RETHINKING PENSION REFORM – SIMPLE APPLICATION TO THE JAPANESE SITUATION

Abstract

As with all countries around the world, the ageing of Japanese society is putting severe pressure on the public pension system. The Japanese system is complex with a basic pension for all citizens, but different forms of additional support for self employed, private sector and public sector employees. The basic pension is covered through contributions and a subsidy by the government. This government contribution is derived from general taxation and is increasing over time as a percentage of the overall wage bill, but is a fundamental pillar of the concept of social solidarity. The public Social Security pension system for private sector workers has the highest coverage of the 3 working groups (30 million out of a total of 70 million) and has recently been converted to a “fixed premium” system, whereby contributions of employers and employees is being raised gradually but fixed thereafter. In other words, it appears that the system is being converted to ensure that additional taxes are not forced on the working population or companies as the population pyramid deteriorates, and to pass on some risk to pensioners by potentially lowering benefits and ensuring a “limited balanced system”. Some attempt has been made to prevent a major decline of benefits through certain options making the system largely defined benefit. Japan has a unique set of favorable circumstances. The surplus of contributions over pensions in the past has been accumulated in a Trust Fund. These monies were previously loaned to the government but a recent reform led to a transition of this fund to a market-based global portfolio with appropriate governance and oversight. We apply some insights from Modigliani and Muralidhar (2003) to the Japanese system and demonstrate that given the unique and far-thinking measures already undertaken by the Japanese, that the financing of pensions is robust. However, rather than gradually depleting the fund over the next 95 years, if a small improvement can be made to the target return of the fund, potentially contributions could be reduced, while also lowering the volatility of contributions. Modigliani and Muralidhar (2003) showed that keeping a system partially funded was beneficial relative to a pure pay-as-you-go system as it could lower the volatility of contributions and make countries more competitive (as contributions are a tax on companies and could lead to higher wages). Japan has a unique opportunity to manage the most dramatic ageing of a population globally through some innovative, minor modifications, especially since they area at a very advantageous situation currently relative to countries such as the United States.