2007
Social (in)security for all: Pension reform in Central and Eastern Europe
Bulgarian Gender Research Foundation (BGRF)
Bulgarian-European Partnership Association (BEPA)
The reforms of the social security systems in Central and Eastern Europe (CEE) were not driven by a commitment to better compliance with international human rights standards, but rather by the trends of economic restructuring in these countries. For some countries like Poland, Hungary and Bulgaria, the reforms were more radical and the choice of social security reform paradigm was conditioned by the need for heavy debt servicing, and therefore negatively impacted by the World Bank ‘assistance’ for such reforms. The social and gender aspects of pension reform were systematically neglected as the ministries of finance were the main architects and actors of the reforms.
The following critique of pension reform in
Central and Eastern Europe (CEE) is based on the analysis and outcomes of
research by economic experts who compared the two main paths of social security
reform in the region (Mueller, 2003). It is further informed by a critical
analysis of the World Bank policy in the region elaborated by independent
experts.
An ageing population and the financial troubles facing public pension schemes,
as well as a new wave of pension reforms in Latin America, triggered renewed
debate about the need to reform old-age security schemes in Eastern Europe in
the mid and late 1990s. The international pension controversy over whether to
basically maintain a public pay-as-you-go (PAYG) system by adapting its
technical parameters, or to implement a private, fully funded pension scheme
such as the one introduced in Chile in 1981, brought about non-uniform
paradigmatic choices in the countries of the region.
The main factors behind the pension reforms in the CEE were structural: economic
transformation, institutional factors and those related to the role of specific
political actors. Although Pierson and Weaver (1993) and other economists and
political scientists advocate a cautious retrenchment rather than a fundamental
regime change in old-age security, in cases of severe demographic crisis, the
reforms in the CEE countries showed that a radical paradigmatic change is
possible.
But were these changes driven by the principle of social security for all?
The answer is provided by an analysis of the two main patterns of social
security reforms followed in countries like Poland, Hungary and Bulgaria, on the
one hand, and the Czech Republic, Romania and Slovenia, on the other. These two
groups of countries are representative of the two approaches taken to pension
reform in CEE, with the rest of the countries being more or less aligned with
one of the two.
The two models will be further analyzed through the example of countries
representative of each: Poland and Hungary in the first case, and the Czech
Republic in the second.
The legacy of the socialist pension system and post-socialist challenges
Pension systems in socialist CEE had reached virtually universal coverage in
the 1960s and 1970s, and were marked by a number of other characteristics: they
were organized as one-pillar public systems not separated from the state budget
or other branches of social security, allowing for different forms of
cross-subsidizing; employers’ contributions were the only source of financing;
the contribution-benefit link was weak; contributions were not registered on an
individual basis; and wages from only a small number of working years were
considered as relevant earnings. In general terms, both pension differentiation
and average benefit levels were low. The retirement age was also comparatively
low, typically 60 years for men and 55 for women.
The economic transformation affected the existing PAYG systems in a number of
ways. Rising expenditures for old-age security were the result of the shift from
indirect to direct transfers that were needed to counteract the erosion of real
pension value related to adjustment-induced inflation and to the drastic
reduction of subsidies on basic goods and services. On the other hand, the
restructuring of state-owned enterprises had an impact on both the revenue and
expenditure side of public pension schemes. The privatization, downsizing and
closing down of enterprises was accompanied by a mounting number of disability
pensions and early retirement policies. The latter brought about an increased
number of pensioners and a falling number of contributors to the scheme, which
resulted in a continuous deterioration of the system dependency ratio of
existing old-age security schemes.
The pension crisis in the late 1990s was brought about by the economic
transformation and was not linked to the ageing of the population. The existing
old-age security systems had to be reformed both to restore their financial
sustainability and to adapt some of the previous design features to the new
economic order. At that point it was obvious to experts that the essential
reform measures needed included the following: abolishing privileges,
introducing employees’ contributions, separating pension schemes from other
social insurance plans, raising the retirement age, and restricting easy access
to early retirement and invalidity pensions. Other, more controversial measures
consisted of the separation of pension schemes from the state budget and
strengthening the link between contributions and benefits.
Restructuring in Poland and Hungary was not radical enough to restore the
financial sustainability of the public pension schemes, and so despite the high
contribution rates, their old-age security schemes are dependent on state
subsidies. In these countries many of the necessary reform measures, such as
raising the pension age and the abolition of privileges, have met with
considerable political resistance or have even been blocked by constitutional
courts.
By contrast, the restructuring of the public pension scheme in the Czech
Republic has contributed to a stabilization of its financial situation, and in
the first years after the reform, it was running a surplus of 0.3% of GDP. It
should be noted, however, that the differences regarding the financial situation
of public pension schemes in Poland, Hungary and the Czech Republic cannot be
explained only by the respective extent of PAYG reform. The Czech Republic had
the advantage of a more favourable situation in the local labour market, while
Poland and Hungary faced a far more drastic decline in the number of
contributors to the public pension scheme.
Another reform step, the first move towards pluralization of pension provision
schemes, was far less controversial. For example, in Hungary and the Czech
Republic, supplementary old-age security institutions – private fully funded
pension funds on a voluntary basis – were created in 1994 and a reasonable
percentage of the labour force joined these funds. In both cases, a government
incentive for participation was provided: a direct government subsidy in the
Czech case, and a tax credit in the Hungarian case. More radical voices
demanding privatization of pension schemes emerged later in Poland and Hungary.
Pension system reform in Poland and Hungary: the implications of the paradigm
choice
Two major conflicting views on pension reform can be identified. On the one
side, in line with the traditional continental European pension paradigm,
pension administrations, welfare ministries and many social security experts
maintained that a radical regime change in old-age security was not necessary,
since the reform of the existing public PAYG systems would suffice. To them,
fully funded (FF) schemes were acceptable on a voluntary basis only. On the
other side, the respective ministries of finance argued that a fundamental
regime change was inevitable, and that a private FF pension scheme represented
the only appropriate alternative to the financially unviable public old-age
security system. This position essentially promotes the Chilean model. In order
to overcome this fundamental division, small task forces were set up in both
Poland and Hungary to work out a pension reform draft. They were actively
supported by the World Bank, which – in the Polish and Hungarian context of
high external debt – was able to play the role of a major external actor in
pension reform with its internationally well-known stance.
In both countries, the basic conflict between the ministries of finance and the
welfare ministries about pension reform was settled in 1996 when a compromise
was worked out by the respective task forces. This compromise was essentially a
negotiated agreement between both sides with a bias towards the privatization
faction.
Thus, in both Poland and Hungary, the new pension system is a mixed scheme,
combining a mandatory public PAYG pillar with a partially mandatory FF system.
The first pillar – the PAYG tier – is financed by employers’ contributions
and part of employees’ contributions, and is mandatory for everybody. The public pension scheme will cover
acquired pension claims by paying some sort of compensatory pension.
The second pillar – the FF tier – consists of a newly created pension
fund system. Membership is mandatory for young people, as a complement to the
first tier. While joining a pension fund was made mandatory for all new entrants
to the labour market in Hungary, everybody under 30 years of age was required to
do so in Poland.
Although the models in Poland and Hungary are strikingly similar, they differ in
many aspects, particularly in the range of first-year reforms. For example,
Polish reform plans for the first PAYG tier are much more radical.
Given that the privatization of old-age security is only partial, the Polish and
Hungarian reforms are not identical replications of the radical Chilean pension
reform, but instead resemble the Argentine model. The mixed model followed in
Argentina has considerable political economy advantages over the full
privatization of old-age security. For instance, the mandatory pension fund
pillar is being built rather slowly, and this ‘slow track’ approach seems
more appropriate in the light of the still fragile capital market and high
inflation in CEE in the early years of the reforms. Meanwhile, employers’
contributions are maintained to finance the obligations of the public scheme,
even if the respective employee chooses the FF pillar. Maintaining employers’
contributions also complies with the demands of trade unions.
Nevertheless, partial privatization does not avoid all of the pitfalls of the
Chilean model. Besides the fact that CEE capital market risks are considerable
due to the recognition of existing pension claims,
the mixed model can have significant secondary effects which can shrink the PAYG
tier as contributions will increasingly be drained away, making the public
scheme even more unsustainable fiscally and politically. This implies, according
to some experts, that from the medium-term perspective, the mixed model is
biased towards a gradual phasing in of the Chilean model.
As a general observation, public pension systems in Poland and Hungary ran
deficits which had to be covered by the state budget. In this context, pension
system reforms had nothing to do with social policy, and instead, they served to
strengthen the position of the ministries of finance. It is not surprising that
the Polish and Hungarian pension reforms included a partial switch to a FF
scheme, considering that the ministry of finance in both countries basically
consisted of neoliberal economists interested in the macroeconomic advantages
attributed to the switch to a funded system. Furthermore, the influence of the
World Bank was facilitated by both countries’ severe external debt problems.
Basically, the World Bank was looking for a radical pension reform precedent in
CEE, and it succeeded.
A contrasting case: pension reform in the Czech Republic
Contrary to Poland and Hungary, in the Czech Republic the choices made in
old-age security reform have been well within the boundaries of the continental
European welfare paradigm. The old-age security system consists of two main
tiers: a public mandatory PAYG scheme that has been reformed and is running a
surplus, and a voluntary private funded system established in 1994, instead of
the mandatory one suggested by the World Bank.
The World Bank has not had much opportunity to influence the Czech pension
reform process since the country’s debt problem was considerably smaller than
in Poland, Hungary and Bulgaria. The Czech model shows that countries in CEE can
successfully diverge from the World Bank model and hence from the highly touted
Latin American role model.
The missing gender dimension
In the early years of pension reform in the three countries considered
above, gender equality was overshadowed by other concerns that were seen as more
pressing, especially the fiscal and macroeconomic framework. Criteria for early
retirement were liberalized for both women and men, retirement ages were
increased, and pensions were made more individualized and earnings-related.
Women entered the period of the reforms with the privileges from the socialist
years but also with the inherited gender pay gap and the consequences of the
gender segregation of the labour market. However, these inequalities were not
analyzed prior to making decisions about the reform paradigm.
In addition, the reforms undertaken in the region tended to eliminate
redistribution towards low-income workers in both the public and private pension
schemes, which has a greater negative impact on women. Moreover, the partial
privatization of pension schemes which took place in Hungary and Poland, as well
as Bulgaria, raises a major issue concerning the size of men’s and women’s
pensions as a result of their different average life expectancies. Under the
private pension schemes adopted, the use of gender-specific tables leads to
lower monthly benefits for women because their savings must, on average, be
stretched to cover a longer lifetime.
World Bank Independent
Evaluation Group assessment confirms negative impact
The World Bank has been a major player in pension reform in developing and
transition countries for more than two decades. Since 1984, it has granted more
than 200 loans to assist pension reform in 68 countries. The publication by the World Bank’s
Independent Evaluation Group (IEG, 2006) of a major and largely negative
assessment of the Bank’s work on pension reforms constitutes an important
vindication of the criticisms and recommendations for change to the Bank’s
pensions policy made by trade unions around the world, and specifically in
relation to the leading role of the World Bank in designing and implementing
pension reforms during the 1990s in Latin America and CEE. Trade unions have
asserted that the World Bank could
play a useful role by assisting countries to make their public pension systems
fully assume their role by increasing coverage of those excluded and by
modernizing their administration. Instead, the model promoted by the World Bank
has created and exacerbated inequalities.
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World Bank Independent Evaluation Group (IEG) criticisms of the World
Bank pension reform model
Critique of ‘multi-pillar’ reforms
The World Bank’s model of partially privatized pensions, known as
‘multi-pillar systems’, has resulted in lower benefits for retirees,
in part because of extremely high administration costs for the private
accounts that the Bank encouraged, and in stagnant or even declining
levels of pension coverage, despite the Bank’s claim that coverage would
increase with the reforms. In addition, the fiscal cost of diverting
contributions away from public pensions into the mandatory private funds
favoured by the Bank frequently leads to pressure to reduce spending on
other public services.
Despite the rhetoric, the World Bank ignores the gender impact of its
pension reforms and does little to expand benefits to unprotected workers
Given the lack of attention that the Bank has paid to the gender
implications of its reforms, it is not surprising to discover that they
have had a more negative impact on women than on men, a point that has
been confirmed by the Bank’s earlier study of pension reform in Latin
America (World Bank, 2003). As for the Bank’s claims that a primary
motive of its interventions has been to increase pension coverage, the IEG
concluded that in fact, “little
support was provided to expanding old-age benefits to workers in the
informal economy,” and that “the
impact of gender on the welfare of the elderly is assessed in only 11% of
countries.”
Claims about the positive impact of pension privatization on
capital markets found to be unsubstantiated
Another World Bank claim over the years has been that privatization of
public pension schemes contributes to a country’s overall economic
growth by stimulating the development of capital markets. The IEG report
finds that the Bank had no factual justification for doing so, noting that
it had generally ignored financial market conditions in the countries
concerned and failed to evaluate the impact that pension privatization
would have on financial markets. In other words, the Bank simply acted on
blind faith in the magic of the market, since the IEG report concludes
that “most capital markets have not developed significantly as a result
of multi-pillar pension reform…”
There is no valid reason for forcing pensioners to subsidize private fund
managers
It should be noted the World
Bank’s Latin American department came to a similar conclusion two years
earlier, when it found, after examining comparative experiences in Latin
America, that private managers generally proved to be very costly
administrators and that “financial sector development can take place
effectively in the absence of pension privatization.”
The World Bank has a distinct bias towards privatizing public pension
systems and more appropriate options have been ignored
After analyzing all of the pension reform loans granted by the World Bank
between 1984 and 2005, the IEG notes that the Bank “has concentrated on multi-pillar systems rather than PAYG
alternatives or non-contributory schemes …Median World Bank lending per
country implementing second-pillar reforms was USD 50 million, compared
with USD 7 million for those not implementing second pillars.”
The IEG report adds that in numerous countries “the
Bank acted too quickly to support multi-pillar reforms … without
examining options for complementary safety-net programmes to protect
informal sector workers from poverty in old age.”
Furthermore, the IEG
observes that the World Bank encouraged several countries to engage in
pension privatization even though their macroeconomic situation was highly
unstable and government debt was high. For example, it found that the Bank
encouraged multi-pillar reforms in 10 countries of Latin America and CEE
where inflation was well in excess of 15%, and in four others where fiscal
deficits were very high. Consequently, the Bank’s reforms add increased
pressure on public finances, as pension privatization “will
temporarily increase the fiscal deficit because the government must
continue to pay pension benefits while some contributions are diverted
into private funds.”
The IEG study also finds that the World Bank pushed ahead with pension
privatization in several countries of CEE and Central Asia despite the
fact that they “did not have
sound financial systems” when they undertook the reform, thus
adding to the risk that the private funds would be mismanaged.
Private sector corruption is
ignored, technical assistance is inadequate, and high administrative costs are overlooked
The IEG report notes that the majority of countries where the World
Bank sponsored pension privatization had poor corruption control indices,
as calculated by the Bank itself. While the Bank claims to encourage
regulation and supervision of pension fund managers and financial
intermediaries, the report finds that the assistance provided in this area
has been insufficient and identifies serious problems in the regulatory
structures in several countries where pensions were privatized.
Unfortunately, the IEG report does not examine the problem of the high
costs of administering private pension funds as compared to the public
systems that the World Bank encourages countries to scale down. The report
does no more than acknowledge that the privatized funds “have been criticized for high administrative and marketing
costs.”
The myth of private funds’ immunity to demographic changes
The report mentions the World Bank’s continued assertion that funded
private pension schemes protect retirees against demographic shifts,
whereas PAYG systems are vulnerable. It is disappointing that the IEG does
not question this assertion by the Bank’s pension experts, since it has
been discredited for several years. In 2001, a report from the
International Labour Organization (ILO) concluded that the impact of
demographic ageing is similar on both types of regimes.
Source: World Bank Independent Evaluation Group
(IEG), Pension Reforms and the
Development of Pension Systems: An Evaluation of World Bank Assistance,
Washington, 2006.
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A statement prepared by Global Unions for the annual meetings of the World Bank
and IMF in September 2005 summarized the kind of role that the World Bank could
play in improving pensions systems:
Old-age pension systems do face important challenges in many countries. A
starting point for establishing a new system or reforming an existing one must
be that any changes to the pension system should be designed so as to improve
the system for workers and retirees, not to prioritize unrelated goals such as
forcing retirees to give up part of their pension benefits to inefficient
private-sector administrators on the pretext that this will help the financial
services industry develop. In 2001, the International Labour Organization’s
annual conference adopted a tripartite consensus on several points concerning
the future of social security, including giving highest priority to the
extension of those not covered and strengthening, rather than weakening,
solidarity systems. The World Bank would do well to revise its own role in
conformity with the ILO’s consensus when intervening on the theme of old-age
security.
All of these deficiencies imply the need for a major revision of the World
Bank’s approach to and support for pension reform, which also means a revision
of the paradigm of social security reforms in the CEE countries that followed
this model. This has become even more imperative as countries around the world
are recognizing that dismantling public systems and trying to replace them with
partially or totally privatized schemes is a recipe for failure.
References
Global
Unions (2005). The IFIs’ role in implementing global commitments to achieve
the Millennium Development Goals. Washington DC, September.
IEG (Independent
Evaluation Group)
(2006). Pension Reform and the Development of Pension: An
Evaluation of World Bank Assistance, Washington
DC, World Bank.
ILO (International Labour Organization) (2001). Social security:
Issues, challenges and prospects. Geneva, p. 55.
ILO (2003). The
Gender Dimensions of Social Security Reforms in CEE: Case
studies of the Czech Republic, Hungary and Poland. Geneva.
Mueller,
K. (2003). Privatising Old Age Security, Latin America and Eastern Europe
Compared. Cheltenham, United Kingdom.
Pierson, P. (1994). Dismantling the Welfare State? Reagan, Thatcher
and the Politics of Retrenchment. Cambridge University Press.
Pierson, P. and Weaver, K. (1993).
“Imposing Losses in Pension Policy”, in Weaver, K. and Rockman, B. (eds.) Do
Institutions Matter? Government Capabilities in the United States and Abroad.
Washington DC, Brookings Institution.
World
Bank (2003). Keeping the Promises of Old Age Income Security in Latin
America. Washington DC, p. 20.
Notes:
See also the
chapters by Aldo Caliari and Fernando Cardim de Carvalho in this Report.
The influential
World Bank pension reform proposal basically consists of a three-pillar model of
old-age security: a mandatory public pillar with the limited aim of poverty
alleviation among the elderly; a mandatory private fully funded pillar linking
benefits to costs actuarially; and a voluntary savings pillar. Within this
framework, the lion’s share of old-age security falls to private pension
funds.
[3] The Hungarian
pension reform laws were passed by parliament in July 1997 and came into force
on 1 January 1998, whereas in Poland the reform was scheduled to take effect in
1999 after the relevant legislation had been passed by the Polish Sejm in
mid-1997 and late 1998. At almost the same time, pension reforms based on the
same approach were initiated in Bulgaria, where the World Bank played the same
role in imposing its reform model.
The fiscal
burden caused will be substantial, since almost 100% of the economically active
population was insured in the past.
In this way, the
Czech government decided to give the emerging local financial market time to
cope with the influx of pension capital by lowering its amount considerably.
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