the rise and fall of private pensions in central and east europe igor guardiancich c enter for the s...
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The Rise and Fall of Private Pensions in Central and East
Europe
IGOR GUARDIANCICH
CENTER FOR THE STUDY OF EUROPE AND THE WORLDin collaboration with
THE COLORADO EUROPEAN UNION CENTER OF EXCELLENCE AT THE UNIVERSITY OF COLORADO
BOULDER
Monday, February 13
1
Structure of the presentation
1. The ‘new pension orthodoxy’ Averting the Old-Age Crisis Criticism and reassessment
2. Pension privatization in Central and East Europe
The socialist system The transformational recession Refinancing, retrenchment and restructuring Diffusion and variation
3. The financial crisis as dual exogenous shock Impact of the crisis Impact of the Stability and Growth Pact Reform reversals
2
Part I - The ‘new pension orthodoxy'3
The World Bank’s three pillars
Redistributive plus
coinsurance
Savings plus coinsurance
Savings plus coinsurance
Objectives
Means-tested, minimum pension
guarantee, or flat
Personal savings plan or
occupational plan
Personal savings plan or
occupational plan
Form
Tax-financedRegulated fully
funded Fully fundedFinancing
Mandatory publicly managed
(first) pillar
Mandatory privately managed
(second) pillar
Voluntary (third) pillar
Criticism: Economics4
First-order impact is nil‘privatization without prefunding would not increase returns at
all, net of the new taxes needed to pay for unfunded liabilities.’ (Geanakoplos et al., 1998)
‘Funded pensions face similar problems as PAYG schemes, and for exactly the same reason – a shortage of output. The only difference is that with funding the process is less direct and
hence less transparent.’(Barr, 2002)
Second-order impact is doubtful More saving, more investment, more growth Increased labor supply and improved reporting of earnings Lower cost through competition between funds Internationalization of risk: exporting capital vis-à-vis
importing labor
Criticism: Politics5
The backlash of losers‘too often the Bank has not addressed sufficiently the
primary goal of a pension system to reduce poverty and provide adequate retirement income within a fiscal
constraint. It has also focused insufficient attention on the income of the aged.’(World Bank, IEG, 2006)
Persistence of moral hazard private funds are tempting for politicians, as they
accumulate many years of contributions (as opposed to less than one year in PAYG plans)
renationalization as quick budget fix (Argentina, Hungary)
Criticism: Transition costs6
Transition costs during transition government pays public pensions
while workers accumulate their own fundsFour views
Deduction of transition costs
Counting transition costs
Support for privatization
CEE governments World Bank
Opposition against
privatizationILO (?) IMF
Adapted from Casey and Simonovits (2012)
Part II - Pension privatization in CEE7
Socialist pension systems8
Three layers Bismarckian core
employment as legal basis of retirement universalism through the extension of the constitutionally
guaranteed right to work post-war socialist social solidarity
PAYG system increased coverage (small entrepreneurs and farmers) reinforced stratification (jobs
imported Stalinist centralization monolithic public administration
The transformational crises9
Crisis under socialism financial strains
low retirement age and long assimilated periods (e.g. maternity leave)
benefits calculated according to best- or last-years formulae cross-subsidization of other budget expenditures (e.g. social
assistance) poverty in old age
the ‘old portfolio’ problem, due to insufficient indexation
Crisis during the transformation demographic emergency ‘great abnormal pensioner booms’ multiplication of contributors, output decline and tax evasion political exploitation of losers and pampering of core
constituencies
Cumulative GDP growth (1990=100)10
Unemployment rates11
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
CZ 0,7 4,1 2,6 4,3 4,3 4,0 3,9 4,8 6,5 8,7 8,8
HU 1,4 8,2 9,3 11,9 10,7 10,2 9,9 8,7 7,8 7,0 6,4
PL 6,5 12,2 14,3 16,4 16,0 14,9 13,2 10,9 10,2 13,4 16,1
SK 1,2 9,5 10,4 14,4 13,6 13,1 11,3 11,8 12,5 16,2 18,6
SI na 7,3 8,3 9,1 9,1 7,2 6,9 7,1 7,4 7,4 6,4
BG 1,6 10,5 15,0 16,3 18,6 13,7 13,0 14,5 16,0 17,0 16,4
RO na na na na na na na na na 7,1 7,3
EE 0,6 1,5 3,7 6,6 7,6 9,7 10,0 9,6 9,8 12,2 13,6
LV 0,5 0,6 3,9 8,7 16,7 18,1 20,5 15,4 14,3 14,5 14,6
LT na 0,3 1,3 4,4 3,8 17,5 16,4 14,1 13,2 14,6 16,4
RU na na 5,3 6,0 7,7 9,2 9,3 10,8 11,9 12,9 10,7
UKR 0,0 0,0 0,2 0,3 0,3 0,3 1,3 2,3 3,7 4,3 11,6
Informal economy: Household electricity approach
12
1989 1990 1991 1992 1993 1994 1995
CZ 21.7 24.3 31.7 31.8 27.1 24.5 21.8
HU 24.6 25.6 31.1 33.2 33.6 31.4 29.6
PL 22.9 31.6 32.5 31.7 31.1 27.9 23.9
SK 21.7 24.3 32.0 32.0 34.1 32.0 28.4
SI 26.7 26.8 27.4 31.2 28.4 25.0 22.7
BG 23.3 28.9 33.7 34.1 34.0 35.9 34.0
RO 17.3 24.4 36.9 39.0 37.5 34.2 28.3
EE 16.9 22.0 32.0 37.4 38.4 38.1 35.8
LV 17.3 19.4 22.6 41.7 45.5 43.1 43.7
LT 17.0 21.0 31.7 47.4 52.2 47.6 46.0
RU na na na 37.8 36.0 39.1 39.2
UKR na na 28.1 37.4 47.0 54.6 52.8
Great abnormal pensioner booms13
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 %
CZ na na na 2,521 2,519 2,523 2,498 2,507 2,545 2,537 0.6
HU2,58
72,66
82,79
52,86
82,94
83,01
03,05
93,10
43,13
93,18
4 23.1
PL5,59
86,15
46,50
56,70
36,87
37,03
67,17
27,31
37,46
67,52
4 34.4
SK na na na na 1,386
1,387
1,393
1,402
1,415
1,435 3.5
SI na 419 449 458 458 460 463 468 472 476 13.6
BG 2,2732,34
72,44
32,44
02,42
42,40
92,38
12,39
22,38
72,38
1 4.8
RO 2,570 3,018 3,201 3,253 3,439 3,600 3,740 3,875 4,020 4,181 62.7
EE 361 374 383 387 376 375 375 374 375 378 4.7
LV 610 648 661 665 663 666 662 664 660 653 7.0
LT 879 909 891 897 907 898 930 990 1,076 na 22.4
RU 32,848
34,044
35,273
36,100
36,623
37,083
37,827
38,184
38,410
38,381 16.8
UKR na 13,100
13,600
14,200
14,500
14,500
14,488
14,487
14,535
14,520 10.8
Three reform phases14
Refinancing rapid increase in social security contributions (PL 25% in
1981; 38% in 1987-9; 45% in 1990) discontinued due to declining international competitiveness
Retrenchment arbitrary freezing of indexation of all but minimum
benefits struck down by Constitutional Courts (lack of exceptional
circumstances)
Restructuring politically superior, allows for quid-pro-quos resonates with the public (equity as individualization) obfuscates cuts in public pillar
Diffusion and variation15
Different types of privatization Substitutive (KO) Parallel (LT) Mixed (BG, HR, EE – not only carved out, HU – reversed, LV, MC,
PL, RO – stalled, SK – partly reversed) Voluntary (AL, CZ, SI – quasi-mandatory, SR)
Coverage Mandatory for young workers (HU only new workers) Voluntary for intermediate cohorts (PL 30-50; HR 40-50) Not available to older employees (HU rare exception, active errors)
Size Substantial (HU 68/33.5; LV 210/20; PL 7.3/19.52; SK 9/18) Medium (BG 25/23; HR 5/20; EE 4+2/20; LT 2.55.5/18.5; RO
2.56/28) Small (SW 2.5/18.5)
Impact of privatization on deficit/revenues
16
Country Budget balance
Transition cost
Balance if no reform
Lost revenues 2007-60
Bulgaria 0.1 -0.7 0.8 45
Estonia 2.6 -1.3 3.9 64
Latvia -0.3 -0.8 0.5 99
Lithuania -1.0 -0.9 -0.1 43
Hungary -5.0 -1.2 -3.8 93
Poland -1.9 -1.3 -0.6 167
Romania -5.4 -0.3 -5.1 67
Slovakia -1.9 -1.0 -0.9 106
Part III - The financial crisis17
Shrinking demand Most of CEE are small and open economies (<1M – 10M
people). Banks became illiquid in late 2008. Fall in international orders triggered an economic
collapse.Asset bubbles
Hungary and Baltic states had excessive exposure to foreign-denominated mortgages.Country BG HR CZ EE HU LT LV PL RO SK SI
2008 6.2 2.2 3.1 7.5 0.9 2.9 -3.3 5.1 7.3 5.9 3.6
2009 -5.5 -6.0 -4.7 -3.7 -6.8 -14.8
-17.7
1.6 -6.6 -4.9 -8.0
Stability and Growth Pact18
Maastricht criteria for EMU membership: inflation max 1.5 pp higher than the average of 3
lowest-inflation Member States budget deficit <3% of GDP government debt <60% of GDP long-term interest rate max 2.0 pp higher than in 3
lowest-inflation Member States ERM II joined for 2 years prior to accession, no
devaluationStability and Growth Pact (SGP)
Enhanced monitoring procedures Sanctions through Excessive Deficit Procedures (EDPs) Renegotiation and increased flexibility in 2005
SGP and Pensions I19
SGP should not encourage or discourage any particular economic structure (pension system).
Reform of SGP (2005), special treatment in EDPs: granting time for the adaptation of fiscal policy to the front-
loading of deficits; excluding the compensation for systemic pension reforms
(assets of funds not offsetting government debt); introducing a transitory period of 5 years (2005-9)
application of a degressive scale, if deficit is close to 3% and excess reflects the costs of the reform.
SGP and Pensions II20
Criticism: triggered by expiry of the transition period, soaring budget
deficits; 2nd pillars mature in 40-50 years, 5 years are insufficient; reformers should not be penalized with regards to the
Maastricht criteria.Demand for SGP revision
letter of 8 CEE countries plus Sweden change the statistical treatment of private pension funds; deduct fully the costs of implementing systemic pension reforms
from the budget deficit in the context of the EDP; refusal of interim relief (deviations from accounting rules must
be limited, comparability with similar measures, statistical certainty);
new draft rules allowing for flexibility for virtuous countries.
Reforms and reversals21
Temporary measures many CEE countries froze the indexation of pensions
(wages of public employees, social transfers) during 2010-12
Parametric reforms various CEE countries introduced a number of
‘overdue’ parametric reforms: higher retirement age fewer early retirement venues lower regular indexation
Reversal of privatization governments prefer to spend for Keynesian measures
than for transition costs
Reversals of privatization22
Bulgaria Contributions: frozen at 5% during 2007-14, rising to 7% in 2017Switching back: early retirees brought back to PAYG system
Estonia Contributions: suspended temporarily (employees can pay in 2%)
Hungary Contributions: diverted back to public pillarSwitching back: strong incentives to all pension fund members
Latvia Contributions: reduced from 10% to 2% temporarily
Lithuania Contributions: reduced from 5.5% to 2% temporarily
Poland Contributions: reduced from 7.3% to 2.3%, rising to 3.5% by 2017Switching back: allowed in 2006 for early retirees
Romania Contributions: frozen at 2%
Slovakia Switching back: allowed to all pension fund members, no mandatory entry for new workers