Why joining social security pension schemes is mandatory

KenGen shareholders tour Olkaria geothermal plant in Naivasha last year. The company estimates that it needs about Sh437 billion within the next five years to keep pace with rapidly growing demand for power. File 

In most parts of the world, governments interfere in the market economy by requiring workers (or their employers) to make specific provisions for retirement income. The requirements range from mandatory individual saving plans in Chile to large, pay-as-you-go-social security programs in some Western Europe countries.

A market economy operates on the premise that interventions such as these must be justified as necessary to correct for a market failure. The idea is that the intervention will enhance social and economic welfare because markets would not have operated properly in absence of the intervention. A first condition for such intervention is the existence of reaction of the market failure. Two of the market failures postulated mostly common are       :

Left to their own devices, many individuals will not provide adequately for their own retirement. As they age, they will regret that they had not been forced to make more adequate provision. By preventing younger people workers from acting in away they will subsequently regret the government can improve each such individual’s own welfare. 

If society decides that it will not allow its older members to starve, it creates a disincentive for individual provision for retirement. Mandatory intervention can protect the prudent members of the society (those made financial plans for retirement from having to bear the extra expense of caring for the imprudent (those who did not).

A second condition for government intervention is a reasonable chance of success. Government policies that fail cannot be defended just because they were based on good intentions. This implies certain characteristics that government pension intervention should have.

Interventions must be structured to be consistent with the presumed market failure. For example, interventions justified by the need to correct for myopia must be structured in a ways that limit a worker freedom to decide the timing of benefit receipt since, by assumption, without such limits workers would seek to draw down their retirement entitlements too early in their careers.

By definition, pension system seeks to alter individual behavioural and to change income flows. It cannot achieve this results without enforcement of its mandatory provisions and effective administration of its institutions. No matter how is desirable they may be, the goals will not be achieved if workers are able to avoid making required contributions or if assets accumulations are dissipated through mismanagement.

To achieve the desired economic gains, retirement program must be politically and economically stable institutions. Under most approaches, individuals will participate for 55 or 60 years or more in the system, counting the years spent as a retiree/annuitant. The system must be stable that workers can have confidence that it will fulfill its promises or its daily obligations; the desired economic gains cannot be realized fully without such stability.

The system needs to reinforce other national economic and social policies, such as encouraging or discouraging labour force participation or savings. This is also an important ingredient in achieving the requisite political and institutional stability. A system which does not reflect the dominant values and economic policies and its society is unlikely to have the political support necessary to guarantee the stability needed to its basic purpose. Therefore any scheme it must be consistency with other national economic policies

      

The economic production process generates incomes that flow, in the first instance, to workers and capitalists e.g.(those who  supply labour and those who own labour.) in the market economy, each, in turn, is able to consume goods and services, by using all  or part of their income to purchase consume goods in the market place. Since by definition the retired population does not work, their consumption must be supported, in part if not entirely, through transfer from the earnings of the working age population.

Societies employ various combinations of three different mechanisms to achieve these transfers: Informal, intra family transfers through which working age working transfer resources to retirement family members. Mandatory contribution and benefit (or tax and transfer) programs through which some part of the incomes of the working age populations (and perhaps, of the capitalist of all ages) are taxed to support cash payments to the retired; and asset swaps through which the retired population sells assets to the working age population. This may be simple transactions such as selling jewelry, gold, a farm or a house   or they be more complicated transactions handled through financial intermediaries.

The first of these mechanisms is the dominant form in the preindustrial societies and in the rural area of more advanced countries. The second captured both contributory social insurance schemes as well as benefit programs funded fro general tax revenues. Private pensions and individual retirement savings plans are the examples of the third type.

Note that all three mechanisms share the same attribute that the working age population reduces its own consumption, either voluntarily or mandatorily, to free up capacity for the aged to consume. Taken by itself, none increases the amount available for consumption in society as a whole.