The Political Origin of Pension Reform

Pension funding, the extent of reliance of retirement income on private capitalized funding versus a state guarantee, varies enormously across countries. This paper argues that political preferences played a major role at the time of the historical decision on pension funding. These choice also became self-reinforcing, since the population will not support investor protection when its retirement income does not rely on financial claims on the private sector. A political economy approach predicts that when the middle class has a high degree of financial participation, a political majority will support investor protection and limited fiscal redistribution. In contrast, in democracies with high wealth concentration, pivotal voters will prefer labor protection over minority investor protection, and favor a statefunded retirement system. We present empirical evidence that variation in pension funding in democratic countries is well explained by wealth distribution shocks in the first half of the XX century, which occurred before the establishment of national pension systems. The effect is both economically and statistically very significant: a large shock reduces the stock of private retirement assets by 58% of GDP. The results stand after controlling for complementary explanations, such as legal origin, past and current demographic controls, measures of stock market performance, or other major financial shocks that were not specifically redistributive.