The Political Economy of Pension Reform Igor Guardiancich European University Institute R. Kent Weaver Georgetown University & The Brookings institution
Outline: • Challenges and Options in Pension Reform • Comparing Patterns of Pension Reform in West and Central/East Europe • Explaining Patterns of Change • Lessons on the Political Limits of Reform
The Five Challenges of Pension Reform: 1. Demography 2. The welfare of seniors 3. Financing 4. Behavioral change Politics – Can a reform be: 5. – Adopted (without harmful design flaws) – Implemented effectively (and meet performance objectives) – Sustained politically (rather than eroded or reversed)
Patterns of Pension Reform in EU15 (and other OECD) Countries
Pension Reforms have: • Become Aggressive in the Past 20 years • Transferred increased market risk from government to current and future pensioners • Followed a general sequence-- 1. Refinancing – Increase payroll tax base and rates – Add dedicated revenue sources or increase general revenue subsidies Followed by:
2. “Stealth” retrenchment to benefits and eligibility (easier to hide) e.g., – Changes in years of work required for full benefit – Changes in indexation formulas Followed by:
3. More visible retrenchment, e.g.: • Increased penalties for early retirement • Increasing standard retirement ages, especially for women — and widespread breaking of the 65 “upper limit” Initially with long lead times to make them more politically acceptable Followed by:
4. Modest structural reforms in some EU15 countries, e.g.: • Automatic Stabilizing Mechanisms (ASMs) provide “clean hands” cuts, e.g., – Notional Defined Contribution – “Sustainability factors” in benefits – Automatic increases in retirement ages • Individual Defined Contribution (DC) Accounts — largely as a modest supplement to rather than replacement for existing pension tiers (e.g., Sweden, Germany, Italy)
5. No pattern of convergence toward a single type of “pension regime” in EU15 1950 1974 1985 1995 2012 Sweden * Italy * NDC Germany * Bismarckian Austria France Universal Ireland Denmark Switz. U.K. Mixed Neth. Residual Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.
6. Post-2007 financial crisis leads to renewed rounds of retrenchment in EU15 rather than structural reform, e.g.: • Increases in standard retirement age • Further restrictions on early retirement • Further limitations on special provisions for specific occupational groups • With some use of ASMs (e.g., Spain, Greece) rather than full NDC
7. Automatic Stabilizing Mechanisms in OECD countries have a mixed record on sustainability: • Sweden- Sustained but: – partially evaded through tax mechanism – Effects made less visible by shift in formula • Germany 1- Repealed • Germany 2- Partially and temporarily suspended • Italy- Suspended, strengthened and supplemented
Patterns of Pension Reform in Central and Eastern Europe
1.Reform phases in CEE countries followed similar modal sequence to OECD • Refinancing – rapid increase in social security contributions (e.g., 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
2. Compressed and Higher level of Pension Restructuring in CEE 1989 1995 2000 2005 2013 Latvia * NDC Poland * Slovenia Bismarckian Hungary Slovakia Estonia* Bismarckian Lite Lithuania* Universal Czech Croatia* Mixed Residual Kosovo* Asterisk indicates that a country has added a small mandatory or quasi-mandatory defined contribution individual account tier.
including move to multi-pillar systems, but with substantial cross-national variation • 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 6 8/33.5; LV 2 10/20; PL 7.3/19.52; SK 9/18) – Medium (BG 2 5/23; HR 5/20; EE 4+2/20; LT 2.5 5.5/18.5; RO 2.5 6/28) – Small (SW 2.5/18.5) 15
3. The financial crisis led to additional incremental retrenchment in CEE… • Temporary measures – many CEE countries froze the indexation of pensions (wages of public employees, social transfers) during 2010-12 • Various CEE countries introduced a number of “overdue” incremental reforms — e.g.,: – higher retirement age – fewer early retirement venues – lower regular indexation 16
4. …and to some reversals of privatization and reallocations of contributions Bulgaria Contributions: frozen at 5% during 2007-14, rising to 7% in 2017 Switching back: early retirees brought back to PAYG system Estonia Contributions: suspended temporarily (employees can pay in 2%) Hungary Contributions: diverted back to public pillar Switching 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 2017 Switching 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 …as governments prefer to spend for Keynesian measures than for transition costs
Summary comparison: Some parallel trends between EU15 and CEE countries, but reforms in CEE countries were: • Compressed in time, • more likely to be structural, and • more prone to move to and retreat from of multi-pillar reforms than in EU15 countries Why? And what lessons does it suggest for the future?
Explaining Patterns of Reform
Three “clusters” of explanatory variables: 1. The problem stream — what are perceived to be the key problems needing a response 2. The policy stream — what responses are perceived to be viable 3. The policy stream — what interests have influence, and how decisions are made 20
A Politically-mediated Model of Pension Policy Change Cluster 1: Economic- Cluster 3: Political/ Demographic variables Institutional variables Demographic Incentives for politicians, mediated by: change Domestic Political- Group Fiscal political partisan environment pressures institutions environment Economic (politics stream and decision procedures) Competitiveness Status of pressures The Elderly New social Direction risks And Extent Labor of Policy Market Change: Available Strategic Partici- Perceived need - Retrenchment incremental Decisions by pation of for policy change - Refinancing and regime politicians Older (problem stream) - Modified or transition options Workers new policy (policy stream) regime (restructuring) Policy feedbacks: Afforda- Institutional - Policy regime bility of Cluster 2: Carriers of reform - Micro-rules Pension Policy Feedbacks Ideas (e.g., - Age of policy Regime and Ideas WB, EU, OECD) regime
Cluster 1-Economic/Demographic Constraints • In EU15 countries, both low rates of economic growth and high public pension spending lower the interval between rounds of pension retrenchment • But the relationship between demographic aging and retrenchment actions is weak Source: Juan J. Fernandez, “Economic Crises, High Public Pension Spending and Blame Avoidance Strategies: Pension Policy Retrenchments in 14 Social-Insurance Countries, 1981- 2005”, Max Planck Institute Discussion Paper 10/9, 2010
Reform pressures in CEE countries exacerbated by extreme compression of economic-demographic changes, Total Fertility Rate, 2008 including: (Births per woman) • declines in fertility rates Source: U.S. Department of Health and Human Services and Department of Commerce, An Aging World, 2008, p. 22.
• a boom in the number of retirees and soaring unemployment rates as a result of economic restructuring a fiscal crisis exacerbated by weak GDP growth in most countries
Diversion of contributions back into first pillar pensions in CEE countries spurred by: • post- 2007 financial crisis, which exacerbated the “double payment problem • Stability and Growth Pact Source: Social Security criteria, and failure Administration, International Update, March 2012, p. 1 to win exemption
Cluster 2- The Policy Stream: Policy Feedbacks and Institutional Carriers of Ideas 1. “Positive policy feedbacks” limit the pension reform options of policymakers: – Constrain choice sets – Create constituencies who resist any change that would make them worse off 2. Age and maturity of pension regime makes change more difficult (e.g., “double payment problem”)
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