@worldbank.org. (42 pages)
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