Pension Funds in Developing Economies

The pension system is very well developed when it comes to the western world. However, when we look at middle income as well as lower income countries, the pension system still has a long way to go.

The pension coverage in developing economies is very low. This means that a large number of people face financial, medical and social difficulties after their retirement.

Several studies have been conducted in order to explore the lower penetration of pension in developing economies. The main reasons which cause this lower penetration have been listed below in this article.

  1. Change in Social Mindset: The first and most important point to understand is that people in developing economies live in cultures which are very different from the western world.

    Most people in the western world manage their finances on an individual or a nuclear family level. However, in developing nations across the world, social ties are given much more importance. Hence, there is a culture of joint families in which care is provided to the elderly by the younger generation.

    Increasing westernization is leading to an individualistic culture in developing economies as well. However, the transition is likely to take some time. Hence, one of the biggest reasons for lower penetration of pension schemes is that most people do not believe that they need to plan for their retirement. Instead, they rely on joint families and such other social systems.

  2. Lower Percentage of People in Formal Jobs: Pension funds are more prevalent in western economies because a large percentage of their workforce works in formal jobs. Hence, they can be educated about the benefits of pension funds.

    Also, in some countries, pension contributions are made mandatory and are deducted before paying wages to the workers. Such a system is not possible in the developing world because of the large number of people working in unorganized jobs.

    In many developing nations, it is common for more than three fourths of the country’s workforce to be working in unorganized jobs. Governments and pension funds find it very difficult to educate these workers about the benefits of pensions. Also, bring them under the scheme by way of mandatory contributions is not a feasible alternative.

  3. Fewer People in Tax Net: The taxation rate in western democracies is quite high. As a result, when the government gives a tax break to people who invest in pension funds, the motivation for making such investments is quite high. The situation is very different in developing economies.

    As mentioned above, most of the people in developing economies work in unorganized jobs. Hence, a large portion of their income remains unaccounted for. Therefore, they are not very concerned about the taxation rates or the tax benefits which pension funds offer.

    Governments in developing countries have realized that offering tax breaks to investors is not an effective way to induce investors to make pension fund investments.

  4. Lack of Belief in Financial Systems: Developing countries tend to have a volatile economy. For instance, there are many South American countries which have seen rising inflation rates in the past few decades. This high inflation has translated into hyperinflation for many countries and hence their currency has become worthless. It is common for such countries to have a lot of political instability.

    Since governments change very often, the financial policies also change very often. This is the reason that people in such countries are not comfortable locking in their money for long periods of time.

    Liquidity i.e. the ability to divest their investment and deploy it in a different asset class is very important to these investors. Since pension funds are not liquid, they do not find many takers in lower income developing countries.

  5. Lower Wages: People in western countries have relatively high wages. There are minimum wage laws which make it mandatory for every employer to pay a decent wage to their employees. Hence, if a person is employed in the western world, they have a high level of disposable income. As a result, they have enough money to make substantial periodic contributions to pension funds. However, when it comes to people in developing countries, the wages are extremely low.

    In a lot of cases, people can barely survive on the wages that they earn. As a result, there is less disposable income available which can be channelled towards making periodic payments to the pension fund.

  6. Low Last Mile Connectivity: The lack of proper financial infrastructure is also a very real problem in the developing world.

    In many countries, a large percentage of the population stays in rural areas. Such areas tend to be remote and there is no availability of proper banking infrastructure in such places. Hence, even if people want to invest in pension funds, they are unable to do so. This problem has recently been addressed by microfinance companies. These companies are trying to provide last mile connectivity to people who reside in remote areas.

    Pension funds need to tie up with microfinance companies in order to build a system to educate investors as well as to enable dependable financial transactions in remote locations.

To sum it up, pension funds systems exist all over the world. However, the level of development is different in different countries. In some parts of the world, pension funds have achieved saturation. However, in other parts, the penetration is very low. Global pension funds are trying hard to tap the developing economies since it is widely believed that these economies will be responsible for the next wave of growth in pension fund industry.

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Pension Funds