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