THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 330

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PA R T I I I

Financial Institutions
pension plans, benefits are typically paid out from current contributions, not tied
closely to a participant s past contributions. This pay-as-you-go system led to a
massive underfunding. The problems of the public pension plans could become
worse in the future because of the growth in the number of retired people relative
to the working population. The government has been grappling with the problems
of the public pension plans for years, but the prospect of a huge bulge of new
retirees has resulted in calls for radical surgery (see the FYI box, Should Public
Pension Plans Be Privatized?). In 1999, for example, the CPP was given authority
to sharply increase contribution rates from 5.6% in 1999 to 9.9% in 2003. It was
also given the authority to invest its accumulated assets in the market in order to
earn a higher return so that future increases in contribution levels will not be
needed.

FYI

Should Public Pension Plans Be Privatized?

In recent years, public confidence in the
public pension plans has reached a new low.
Some surveys suggest that young people
have more confidence in the existence of flying saucers than they do in the government s
promise to pay them their public pension
plan benefits. Without some overhaul of the
system, public pension plans will not be able
to meet their future obligations. The government has set up advisory commissions and
has been holding hearings to address this

problem.
Currently, the assets of the public pension plans, which reside in trust funds, are all
invested in government securities. Because
stocks and corporate bonds have higher
returns than government securities, many
proposals to save the public pension plans
suggest investing part of the trust fund in corporate securities and thus partially privatizing the systems.
Suggestions for privatization take three
basic forms:
1. Government investment of trust fund
assets in corporate securities. This plan has
the advantage of possibly improving the
trust funds overall return, while minimizing transaction costs because it exploits
the economies of scale of the trust funds.
Critics warn that government ownership

of private assets could lead to increased
government intervention in the private
sector.
2. Shift of trust fund assets to individual
accounts that can be invested in private
assets. This option has the advantage of
possibly increasing the return on investments and does not involve the government in the ownership of private assets.
However, critics warn that it might expose
individuals to greater risk and to transaction costs on individual accounts that
might be very high because of the small
size of many of these accounts.
3. Individual accounts in addition to those
in the trust funds. This option has advantages and disadvantages similar to those
of option 2 and may provide more funds

to individuals at retirement. However,
some increase in contributions would be
required to fund these accounts.
Whether some privatization of the public
pension plans occurs is an open question. In
the short term public pension plan reform is
likely to involve an increase in contributions,
a reduction in benefits, or both. For example,
under the 1997 changes to the CPP Act, the
percentage of liabilities of CPP that are
funded is expected to increase from the current 8% to 20% by 2018.