Liberalizing foreign investments by pension funds: Positive and normative aspects

The paper evaluates the economics of foreign investment regulation for pension funds, with a focus on developing countries, where fully-funded pension systems are being started de novo. The analysis proceeds in three steps. First, it is argued that the benefits of global portfolio diversification apply particularly to developing-country pension assets because the volatility of asset returns is high while the risk tolerance of pensioners is low. Second, restrictions of foreign investmetn by domestic pension funds can hardly be justified on ground of financial-development arguments: the paper presents crosscountry evidence which shows little suppert for the claim that the accumulation of pension assets would provide strong externalities for financial development. Moreover, the home bias generally observed in pension fund investment should translate into sufficient potential demand for domestic financial assets as to deepen markets and develop the institutional infrastructure. Third, a case for initial localization requirements, however, can be derived from the fiscal costs of moving from unfunded to fully-funded pension systems if fiscal illustion and domestic tax collection costs are important. (C) 1997 Elsevier Science Ltd.