THE INTERFACE BETWEEN STATE, OCCUPATIONAL AND PERSONAL
PENSIONS IN AN EMERGING ECONOMY
A presentation to the EURACS Conference "Pensions
in Europe"
Budapest, October 4/5, 1996
Introduction
It has been understood all along that the process of transformation
and privatization of the formally centrally planned economies
will involve a drastic reduction in the cash flow accruing to
the state treasury. The reason for this is the disappearance of
a great deal of economic activity from the public ambit. On the
other side of the budgetary equation, social commitments, including
health care, pensions, as well as the costs of maintaining the
entire government apparatus remain. In a situation like this,
there is a natural tendency for a significant budgetary deficit
to appear. The theory proved to be right.
Publicly Provided Pensions
The typical planned economy in Europe had a centrally provided
pension system. The pension formula (wage and service related)
was common to all citizens, but the institutions provided for
the quasi-arbitrary enhancement of pensions by political fiat.
There were no central records on wages and service. An actuarial
evaluation of such a system is difficult, but in any case, those
in charge before 1989 did not seem to be interested. Following
the commitment to transformation, large budgetary deficits, and
pension commitments of hard-to-forecast magnitudes appeared. At
least in some transforming economies, this development coincided
in time with adverse demographic developments, as well as an economic
downturn associated with the transformation process.
Under these circumstances, it became realistic policy to aim for
a level of pension provision providing survival income for all
retired citizens. For some transforming economies, even that goal
could not be met.
This is where there is a parting of the ways among the emerging
market economies. The Czech Republic, Hungary, Poland and Slovenia,
are candidates for early admission to the European union. A number
of the other transforming economies however, will continue to
have to struggle to obtain and to maintain survival level incomes
for their pensioners. For the latter group in particular, whatever
retirement income in excess of survival is desired, will have
to come from privately provided pensions. In line with this expectation,
we hear of numerous private pension plans springing up with little
by the way of legal provision for regulation.
In the four countries named, and perhaps in some others, national
income is now, or should soon be, at the level that permits the
general provision of floor level public pensions. Here too, the
provision of additional comfort in old age will have to come from
the private sector. The policy problem of how much to provide
seems to be constrained by the present level of payroll taxes
and employee contributions to finance the existing public structures.
It is difficult to imagine any of the four governments enacting
increased levels of compulsory contributions in the near future.
Accordingly, private provision may have to come, as is currently
planned for Hungary, from the diversion of funds now coming into
the public system. That in turn raises what might be called a
cash flow problem for the state pension system. This points to
an interesting question in macro-economics. If the central budget
is to fill the gap, and as a result a higher current deficit arises
in the government's accounts, does that cause additional strains
in the economic system?
The orthodox view on this question is that the increase in the
budgetary deficit will increase national debt with all the undesirable
consequences thereof. A more recent perception points to the ongoing
existence of an unrecorded national debt arising from existing
pension promises. If the government budget is used to finance
a paydown of the implicit national debt referred to in the preceding
sentence, all that happens is that implicit debt becomes explicit,
or recorded, national debt. The economic consequences are restricted
to the perception of myopic observers, who have previously disregarded
the existence of the implicit debt. How much is this consequence
worth as a restraint to the reform process?
The General Issues
Looking at the early candidates for European admission, it is
clear that in the 40/50 year horizon of pension planning, their
long-term problems will be the same as those of the other OECD
countries. I can see two sets of problems; one in the public,
and one in the private sector.
In the public sector, we are accustomed to looking at the cash
flow problems of pension schemes to assess their viability. By
this criterion, a combination of premium increases and benefit
reductions will solve almost any problem. Let me propose a second
criterion not usually invoked. The participants in the public
system have to be satisfied that their contributions will stand
scrutiny as an investment in competition with other investments
in the market. In plain English, this means that the internal
rate of return to the participant should be no lower than 3% real.
This was no problem with the early stages of the pay-as-you-go
system in the Unites States and in Canada, and I presume elsewhere,
because rates of return to the early participants were spectacularly
high in the double-digit range. We now know that demographics
and slow economic growth are making the return close to zero and
perhaps negative to persons now starting their careers. People
are not stupid. They mistrust government pension plans and rightly
so. Nothing will save these plans from politicians who draw their
inspiration from public opinion polls.
This suggests that in the public sector, public assistance to
the poor should be disentangled from the general provision for
pensions. It is reasonable to legislate that those who can, should
provide for their own old age. It is decent and humane to provide
for those who, for whatever reason, could not.
This policy outline suggests a restriction of the public sphere
to the provision of assistance to the poor and the enforcement
of compulsory savings as an act of paternalism, as well as an
attempt to minimize public charges. Given demographics and economic
growth in advanced industrialized societies, it is unlikely that
pay-as-you-go funding will meet the needs of people expecting
the 3% real-rate of return, or more, on their pension savings.
Consequently, it is reasonable to expect countries to legislate
compulsory savings with full funding, looked after by private
investment management.
Presumably, compulsion to save should be minimal and restricted
to the modest goal of survival in old age, or to the case of disability.
The rest of pension provisions will be by necessity up to the
decision of the citizen. This raises the question of desirable
coverage in terms of wage replacement ratios. In traditional pension
planning, we have assumed that a traditional 70% replacement ratio
will amply cover the retirement needs of a person who withdraws
from the labour force, spends his day on no too-demanding leisure
activities, and eventually fades from the scene. Looking down
the road, the picture painted in the previous sentence is increasingly
unrealistic.
It is useful now to distinguish between young pensioners and old
pensioners. Young pensioners may in fact continue to earn money
on post-retirement/part-time jobs to supplement their pensions.
Others will use their newly gained leisure to adopt a new expensive
"golf in Algarvae" lifestyle, where presumably the 70%
replacement ratio might be less than adequate.
And then there are the "old pensioners". These are persons
who have lost their health and the ability to carry on independently.
Advances in medicine assure us that there will be more and more
such persons. In order to deal with the economic consequences
of the increased prevalence of dependency, considerably more money
is required on the level of the household than for "young
pensioners".
Conclusion
What does all this tell us? First, the public systems are likely
to limit their long-term involvement to assistance to the poor.
Second, there will be more publicly legislated compulsory savings,
probably managed in the private sectors. Third, increased longevity
in the industrialized countries will lead to a serious re-examination
of pension plans providing constant replacement rates. In sum,
the actuarial profession may have to rethink the basic pension
plan designs now provided.
Antal Deutsch
Professor of Economics
McGill University
Montreal, Canada
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