Pension reform is an important topic on the political agenda among most countries with mandatory national pension schemes. Where a national mandatory scheme does not exist, governments are actively considering how to introduce one. For 50 years, economists and policy experts of all stripes have debated the pros and cons of pay-as-you-go (PAYG) versus fully funded (FF) pension schemes. Usually, it is understood that the FF scheme under consideration would be a privately managed defined contribution scheme, while the PAYG scheme is assumed to be a publicly managed defined benefit scheme, the details of which are seldom specified. This approach also informs Sergio Cesaratto's well-structured and well-written exposition. The author examines the economic assumptions of PAYG and FF pensions, and he uses economic theory masterfully to examine the assumptions underlying arguments for mandatory PAYG and fully funded pension schemes under a critical light.
The volume begins with a discussion of Samuelson's classic PAYG model as a means for smoothing consumption over time. In the Samuelson view, which emerges from neoclassical growth theory and is adopted by many mainstream economists (including this reviewer), the raison d'être of PAYG is that individuals would voluntarily contribute what they would otherwise have saved on their own for retirement, given equivalence between the rate of interest and the growth rate of income. Cesaratto then presents his own (non-orthodox) position on PAYG by discussing the Lerner critique which labels the Samuelson model as “insurance fiction”. In other words, he posits that PAYG is simply a tax-transfer system, no matter how you look at or design it. For a neoclassical economist, a FF pension scheme would seem the most obvious means of transferring consumption to the future, so the “insurance fiction” is actually a convenient marketing ploy for (otherwise neoclassical) social engineers to sell a PAYG approach. Samuelson's classical exposition is also seen as providing an expositional foundation for the recently invented “notional defined contribution” (NDC) scheme; yet since Cesaratto views all PAYG plans as insurance fiction, the NDC model too is a new twist on this fiction. These NDC plans are believed to (a) create financial stability, and (b) redistribute lifetime resources from steep to flat career earners, compared to a final salary DB scheme. A weakness in the author's exposition of NDC is that it entirely misses the Swedish NDC approach under development from the early 1990s.
While mainstream economics sees state intervention in the pension arena as a response to market failure, here too, Cesaratto proposes another perspective. Instead of promoting the “insurance fiction,” he argues that economists should recognize and direct resources towards studying PAYG as a social institution involved with classical distribution theory, which focuses on conflicts of interest and the distributional consequences of the political expression of these. In this reviewer's opinion, the forces behind reform are surely political, representing the specific interests and power constellations of the time – and irrespective of whether the result is PAYG, FF, or some combination. The author's frequent references to Marx and a lack of reference to the public choice literature prevent this discussion from getting up steam.
In this reviewer's opinion, the book's strongest section is the work on developing and critically examining the assumptions underlying economists' standard view that FF dominates PAYG systems. For any given supply of labour, neoclassical theory holds that an increase in the saving rate leads to the adoption of more capital-intensive production techniques and is accompanied by a rise in the capital-labor ratio. New investments increase the marginal productivity of labor, resulting in a higher real equilibrium wage and higher real output. For this reason alone, a country considering the introduction of, or a change in an existing, mandatory scheme would do best to introduce a funded scheme, at least assuming reality conforms to this paradigm. Cesaratto examines the assumptions required to fulfil this prophecy. The first assumption examined is, will FF pension reform create national saving? The author peruses the arguments why this may or may not occur. Given that FF reform creates national saving the next question is, why should we believe the neoclassical story that this saving is funnelled into investment? What if the economy is demand- rather than supply-driven, even in the long run? The author argues that in the latter case, there is no reason to accept a priori any direct link between saving and investment. Similarly, he questions the widely held belief that FF saving from the “Northern hemisphere” will be channelled “automatically” into investments in the “Southern hemisphere.” Cesaratto thus rejuvenates the “Cambridge vs. Cambridge” controversy of the 1960s, questioning whether FF pension schemes will be resilient in the face of labor force decline and whether capital will be transformed smoothly into consumption for the elderly, when needed.
The book also includes several country case studies, including the FF pension reform proposal proposed by Modigliani and colleagues for Italy, and Feldstein's proposals for the US. The Chilean pension reform is also reviewed, where the author concludes that Chile's pension system success over the last 25 years was mainly attributable to budget discipline, currency depreciation, and export-driven growth (rather than pension reform). The author devotes an entire chapter to the US debate on the Social Security surplus.
This book is a scholarly treatise that illuminates the precepts of neoclassical economics and pensions which orthodox pension economists tend to take largely for granted, and it challenges readers to examine other possible interpretations. Not surprisingly, the book has no single “preferred” pension reform. Rather, its value-added is to offer a well-marked and easy-to-follow pathway into the economics of pensions, along with a challenge to take close stock of assumptions. For this reason, both newcomers and specialists will find it worth their time to read this book.
