Avoiding the State Pension Scheme Crises in Europe
by Teodor Stan
In the grips of recession fear runs high across the developed industrialized world, that the welfare state is being dismantled starting with national pension schemes. One alarmist misconception is that governments, in desperate attempts to address the insolvency of their centralized pension plans, are seeking to abolish the pension schemes altogether. It is not in the interest of national governments to do so. Pension schemes had always acted as political tools creating social stability and augmenting pensions has generally been a tool abused by populist politicians. Curtailing that abuse without destroying the state pensions, and at the same time making them fit for current demographic patterns, is what should be sought through moderate reforms. That is achievable, and has been done even in poorer Eastern European countries, so it should not be such an insurmountable task for western EU countries among which Italy seems to be the laggard.
Current, overly generous schemes are economically unsustainable, but closing them or too drastically curtailing them would also be politically unsustainable since it would lead to rising poverty and social instability. Needed reforms should rather be a return to the core reasons for which state pension plans were initially created. They were created to prevent the fall of large social groups into poverty, to smooth consumption patterns over a lifespan so as to help individuals maintain a consistent lifestyle and thirdly to maintain a compact between generations. State, pay-as-you-go pension schemes became central components of national welfare regimes especially after World War II because centralized national administrations could depend on the positive demographics of their population and they could foresee steady productivity gains that would allow them to maintain fiscally salient pension programs. This is no longer a valid predicament for any western European country, unless of course one imagines the accommodation of a massive migrant workforce that would radically change the demographic outlook. Reform is needed so as to reflect current demographic reality, the changing nature of the family unit, the unsustainable consumption pattern of the younger generation and the transnational labor force mobility. Instead of simply deploring irreversible social trends, governments can act swiftly and avoid the pension crisis.
Moderate reform options do exist and all EU countries should pursue versions of such policy tinkering. Even with a highly mobile labor force, governments can still play a central regulatory role. They can regulate the transferability of pension rights and modify accrual rules, they can enforce anti-age discrimination provisions, they can provide tax incentives for employees to keep older workers and they can encourage programs for the retraining of older workers. The most common tool used by governments is to manipulate the effective retirement age. Early retirement had been more liberally managed in 1970s and 1980s, when governments were more concerned with the cost of unemployment benefits than with the consequences of early retirement. The same liberal approach to early retirement was applied in all post-communist countries in the early 1990s, when communist era mammoth factories were being closed and unemployment was rampant. This behavior only exacerbated the fiscal instability of state pensions. Even if people react strongly to the raising of the retirement age, reforms can be packaged in more palatable terms that would include positive financial incentives. Governments can discourage early retirement by instituting substantial reductions to pensions for early retirees and adding premiums to individuals working beyond the established retirement age. In addition to restricting early retirement, governments can curtail abused patterns of retirement due to reasons of health. These moderate measures could to some degree reduce the impact of population ageing on the state pension schemes.
EU institutions have attempted to raise the issue of pension investment as related to regulations under the common market principle. In particular the EU attempts to monitor occupational retirement provisions and issues related to pension rights portability, but it is yet unlikely that the EU would be the stage for a continent-wide, one-size fits all approach to pension reform. There are too many differences in the national policies of each country. Different choices are being made by each national government but there is particular consistency across most of the Central and East European states which follow the multi-pillar approach initially proposed by the World Bank. This multi-pillar approach keeps the state schemes, complementing it with private schemes, maintains both compulsory funded schemes and consolidates voluntary funded schemes. The blueprint for this type of pension reform was proposed in 1994 and almost all formerly communist EU states adopted it. Initially, it was implemented by the Polish and Hungarian reformers and more recently even by the reform timid Romanians. The reasons for creating an alternative to the public system pension scheme and for establishing privately managed schemes were to reduce distortions to labor market incentives, improve economic efficiency by allocating assets through financial markets and also to insulate the pension system from political interference. Governments in these countries still regulate the privately managed funds, for example by restricting investments of the funds outside national borders or by encouraging private pension funds managers to invest in government securities. While political interference may not have been completely curtailed with the advent of the private pension sectors in these countries, there is a better chance that pension funds would not be abused for electoral purposes. Interestingly, the creation of this public pension sector did not lead to public protests as it was the case with post-communist transitional privatization schemes in the early 1990s. Rather, people seem to like the idea of not giving their pension money to the state and have a sense of control over their private pension accounts. Maybe there is something to be leant from the implementation of this regional experience. My hunch is that the EU will in the future look closely at monitoring these private pension schemes so that fraud and abuse in their management would be avoided.
The debate over state pension reforms should be focused on identifying a national, consensus based mix of state and private pension plans that stand a chance at providing long-term economic sustainability. Voters will always demand to be taken care off in their later stages of life irrespective of the financial situation of the pension funds, so the situation needs to be addressed now, before the state schemes falter and become national burdens. Though I do not believe that one continental approach would fit all the different national pension necessities of EU member states, I do believe the regional path taken by the formerly-communist countries of the EU is a good experience to be studied and replicated. For political salience these reforms should be publicly debated at the national level, packaged together and swiftly implemented. If clearly explained, people will understand the necessity of these reforms and adapt to the new system if a structure of positive incentives is provided.