Global Aging Issues
Interview with the Honorable Francisco Gil Díaz
Secretary of Finance and Public Credit, Mexico / News Release
February 27, 2006
Related links
- Read this article in Spanish
- Ministry of Finance and Public Credit, Mexico external link
- Fact Sheet on Mexico's Aging Population
Learn more about the AARP Global Aging Program
Today, Mexico is a developing country with a relatively young population; however, it is undergoing demographic changes similar to developed countries. Decreases in fertility rates and increased longevity will make Mexico’s population as old as the United States’ by 2050. What steps must Mexico take to capitalize on the opportunities of an aging population and to ensure that Mexicans can age with dignity, security and independence?
AARP’s Global Aging Program interviewed Francisco Gil Díaz, Mexico’s Secretary of Finance and Public Credit to discuss the future labor, fiscal and social policy reforms that Mexico should make to ensure economic competitiveness and increased quality of life in the face of its aging population. Past policies were also discussed, including a 1997 pension reform, which converted Mexico’s old defined benefit pay-as-you-go system into a funded defined contribution system for private sector workers.
GAP: By 2050, demographic forecasts predict the Mexican population will be as old as the U.S. population. What are the main steps Mexico must take to prepare for its aging population?
FGD: In 40 years, Mexico will experience the same transition that France has been undergoing in the past 250 years. While Mexico’s current share of the elderly among the total population is similar to that of France in the 18th century, both shares will be equal in 2050.(1)
In the following decades Mexico will need to achieve a high rate of economic growth to guarantee future generations an adequate living standard. Such a challenge can only be adequately faced by improvements in the human and physical capital stocks. In this sense, the demographic challenge expands over several dimensions demanding sound economic polices reflected in the quality of governmental institutions, labor markets, macroeconomic management, education and business environment, all of which have an impact on productivity.
The demographic transition in Mexico is in its early stages, implying that in the short and medium terms there will be a rapid increase of the working age population, which offers the opportunity for boosting economic growth and living standards, often referred to as the demographic bonus. Expected changes in population growth and life expectancy will result in an increase of the share of the working age population from 62.0 percent in 2000 to 67.3 percent in 2010, an increase of 12.8 million people. Such an increase will demand the creation of a similar number of jobs. In order for the demographic bonus to become an asset and not a liability, these new jobs should be associated with higher productivity, which in turn, will depend upon improvements in the stock of human and physical capital.
Mexico needs to undertake reforms in order to facilitate job creation through flexible labor markets, to foster physical capital accumulation by having in place well functioning financial markets, setting a favorable investment climate and business creation environment, as well as to promote human capital accumulation through education and health.
In addition, current and future workers should be certain to get a pension at the moment of their retirement; today we have the opportunity of putting in place pension systems adequately designed for our future age structure. In this regard, it is necessary to consolidate the private pension system and to reform the public pension system(2) to solve the problem of its large actuarial deficit. A pension system should be financially sustainable where benefits correspond to contributions.
While the retirement funds for private sector workers have been a success, some changes can be made to improve their functions: it is necessary to reduce their administrative costs and reach a greater return on investment via risk diversification and the continuous development of the domestic financial markets.
In particular, it is necessary to keep strengthening domestic financial markets and widening the investment options. The increasing resources of pension funds should be invested in high return projects, and it is necessary, at least desirable, that the Mexican economy creates those projects.
Another major challenge is to widen the coverage of the pension systems, especially to those individuals working in the informal sector. One way to accomplish this is to incorporate a large share of these workers into the formal sector and complement them with voluntary enrollment to the pension system. If these workers are not incorporated to some pension scheme, in the future there will be political pressures to grant them living subsidies in their old age, with the consequent public finance impact.
In sum, to face the demographic transition challenges, both in the medium and long term, Mexico must undertake reforms to foster investment, human capital, productivity and to consolidate the financial markets and pension systems.
GAP: Are there lessons that can be gained from looking at the experiences of the U.S. and other developed countries? Since Mexico will age faster than other developing countries, are there lessons that they will be able to take from Mexico?
FGD: A remarkable feature of the responses to population aging is that although this process is more advanced in industrial countries and, therefore, the urgency of putting in place long-term solutions is larger there, many of the proposals that have been raised in developed parts of the world, to a great extent, only postpone the moment to make necessary changes to pension systems and frequently with larger costs.
For example, in developed countries it has been suggested that immigration can help to maintain the proportion of active workers to retirees; however, for the medium term, this approach will require unfeasible growing numbers of young immigrants since these workers will eventually grow old and will in turn demand retirement benefits, and by then, the liabilities of the pension systems will be even larger than today.
Also, it has been suggested to orient tax and family policies to promote the participation of women and young people in the labor force. But, as it happens with immigration, new entrants will some day retire and in the meantime the actuarial deficit of the pension systems will rise at a faster pace than before.
In this regard, developing countries offer a better example of dealing with the solvency problem that the “pay-as-you-go” pension systems face because of demographic transition, Chile being a remarkable example.
After fiscal and financial reforms in the 1970’s, Chile was able to replace the unfunded “pay-as-you-go” system with one of individual capitalization. At that time the ratio of active workers had been falling from 8.6 in 1960 to 2.5 in 1979 making evident the insolvency of the pay-as-you-go system. In 1980, the Chilean government decided to change the nature of the pension system by transforming it into a capitalization one, rather than pursuing partial reforms that would correct only some of its most glaring problems.
In the new system, the worker’s contributions are deposited in an individual account that is managed by private fund managers (AFP). The pension amount will depend on the savings level; in this form, the pension benefits are tied to contributions. In addition, fund managers buy insurance to finance the disability and survival pensions of their affiliates.
Each worker has the option to choose the institution of their preference and change it at any moment. Also, the worker can choose between different investment funds according to their age and risk aversion. In the new scheme, the principal role of the government is granting a minimum pension and regulating the system.
Another important feature of the Chilean system is the flexibility enjoyed by workers at the time of retirement. They can choose between life annuities or other deferred schedules.
Since its introduction, the privatized pension system has grown rapidly. With around two-thirds of all workers participating in the system, total assets under management by the AFPs amount to US$59 billion—equivalent to just over 60 percent of GDP at the end of 2004. In Mexico, the private sector pension system was reformed along these lines in 1997.
The main lesson that other countries could learn from Mexico is the overhauling in 1997 of the pension system, which transformed it into a fully funded system. As of October of 2005, the pension fund manager (Afores)(3) registered more than 34 million individual accounts, equivalent to 99 percent of the potential market(4). Resources managed by Afores reached 557 billion pesos, equivalent to 6.8 percent of GDP, which have contributed to the development of long-term financing and financial markets in general.
GAP: Mexico’s pension privatization reform of 1997 has been criticized because it allows workers who were contributing to the old public system to receive the same benefits that they would have received from the state, if they are higher than their private account savings. In essence, the burden is still on the state to provide a guaranteed benefit. Could you speak to this issue?
FGD: The option given to active workers at the time that the Social Security Law was amended certainly increases the transition cost of the pension system reform. But a scheme of this nature was necessary to make the reform politically viable and with support from all the actors involved. Also, at the time of the reform, calculations pointed to the capability of public finances of absorbing this cost.
Apart from stopping the accumulation of liabilities by the private sector workers’ pensions system, which in turn makes the public finances sustainable; this reform made the population aware of the importance of retirement savings and has contributed to the development and expansion of the domestic financial markets, especially the long-term financing.
Although the alternative given to the workers was an additional cost to the pension system reform, the positive results have offset to a great extent the cost. In particular the Afores have had a positive economic impact. As of October 2005, resources managed by Afores reached 557 billion pesos, equivalent to 6.8 percent of GDP, which have contributed to the development of long-term financing, as well as the financial markets in general.
Also, Afores have contributed to increasing financial savings, allowing the financing of long-term productive projects. In 2004, the Investment Societies Specialized in Funds Management (Siefores)(5) amounted 77 billion pesos for public and private productive projects, and it is estimated that they will reach 1,445 billion in 2040. Also, the share of Siefores in financing the private sector has increased from 0.3 percent in 1998 to 10.6 percent in 2004.
GAP: Currently most pension assets are invested in government bonds. Could allowing greater diversification strengthen capital and financial markets?
FGD: Yes. In fact, in order to improve the current return and risk profile of pension funds in Mexico and to give an impulse to the development of domestic financial markets, in 2004, amendments to the investment regime for Afores were approved to make it more flexible and to allow for greater diversification. In particular, such amendments allow for:
- Gradually opening the investment regime of Siefores -- The National Retirement Fund System Commission (Consar)(6) approved the Siefores to invest in equity linked notes with principal protected at maturity. These instruments have a return that is determined by a stock index and are protected against losses by guaranteeing a minimum redemption value at maturity equal to the original investment. Siefores were also allowed to invest in international securities issued by central banks and multilateral financial organizations with high rating standards.
- Giving to workers investment choices according to age and risk aversion:
- Basic Siefore 1 only invests in domestic and international fixed-rate instruments. This fund was designed for ages 56 or older, but any worker can participate in it.
- Basic Siefore 2, in addition to the domestic and international fixed-rate instruments, can invest a maximum of 15 percent of the portfolio in variable-rate instruments through equity linked notes with capital protected at maturity. This fund was designed for workers below 56 years old.
The option to invest in variable-rate instruments will increase the returns, and the possibility to invest in international securities will increase the portfolio diversification, reducing the risk. Nonetheless, it is necessary to keep strengthening the domestic financial markets and widening the investment options. The increasing resources of Afores should be invested in high return projects, and it is necessary, at least desirable, that the Mexican economy creates those projects.
GAP: Investors in private retirement accounts in many countries have commonly been hit with high administrative fees on their investments. How has Mexico dealt with this problem?
FGD: Market competition has been an instrument envisaged to reduce the administrative fees charged on retirement accounts. It has been promoted through different policies:
- Facilitating Afores change -- The Consar has issued new rules to deregulate the transfer of individual accounts:
- The workers can initiate the transfer of their individual account in the new Afore, not in the previous one, and they can change Afore more than once a year.
- Requisites to change Afore were eliminated and now transfers can be done through the Internet.
- New workers who do not choose Afore are assigned to the cheapest intermediaries. - More and improved information about returns and fees available to the worker.
- Since September 2003 there is direct telephone assistance from Consar to workers.
- New regulation rule comparisons between Afores that grants impartial and homogeneous information.
- A “New Statement Account” that includes relevant information about: i) comparatives of returns and fees between the Afores, ii) balance of contributions and returns of workers’ contributions, iii) details of contributions, iv) real fees charged on the worker’s account by the Afores and, v) returns generated by investment funds. - In addition, several actions have been taken to reduce the operating cost of the Retirement Fund System. Among them:
- A centralized database for the system that reduces costs, compared to each Afore having its own database.
- Creating a housing account database into Procesar (Manager of the National Database). The database updates daily the balance of housing accounts, which eliminates more than 850 million annual transactions on the system.
GAP: What is the Mexican government doing to expand pension coverage to a larger share of the population? (i.e. informal workers and those who do not contribute)
FGD: In this regard, the federal government has taken the following actions:
The Retirement Saving Systems Law was amended in 2002 to allow workers not affiliated with IMSS(7) to open an individual account in an Afore. Voluntary contributions to the pension system are deductible up to 10 percent from income tax up to certain limits and some deferral of income tax payment is allowed.
This measure is intended to enroll independent workers such as lawyers, carpenters, accountants, plumbers, doctors, retailers, and taxi drivers who usually do not have access to safe savings options with fiscal benefits.
The recent approval by the Chamber of Deputies of the “Oportunidades Retirement Program” will provide opportunities to low income individuals who are over 40 years of age to open an individual account with monthly voluntary contributions matched by federal government contributions.
GAP: I understand the Fox government is having trouble passing labor market and fiscal reforms in Mexico. Why is this?
FGD: Some initiatives have had trouble being approved by the Congress, but it could be read as a sign of the developing of a democracy, which will eventually evolve to allow for long-reaching agreement mechanisms without single party majority. In this sense, it is worth highlighting that according to a recent poll(8) there is a trend developing that suggests people want a Congress with a majority of the President’s party.
In 1995, the last time that the value added tax was modified, the President’s party had a majority in Congress (60% of the Deputies and 74.2% of the Senate); during the present Administration, the President’s party has held a minority [of seats] (Deputies: 41.4%, 2000-2003 and 30.2%, 2003-2006, Senate: 35.9%).
It is no longer the time when the President imposes his will on the Legislative Branch.
GAP: What do these reforms mean for the future growth of social insurance systems in Mexico?
FGD: These reforms are necessary to improve the performance of the social insurance systems. On the one hand, the fiscal reform will raise the public fiscal revenues necessary to cover social priorities such as the social insurance. On the other hand, the labor reform will help to broaden the level of formality which will imply more workers paying contributions and broadening the coverage of social security.
It is worth notice that pension, fiscal and labor reforms have positive [correlating] feedback. A pension system that is financially sustainable will diminish pressures on public finances releasing resources to cover other social priorities and fostering growth and job creation. Also, a national pension system will allow for pension portability when workers change from public to private sector [employment], helping to free mobility between sectors and making the allocation of the workforce across the economy more efficient.
The effect of the fiscal and labor reform is similar to the “demographic dividend” in the sense that their implementation will bring a great opportunity to increase the potential growth of the economy. It is necessary to approve these structural reforms to cope with the future necessities of the aging society.
GAP: There has been much discussion surrounding the reform of Mexico’s generous public employees’ pension fund. What is your position on reform options?
FGD: A permanent solution for the actuarial deficit of the public pension system is to migrate to a system of individual accounts. Such a scheme would insure the solvency of the pension system since the benefits are tied to contributions, eliminating the deficit that builds up as the population ages.
Notwithstanding the increase in contributions to the State Workers Social Security Institute (ISSSTE)(9) since 1983, pensions are not covered by the actual contributions; the cost has been complemented with federal government transfers(10). A reform to the public sector employees’ pension system should have the following characteristics:
- Individual accounts: Workers should be the sole owners of their resources.
- Financially sustainable: The contributions to individual accounts made by workers and government should correspond to the benefits at retirement.
- Portability: Workers should preserve their pension rights when they change jobs, even when switching from the public to the private sector.
- Certainty: A minimum pension should be guaranteed to workers of lower income.
The rights of the current workers may be acknowledged with a bonus. A reform with these characteristics will reduce public finance pressures in the long-term and in the short and medium terms, expenditure pressures will be channeled to the individual accounts, instead of going to finance current pensions.
GAP: How important is it to Mexico’s future economic development and growth for the government to improve social insurance and health care systems?
FGD: Economic growth depends on the policy environment, as reflected, for example by quality of education policy and health care systems. In this regard, one of the priorities of the federal government has been social development as a source of growth and to reduce poverty.
The importance of these factors for the current Administration has been reflected in the impulse given to social programs. In this regard, “Oportunidades” is a good example. This program gives the opportunity to Mexicans in extreme poverty to get into quality education, health care services, and proper nutritional levels that allow them to participate in society and leave their situations of poverty.
The “Oportunidades” program has incorporated families in the urban regions, as well as high school students. It is worth highlighting the following results:
- The “Oportunidades” program has doubled its coverage from 2.5 million families in 2000 to 5 million in 2005.
- It is expected that 2.4 million children under 5 years old will be controlled to avoid undernourishment and 5.5 million children will receive an education scholarship.
- For 2006, a budget of 35.6 billion pesos was proposed [to fund these programs], 8.8 percent greater in real terms than the previous year.
The System for Social Protection in Health creates a system of family insurance based on the Popular Health Insurance to ensure that all individuals have access to affordable health-care insurance, particularly those who are poor. By the end of the present administration, 5 million families will be incorporated into the Popular Health Insurance program.
GAP: GAP: What impact would the signing of a Social Security totalization agreement have on the Mexican economy?
FGD: An Agreement of Social Security with the United States will bring different benefits such as:
- The elimination of dual social security taxation for employers and temporary workers in the United States and Mexico.
- Help fill the gaps in benefits protection for workers in the United States and Mexico who have worked in both countries, but not long enough in one or both countries to qualify for benefits.
- Just like pension portability between the public and private sector, the pension portability between countries will make more efficient the allocation of the workforce.
The Agreement approval will reduce the cost of temporal legal migration between Mexico and the United States. Moreover, it will provide more incentives for workers and families to return to their country of origin at the end of their labor activity, because they will be receiving benefits for the social insurance contributions in both countries.
GAP: What will the aging U.S. population and shrinking U.S. labor market mean for Mexico? Since the U.S. will grow old before Mexico(11), do you foresee an opportunity for the Mexican economy, in the sense that U.S. companies may look to outsource jobs and invest in Mexico? Will Mexico be trying to build its human capital to become a source of skilled labor that can supplement the aging U.S. workforce?
FGD: Population aging in the United States could bring an opportunity of economic growth to Mexico, in the form of capital flows to Mexico. According to different studies, as population grows older in the United States, large declines in rates of labor force growth and aggregate private savings are expected to occur.
This slowing workforce growth will reduce domestic investment opportunities, because employers will have less need to provide new equipment and facilities for additional workers. In this form, the demand for investment funds in the United States might initially tend to fall faster than savings, thereby creating incentives for outsourcing and investment overseas. Because of the relative state of its demographic transition, Mexico would be a major recipient of such outsourcing and investment flows.
We must stress that the aging process in the United States merely creates an opportunity for economic growth, and, in a sense, doubling the demographic bonus. Whether or not such potential is captured depends on setting the conditions for attracting investment and job creation. Such conditions, mainly involve a business friendly environment, good quality of governmental institutions, flexible labor markets, responsible macroeconomic management, trade openness, competitive conditions and an efficient educational system. Only through the sustained impulse to competitiveness and economic performance will Mexico be able to take advantage of population aging in the United States and other developed nations.
Footnotes:
(1) See Roberto Ham, Ciclo de conferencias “La población de adultos mayores: retos y oportunidades”.
(2) The “public pension system” in Mexico refers to the pension scheme for federal employees. In 1997, Mexico implemented a pension reform, which involved only those workers employed within the formal private sector. These workers were transitioned from a pay-as-you-go social security system to a funded defined contribution system. Federal workers were excluded from the reform and they still participate in a generous defined benefit pension scheme, which has been subject to large deficits and debates for reform.
(3) Administradoras de Fondos para el Retiro (Afores) are the specialized financial institutions that administer the individual accounts within the Mexican pension system.
(4) The potential market estimated by Consar for the last quarter of 2006 is 35,271,197.
(5) Siefores are mutual investment funds administered and managed by the AFORES that invest the resources they receive from individual retirement accounts in accordance with social security laws.
(6) Consar is the public agency responsible for regulating and supervising the retirement savings system in Mexico.
(7) The Instituto Mexicano del Seguro Social (IMSS) or Mexican Social Security Institute is the governmental organization responsible for health, pensions and social security in Mexico.
(8) See Consulta Mitofsky, “Así van… rumbo al 2 de julio de 2006”, November 2005.
(9) ISSSTE is the pension system for federal government workers in Mexico, which includes approximately 2 million workers. While private sector workers in Mexico are required to contribute to private, defined contribution pension plans, federal civil servants belong to a pay-as-you-go pension system. Through this system, civil servants receive generous benefits with high replacement rates and without a retirement age limit.
(10) See ISSSTE (2004), “El ISSSTE: Entorno, Situación Financiera y Perspectivas”.
(11) The UN projects the average annual growth rate in working-age population in 2010 – 20 in Mexico will be 1.6% compared to 0.5% in the United States, and in 2020-30 it will be 0.9% in Mexico and 0.3% in the United States.
The views expressed in this article do not necessarily represent the views or policies of AARP.
Biography
Secretary Francisco Gil Díaz currently serves as Secretary of Finance and Public Credit in the cabinet of President Vicente Fox. He brings to this position a remarkable breadth of experience in Mexico’s economic and financial affairs and has previously served as Chief of Economic Projections in the President's Secretariat, economist at the Bank of Mexico (Central Bank), General Manager for Economic and Financial Studies of the Finance and Public Credit Secretariat, manager of the Bank of Mexico Data Analysis and Organization Unit, and Revenue Policy General Director of the Finance Secretariat.
For the past twenty years he has worked for the Bank of Mexico as Assistant Director and later as Director of Economic Research. He has also held the position of Under-Secretary for Revenue of the Finance and Public Credit Secretariat. Before his appointment as Secretary he was General Manager of Avantel, a Mexican telephone and internet service provider.
In the academic area, he has been a Professor and Coordinator of the ITAM (Mexican Autonomous Institute of Technology) Economics Program. Mr. Gil studied economics at ITAM and later received a Ph.D. in Economics at the University of Chicago. He was born in Mexico City on September 2, 1943.