Sweden’s track record of pensions reform over the last ten years provides valuable lessons for wealthy, middle-income, and developing countries that worry about the continuing solvency of their current pensions systems, according to a new World Bank pensions report released in Brussels today.

The expenditure level for public pensions in most Western European countries is well above that of other highly industrial and postindustrial countries at a similar income level. The average of public pension expenditures as a percentage of gross domestic product (GDP) for the 15 EU countries in 2000 amounted to 10.4 percent (this is a low estimate because it includes only the expenditure under the projection exercise of the Economic Policy Committee 2001). The Organisation for Economic Co-operation and Development (OECD) estimate is about 1.3 percentage points higher (OECD 2002). The average for the non-European and affluent OECD countries—Australia, Canada, Japan, New Zealand, the Republic of Korea, and the United States—in 2000 was about 5.3 percent: that is, roughly half. In the EU, only Ireland (4.6 percent) and the United Kingdom (5.5 percent) have similar levels. This difference is also shared by the accession countries in Central and Eastern Europe. Except Romania (5.1 percent), all others have expenditure shares close to the EU average (and in Croatia, Poland, and Slovenia, well above) and hence much higher than non-European OECD countries, despite an income level of one-quarter and less. Poland’s public pension expenditures, at close to 15 percent of GDP, rival that of Austria and Italy for the world championship.

In reviewing the experiences of three other countries which followed the Swedish model, Italy, Latvia, and Poland, the report says that their emphasis on non-financial defined contributions (NDC) design has allowed them to organize comprehensive reforms to their pensions systems with positive results to date. An NDC system operates as individual retirement account but on a “pay-as-you-go” basis.

With demographic and economic pressures forcing both developing and developed countries to undertake urgent pension reform, the report—Pensions Reform: Issues and Prospects for Non-Financial Defined Contribution (NDC) Schemes—says an NDC approach, which still commands widespread political support in Sweden a decade after its launch, could be an important model for other countries to assess. The report says that greater numbers of women in the global workforce, rising divorce rates, changing employment patterns in the global economy, rising budget deficits, and rising numbers of elderly are all driving the urgency for pension reform. An NDC reform helps address all these reform pressures.

“Although the reform experience in Latvia, Poland, and Sweden is encouraging, we wanted to be sure that the NDC approach wasn’t just the latest fad in pensions reform,” say the co-editors of the report, Robert Holzmann, Director of Social Protection at the World Bank, and Professor Edward Palmer, Head of Research at the Swedish Social Insurance Agency. “Based on the evidence, NDC is a most promising new approach to pension reform at a time when virtually every country in the world is looking at the viability of their pensions systems, and wondering how to relieve their demographic and economic pressures, while avoiding creating additional burdens for future workers.”

For example, the report suggests that reforming the Japanese ‘pay-as-you-go’ system along the lines of a Swedish-type NDC system would very much help Japan overcome a number of problems in its current schemes. Japan faces the additional specific challenge of handling huge excess liabilities resulting from entitlements of past pension contributions, equivalent to 130 percent of GDP in 2004.

Promising but not fool-proof

For all its promise, however, the report warns that the new approach is not foolproof, and that successful implementation depends on several key issues. In particular, previous experience in Italy, Latvia, Poland, and Sweden suggests that the NDC approach has to be politically well-managed.

As in the case of other reforms, communicating the meaning and implications of pension reform clearly to a country’s workforce, its elderly population, private companies, and other important groups, is critical to generating widespread support for change. Although the NDC’s ability to achieve financial sustainability seems to have been understood and embraced by experts, it may be difficult to implement, both for technical and political reasons. But, perhaps most importantly, too little thinking has been given to the issue of “tax overhang” or fiscal legacy of the old scheme.

Lastly, the report recommends that NDC schemes be assessed as part of a broader (multi-pillar) pension concept and not (only) viewed in isolation. This suggests the wisdom of adding a social pension, as well as a funded pension wing to a reformed system along the lines of an NDC approach. One question that needs more attention is how to integrate occupational schemes into the overall pension framework. This may be relatively easy for, say, pensions of civil servants, but it is likely to require more thinking for, say, farmers or laborers in developing countries. Yet, an NDC reform promises to eliminate obstacles to mobility across professions, countries, and regions. This approach makes it an interesting candidate in areas of economic integration such as the European Union, but also China and other emerging economies.

Solutions—no one size fits all