The 1997 pension reform in Mexico

In 1995-96, Mexico shifted to a multipillar approach to old-age security. The objective of the publicly managed first pillar is redistribution; a fully-funded second pillar provides for mandatory individual savings accounts and competitive but exclusive and specialized pension fund management; the third pillar is voluntary savings. The package could provide effective income security and protection against old-age poverty, in a manner compatible with goals of savings and economic growth. It offers Mexico's first real opportunity to shift to a defined-distribution model and to expand and deepen institutional investors - although in the short term its impact on capital markets will be limited by the need to focus on the security of pension fund investments. The reformed systems provides for a probably irreversibly shift toward private intermediation of most domestic investment funds. Further efforts to improve the pension system should encourage efficiency, confidence, and economies of scale. There are weaknesses in Mexico's pension design - especially the limited scope for workers in the private sector, the continued role of the housing-fund component, and the moral hazard implications of the lifetime-switch option. But Mexico achieved radical reform with its pension system within a difficult political and economic environment. And the timing of the reform was appropriate. The age structure in the existing system was very young, so coverage could increase. Also, reform took place after the inflationary 1980s and the recent financial crisis, which eroded the real value of old pensions, the acquired pension rights of the transition generation, and the minimum pension for minimum-wage retirees. If returns on invested contributions are high enough, much of the transition generation will choose the defined-contribution alternative over the old pay-as-you-go system. This will release the government from pension liabilities, except for the minimum pension guarantee for new affiliates. Ensuring the system's long-term success will require improved financial performance from INFONAVIT, the authorities' political will and regulations, and the system's flexibility in the face of changing circumstances.