Editor comment
Lech Kaczanowski
17.03.2011
Poland's pension pickle
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| Editor, news2biz POLAND |
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Poland's ailing pension system, which prior to the global financial meltdown had often been brought up as an example for the aging western economies to follow, has become the key issue in the country's economic and political debates of the past few months. What dragged the pension funds into the limelight were the government's plans to lower the old-age pension contribution transferred to mandatory open pension funds (OFEs) to 2.3% of gross wages from the current 7.3%. According to estimates, the move will allow for the lowering of the state's borrowing needs by PLN 195bn (EUR 47.8bn) by 2020.
Hence, once the new regulation is signed into law, almost the entire old-age pension contribution (save the said 2.3%) will be held by the state social security institution ZUS (cutting budget expenditures by around PLN 10bn per annum), and would be indexed by a ratio based on GDP growth.
The final shape of the reform, which PM Donald Tusk expects to take effect as of May 1, 2011, is to emerge following discussions in the parliament, but it seems almost certain at this point that Poland's pension system will not be maintained in its current form, despite efforts by lobbyists and bank-affiliated economists to discredit the government's plans.
A costly experiment
It is becoming painfully clear, that the OFEs have been a faulty and very costly experiment for Poland and a source of considerable gains for international financial giants. Introduced in the year 1999, following a World Bank and USAID-backed campaign which promised the Poles a happy and wealthy retirement under palm trees, the Polish pension reform was designed as a three-pillar-defined contribution system.
The first pillar, managed by ZUS, was pay-as-you-go (PAYG), and the other two (open pension funds and occupational pension schemes) were fully funded. The PAYG component as well as open pension funds were mandatory, and occupational pension schemes (which have never really taken off) were voluntary.
Shortly after the new system was introduced, the government found itself in a tight spot, forced to finance payouts for pensioners covered by the old system at the same time contributing to OFE accounts for would-be pensioners belonging to the new system. The resulting gap was to be covered from privatization proceeds, but the latter have proven to be gravely insufficient, thus boosting the country's debt. According to Professor Leokadia Oreziak of the Warsaw School of Economics, between 1999 and 2010, the OFEs generated some PLN 270bn worth of liabilities, representing roughly 43% of Poland's public debt. The annual debt servicing costs associated with the OFE alone total some PLN 13bn or 1.1% of the GDP.
Noble prize winner and Columbia University professor Joseph Stiglitz predicted the problem back in 2005, commenting on plans by the Bush administration to privatize the US social security system [The Guardian, 19 April 2005]:
"Privatization would not protect retirees against the social security system's insolvency; it would merely add enormously to today's fiscal deficit, because partial privatization entails diverting money to private funds that would have been used to close the gap between government expenditures and revenue."
Gambling with borrowed cash
In short, Poland has been borrowing billions only to transfer them to the OFEs which in turn invested the funds into government bonds and stocks that were to generate returns for future retirees. The gains have been rather mediocre, while the country's debt started spiraling out of control, particularly in the wake of the global financial crisis. The founding fathers of the pension reform failed to notice that the OFEs were a project that could have perhaps worked in countries that enjoyed budget surpluses, not ones that have remained for decades in the red.
"Privatization advocates insist, however, that investments in stocks would yield sufficiently higher returns to give individuals the same retirement income as before, with the surplus used to fill the gap. But if markets are working well, then returns will be higher only because risk is higher. There is still no free lunch in economics," Stiglitz wrote in April 2005, way before the financial crisis ravaged the markets, ruining the old-age savings of so many US citizens. The crisis made everyone realize that commercial financial institutions, which were supposed to defend our savings from the unpredictable and greedy state administration, themselves turned out to be the greedy and untrustworthy. And when the crisis struck, they demanded governments to bail them out. There is indeed something Machiavellian about using obligatory retirement contributions to gamble on the stock market. According to the MiFID directive, an individual has to acknowledge the risk involved in investing in stocks and financial instruments. Somehow, this does not apply to the OFEs, which are investing people's old-age savings.
Is there a way out?
The system, which was first introduced in Chile and Argentina, and then in a number of emerging economies that lacked the political and economic muscle to reject such a hybrid solution (the way for instance South Korea and Slovenia did) has been a goldmine for banking & insurance groups that invested people's pension money charging horrendous "management" fees and cashing in on transaction costs.
The first country to pull out of this scheme, attracting heavy criticism from governments that themselves never dared to test the open pension funds experiment on their own citizens, was Hungary. Budapest chose to nationalize pensions, transferring all the resources from the 2nd pillar back into the state-run system. Those, who objected the reform, could stay in the open pension funds, but only a tiny fraction chose to do so.
Poland is heading in a similar direction, although in a much milder manner. The opposition parties as well as the junior ruling coalition members are all opting for making the OFEs voluntary, the Hungarian way, while the government is afraid of making any more radical moves before the autumn elections.
Shattered illusions
More than a decade ago, the OFE represented a promise, but now they are beginning to look increasingly like a curse. Poland's public sector debt is getting dangerously close to the constitutional limit of 60% of GDP. Reaching this limit would require austerity measures so drastic no-one even wants to consider them as a possibility. Meanwhile, the government is facing an ugly smear campaign, financed by the OFEs and their powerful owners in the name of "protecting our pensions." The truth is, that the system is not sustainable and the stake in the ongoing war seems to be a few extra months or years of making money off of what is about to collapse anyway.
It will take a lot of guts for the liberal-minded members of the Polish middle class to come to terms with the realization that the OFEs may be nothing but an empty promise. Admitting that the retirement income one can count on a few decades from now will certainly be insufficient, regardless of who pays it out, is too much for a lot of people, particularly the younger generation, to handle. Hence some (albeit surprisingly weak) protests in defense of the existing pension system. The argument is that Poland should first cut public expenditures and privatize the remaining state-owned enterprises. Indeed, this is something the government is yet to tackle, but unfortunately I have not seen credible studies proving that whatever austerity measures the country manages to implement, would suffice to cover for the OFE-related gap. Poland simply cannot afford to borrow money to buy its own treasury bonds, paying hefty commissions somewhere along the way. There are no free lunches in economics, but some lunches simply cost way too much.