Designing the pension system: Conceptual framework
Countries exhibit considerable variety in the design of pension systems. Apparently, the pension system can be organized in many alternative ways, with alternative allocations of the functions of the pension system to different institutions or ‘pillars’ in the system.
Financial markets can provide for these functions to some extent but market failures and ‘individual’ failures call also for other institutions, including government intervention or mandatory occupational pension schemes. The pension system in fact involves a complex mapping of functions into alternative institutions, which exhibit strengths but also weaknesses. A single unique solution to the optimal design of a pension system thus does not exist. Each system is inevitably second best and involves important trade-offs.
This paper develops an analytical framework for the design of pension systems taking the functions of the pension system as the guiding principle. It discusses the economic principles underlying these functions and their implementation in practice.