What has caused the current problems facing state

pension schemes?Is a shift to funded schemes the best solution?

The purpose of welfare

To provide income support, and therefore a reasonable standard of living for the elderly

History

• The US Social Security programme was conceived in 1935, at the height of the Great Depression (savings were wiped out, and allowed government to borrow)

• Government intervention in retirement plans the result of: (a) Paternalism (b) Annuity Market Failures

Pay As You Go Systems

Refers to retirement plans in which payments collected from today’s workers go directly to today’s retirees instead of being invested in order to pay future benefits

The discussion surrounding PAYG systems

• Was viable to implement almost immediately

• Risk to individual returns is limited

• Low administrative costs

• Returns to the programme are dependant on the ’n’ and ‘r’

The problems currently facing state

pension schemes

The US Government is facing major fiscal imbalance. In 1950, 12% of people of working age were over 65 years old. By 2020, this number is forecast to be 35%

Changing circumstances

• Dramatic improvement in life expectancy

• Reduction in birth rates

• Growth in wages has slowed dramatically

• Legacy payments

Changing from PAYG to Fully Funded

Social welfare reforms

Proposed solutions

• Raise taxes further

• Extend taxable base

• Raise retirement age

• Lower benefits

• Reduce benefits for some groups

• Invest in Trust/Mutual Funds

• Move to a Fully Funded System (Privatisation)

Fully Funded Systems

Refers to retirement plans in which today’s savings are invested in various assets in order to pay future benefits

The discussion surrounding fully funded systems

• Funded by individual savings and would therefore increase the capital stock of the economy

• Investments would match individual risk appetites

• Legacy debt would go unpaid

• Moral hazard

• Make the wrong investment decisions

• Higher administrative costs