firmly in place has been confirmed through an abundance of historical evidence.
State Pension and Long-Term Bond Market
Most countries with state pension systems are now making reforms to the system or have already done so, in order to find sustainable ways to finance the pension systems suitable for ageing population and to minimize the states' burdens to such pension systems. The common factors in such reforms are generally to move away from the pay-as-you-go system and to replace the entire pension system or the part of it with mandatory (personal) savings plan.
Several south American countries have completed their reforms in this way and the World Bank's reports says that such reforms have improved the long-term financial conditions of the governments and stimulated their economic growth. In particular, the introduction of mandatory savings increased the amount of private savings in those countries and improved labor markets as well as financial markets. More importantly, such reforms are said to have eliminated effectively the people's distrust that they only contribute to, but may not get benefits from, the state pensions after retirement.
Despite such worldwide trends, Korea is pursuing in the direction of reinforcing the state pension plan per se. There are only two ways to do so; one is for the government to have people make more individual contributions but to reduce the amount of benefits after retirements. The other is to increase only individual contributions all the more. However, raising the pension contributions, in fact, amounts to increasing taxes, which is not appealing to the politicians mindful of winning elections. And the plan to improve the way to assess the earnings of the self-employed, which KDI recently recommended in connection with the pension system improvement, might have the danger of infringing privacy.
How to improve the financial status of the state pension system
The way deemed to be able to improve the financial status of the state pension system without employing such unpopular methods is to increase the share of the pension fund invested into stocks, because stocks seem to bear higher yields though a bit riskier. For example, the returns of the U.S. state pension fund, which was allowed only to invest in bonds, averaged 2.3% annually as of 1998, but the annual yields of stocks were 7.6% on average during the past 60 years. This difference demonstrates that increasing the share of the pension fund invested in stocks seems to be an easy way of improving the returns of the state pension fund.
Additional elements enticing the government to increase the share of the pension fund invested into stocks, which seems peculiar only to our country, are the thoughts that the government can manipulate the stock market more easily when deemed necessary and, that it can have more control of private enterprises. But the government's several attempts in the past to interfere in the stock market all failed tragically .
On the other hand, if the government had more control of private enterprises by holding more equities of the private companies, the government seems to think that it would become easier for the government to manipulate even the business cycles. However, under such circumstances, the private companies may lose appetites to enhance their competitiveness as we see from the behaviors of the state-owned enterprises. As is well known, the extreme case in this direction, under which the private ownership of enterprises is not allowed, is market socialism. The eastern European communist world which had reformed its communist system into market socialism in 1970s, has had to reform again to introduce capitalism into its economic system , after the collapse of the Soviet Union, in order to be able to compete in the global market.
Then, is there any other way to increase the returns of the state pension system without increasing the share of the pension fund invested into stocks? If there is one, the returns on the pension fund can be improve, without giving the government the power to manipulate the stock market, and without allowing our economy to slip into market socialism.
Developing The Long-term bond market
Developing the long-term bond (including both state bond and corporate bond) markets can be one of the solutions. Presently, in Korea, 3-year bond is the bond of the longest maturity and the difference between the call rates and the bond's rates of the longest maturity is not more than 1% point. In this situation, it is impossible to invest all the pension fund into bonds, without sacrificing the returns of the fund. But if we have 30-year-bond or 50-year-bond markets, the yield difference between the shortest bond's rate and the longest bond's rate can be as wide as 4 to 5% points.
One word of caution is in order here. In Korea, we are not familiar with the concept that the yield rates may vary with the level of risks. That is, the rate differences between the state bonds and the corporate bonds are almost negligible in Korea, compared with the U.S. market, where the concept of the yields varying with the level of risks is firmly established. The relationship between the yield rates and the length of maturities, eliminating the risk factors, is called yield structure or yield curve in the U.S. The yield difference of 4-5% points, as mentioned above, is the yield difference between the longest and the shortest on the yield curve, which eliminates risk factors.
Under these circumstances, the returns of the state pension can be improved if the share of its fund invested in the long-term bond is increased, avoiding higher risks associated with investing into stocks. The returns of the state pension invested only in bonds can be regarded as having improved much higher than actual numerical improvements, if viewed from the risk-averse standpoint that the returns can be sacrificed in exchange for reduction in the level of risks. For example, KDI currently estimates the pension fund will run dry by 2042 based on the assumption of 4.5% annual returns (probably risk factors were factored in here). But if the fund were invested in the long-term bonds and the 7% returns can last, the pension fund will remain healthy even long after 2042.
In addition, if the government encourages personal savings by introducing the mandatory savings system, without changing the methods of assessing the earnings of the self-employed, the effect of improving the financial status of the pension will be greater, because this improvement will reduce people's resistance but stimulate their savings desire. Moreover, if the long-term bond market is working normally, personal savings products associated with higher return will be introduced, resulting in the increase in people's desire to save, which leads to higher amounts of such personal savings.
Developing the long-term bond market also gives more realistic investment guides to the government investments when New Deal-type investments, a very hot topic these days, are actually arranged. For instance, if the government is to build local airports or an administrative city (in chung nam), planning based on the long-term bond rates, 30 years, 50 years, or in between, according to the longevity of each project, rather than on just 3-year-bond rate, will make the investments to be more practical and solid.
Moreover, such long-term bond markets will give more flexibility to the way financial institutes handle their funds. And also the companies can make more reasonable investment plans according to their investment purposes, for they can choose the long-term interest rates most suitable to their respective projects.
New market stimulates the economy
Most importantly, the movements of the yield curve can be utilized to assess the effectiveness of the monetary policy. For example, when the yield curve slopes upwards, it can be interpreted as an evidence showing that the economy is recovering or inflation is looming, and when it slopes downwards, the interpretation is that the economy is being depressed or the monetary policy is deflationary.
By developing the long-term bond market, therefore, we can prevent the pension system from enlarging the share of risky investments in stocks and contribute to enhancing the financial market and industry. In addition, if the pension system adopts mandatory (personal) savings, it can also stimulate the diversification of financial products. If all these were materialized in our economy, our financial industry will develop all the more rapidly. In such a rapidly developing situations, the government influences on the financial industry will fade, and our economy will gain a new momentum to reach a stage one step higher.
Kim, Han-eung Co-representative of Free Citizens' Alliance of Korea (hane9kim@chollian.net)
