National compulsory social security programs trace their origins to the private sector, where medieval guilds and mutual-aid societies offered a means for individuals and families to share the risk of income loss and thus to achieve a level of economic security that they could not attain alone. It was rather late in the history of social insurance that governments began to use state authority to extend basic insurance principles to broad segments of society. In France, for instance, there were 1,420 private mutual aid societies providing old age pensions by 1904 when the state first entered this terrain. The relatively late entry of the state into the social insurance business owes in part to the fact that prior to the twentieth century the risk of income loss was not considered a social problem. With the process of industrialization, however, wide-scale migration to cities meant that workers could no longer rely on the land, their families, or the local parish for income protection. As workers acquired greater political rights, they began to demand broad protections against the array of new risks associated with wage dependence in an industrial economy.

State sponsorship of social security grew in close connection with processes of economic development around the world. But economic concerns were not the only motive behind state sponsorship of social security; many governments also had political reasons for doing so. Chancellor Otto von Bismarck of Germany, for instance, is said to have established the first national social security program in 1891 to tame labor unrest and limit the growth of socialism among industrial workers. "Whoever has a pension assured to him for his old age," Bismarck famously said, "is more contented and easier to manage than a man who has none." Despite such instrumental and sometimes undemocratic origins, by the mid-twentieth century social security institutions had expanded far beyond the minimally functional level needed either to promote economic development or forestall worker revolt. Social security grew on the force of middle-class demands in democratic societies and with the encouragement of diverse social and political philosophies. Ascendant social democratic parties defended social insurance on universalistic principles of equal citizenship and social worth, while Catholic social doctrine upheld more conservative designs based on a male-breadwinner model; corporatist principles, in turn, supported more stratified social insurance programs, wherein benefits were tied closely to income levels. In the United States, the long-standing resistance to broad government interventions in the economy was diminished by the depth and intensity of the Great Depression, which resulted in broad innovations in financial regulation and social welfare provision. The U.S. Social Security Act of 1935 drew on the principles of universal earned rights, offering wage-related, but redistributive, pension benefits for old age and disability.

Government sponsorship of social security took root in the developing world at the end of the nineteenth century as an instrument of early state-building projects. In Latin America, pensions were offered to veterans of independence wars and to civil servants manning outposts in fledgling states laying claim to territorial sovereignty. Social security programs later were expanded as part of state-led industrialization efforts under populist governments such as Juan Perón in Argentina, Getúlio Vargas in Brazil, and Lázaro Cárdenas in Mexico. Social security benefits were typically offered to the urban, formal-sector workers that formed the political bases of these regimes and thus bore the heavy imprint of intersectoral differences in organizational strength and political clout of these workers. In most developing countries, informal sector workers have largely remained excluded from coverage by traditional social security programs.

The decades after the Second World War (1939–1945) brought a rapid diffusion of social security institutions around the world. In the advanced industrial nations, the postwar years were called the "golden age" of the welfare state, as strong macroeconomic growth in the 1950s and 1960s fueled broad political acceptance of government-sponsored social insurance. Social security also laid the foundation for a new social bargain in advanced industrial nations that underpinned the reestablishment of the liberal international trading order that had collapsed in the interwar years. In this bargain, social benefits were provided as compensation for acceptance of the risk and cost of openness to the international economy.

Declining economic performance in the 1970s, along with rising demographic and fiscal pressures, opened the door to renewed political conflicts over the balance between state and market responsibilities for social security. The first signs of this dispute emerged as early as the mid-1960s, although critics of the welfare state only gained momentum in the 1980s. Neoliberals, as they were called, drew on classical liberal ideas to criticize big government and bureaucracy as inefficient and detrimental to individual freedom and responsibility. They argued that the public sector had become a burden on economic activity and had crowded out private investment; as a remedy, they called for a broadening of market forces in the economic and social realms. The liberalization movement drew strength from the economic downturn that gripped the advanced industrial nations in the 1970s, spurring widespread liberalization of trade and financial transactions, privatization of state-owned enterprises, and the deregulation of a host of economic activities over which the state had taken control in the postwar era.

In the developing world, the debt crisis of the 1980s signaled what many believed to be the failure of state-led industrialization projects and thus the necessity of reducing the state presence in the economic and social realms. Proponents of free markets argued that state-led development projects had not only failed to secure the benefits of growth for most of society, but also that market reforms would reverse the inequalities and sectoral privileges that were created by state intervention. The final decades of the twentieth century thus brought extensive efforts to broaden the role of market forces in society and curtail the state's allocative functions, including in the provision of social security.

Social security institutions thus became the objects of extensive reform efforts around the world in the final decades of the twentieth century. In most cases, such reforms involved adjustments to the contribution or benefit rates of existing social security systems to reduce costs or increase revenue. In other cases, reforms entailed a fundamental restructuring of the means and ends of income protection, such as through privatization. Some degree of social security reform is required periodically to keep pace with changing demographic and economic landscapes. This is because the effect of increasing life expectancy and declining fertility raise the number of retired persons relative to the working populations, obliging governments to finance their greater social security obligations with the income from a smaller working-age population. The looming retirement of large "baby boom" populations thus raised the specter of wide financial imbalances if adjustments were not made to the social security programs in many countries.

Demographic pressures have been particularly acute in the advanced industrial nations, where the United Nations estimates that the share of the population over age sixty-five will rise by 83 percent between 2000 and 2050—from to 14.3 to 26.1 percent of the population. Although elderly populations are relatively smaller in middle-income countries, sharp declines in fertility have brought an even more rapid increase in the age profile of those nations. Indeed, the UN estimates that population over age sixty-five will grow by 188 percent between 2000 and 2050—from an average of 5.1 to 14.7 percent of the population in less-developed nations. Urbanization and informalization of the labor force in poorer nations, moreover, have increased demands for social protection just as the contribution base for such programs has narrowed. The result has been the emergence of wide financial deficits in social security programs around the developing and developed world, and broad calls for shifts in the terms on which social insurance benefits have been provided.

Privatization involves a fundamental revision to the basic elements of risk pooling and universalism in social security. In the latter instance, privatization entails a shift from universal eligibility for state-funded social insurance benefits toward the conditioning of such benefits on criteria such as means testing. In addition, the risk of income loss that is shared broadly within and across generations through social security is transferred to the individual, whose fortune in the marketplace becomes the central, although by no means exclusive, factor determining her level of income protection. In practical terms, social security privatization involves three basic changes to conventional social insurance programs. Even though none of these changes implies or requires the other, they have typically been bundled in political discourse and practice. The first is a shift in the way that old age benefits are determined, from the traditional defined benefit system, wherein the pension benefit formula is prescribed by law (often in relation to earnings and years of work), toward a defined contribution scheme, in which only contribution rates are defined ex ante, while benefits vary according to the individual's contribution history and the return to invested funds. This change tightens the link between contributions and benefits to eliminate most elements of income redistribution in the benefit formula. Privatization also involves a shift away from the method of financing pensions on a pay-as-you-go basis, wherein the payroll contributions of the current labor force are used to finance ongoing pension benefits, toward one in which benefits are funded fully by each worker's own payroll contributions. And finally, pension privatization entails a transfer of responsibility for managing pension funds from the state to private sector firms or occupational schemes. The state, however, retains important regulatory and oversight functions in privatized systems and is also the ultimate guarantor of the private insurance market.

Heralded as a "revolution" in social security, privatization was first adopted at the national level by the military regime of General Augusto Pinochet in Chile, which replaced the country's social insurance pension institution with a system of individual retirement accounts managed by private sector firms. Beginning in 1981, workers entering the labor force in Chile would no longer pay into the national social security system, but instead contribute to private retirement accounts through which they receive a pension based on their own contributions and the returns to invested funds. Social security privatization diffused rapidly around the world in the quarter-century after the Chilean reform, revealing strong correlations in space and time as privatization in one nation was followed closely by similar reforms in nearby nations. Indeed, since 1990 more than a dozen Latin American countries have passed legislation to replace state-run social insurance programs in various degrees with private savings schemes. Those reformed institutions typically involve a mix of traditional public risk-pooling systems and private individual savings accounts; however, the relative balance between the two components has varied significantly across nations. By the end of 2008, more than seventy-seven million people were affiliated with a private pension fund in Latin America and more than US$2,263 billion in retirement savings was invested in those systems. Outside of Latin America, eastern Europe and central Asia have been the location of the most transformative social security reforms. More than ten countries in that region have implemented some form of privatization, although the political and financial legacies of earlier social insurance programs encouraged the maintenance of a larger state presence in reformed pension systems. By 2008, five of the countries with significant private pension markets (Bulgaria, Kazakhstan, Poland, Romania, and Russia) recorded more than thirty-four million workers affiliated with a private pension fund, and more than US$89 billion invested by those funds.

Advocates of social security privatization argue that this reform makes a positive contribution to capital formation and to individual choice and freedom. With equal conviction, opponents of privatization warn of the financial risks that are placed on the shoulders of individuals who must bear the cost of unwise or inappropriate investment choices and of an array of macroeconomic and labor market risks that lay beyond individual control. Experts on both sides of the reform debate agree, however, that restoring the financial and actuarial balance to social security programs may be achieved either by revising the parameters of the existing state-sponsored social insurance program, or through privatization.

As the twenty-first century began, the privatization movement in social security began to show signs of slowing; in countries like Argentina and Chile, governments even began to reverse earlier privatization decisions. In East Asia, where responsibility for social security functions has long resided principally in the private realm, governments such as that of the Republic of Korea have instead begun to expand the public sector role in social insurance. Yet other countries have forged a new path in social insurance by introducing a reform model that establishes individual retirement accounts, but without privatization. Whether this marks the beginning of a new trend is as yet unclear.

Because social security institutions play a significant role in the allocation of income and risk in a society, they are likely to remain subject to political and distributional conflicts. And even though the pressures of ever-shifting demographic and economic landscapes are likely to maintain a place for social security on the reform agenda, the outcome of such reforms efforts will remain far from determined.

See also Social Welfare; Welfare State.

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