One and a Half Versus One

"If you touch it, you're dead!" This quote is taken from the material of the World Bank which deals with the problems of the pension systems. The text discusses the necessity, but also the political and social sensibility of the reforms of the pension systems required in many countries. We often hear on television and read in the newspapers about the bad state of things in the area of pension and disability insurance: dissatisfied pensioners, late pensions, lack of funds for payment of the pensions, etc. For better understanding of the state and the problems of pension and disability insurance it is necessary to explain the organization and the structure this system is based on. It consists of one layer which is sponsored by the state, as opposed to the systems in the developed countries which consist of three layers. However, in the West European countries the first layer resembles our system of pension and disability insurance (PIO), with one difference: the pensions usually equal one-fifth or one-fourth of the average salary, while the balance is usually paid through the private pensions (the second layer). The third layer is based on the individual savings of the citizens through various institutions of the market. Due to the lack of confidence in the state which is not capable of paying off the frozen currency savings, the savings institution practically has not existed here for several years. It should be said also that the average pension here is very high compared to the average salary, and some other rights derived from the pensions and disability insurance are generously defined due our socialist/self-management heritage.

Similar systems of pension and disability insurance exist in the East European countries, so our system may only be compared to those. The system of pension and disability insurance is financed following the formula "pay-as-you-go" (PAYG). That means that those currently employed finance the current pensioners; that is, the employed (the policy holders), through various taxes and contributions, set aside each month a substantial amount for the pensioners (the users).

This method of financing produces major problems. The PAYG system works well in the initial phase, under the conditions when there are many more policy holders than users and economic growth, as well as the increase in salaries and employment, is fast. However, when the phase of maturity is reached, which by the widely accepted standard occurs when the ratio of policy holders to users falls below 2.5:1, the problem of covering the growing expenses occurs.

Our system of pension and disability insurance reached the mature phase in the mid-80s, and that was precisely the time when serious difficulties in its financing occurred. The problem is essentially of a demographic character, since the population inevitably gets older. Expressed in figures: in 1965, 4.6 workers earmarked resources for one pensioner; in 1980, 3.6 workers and in 1996 this ratio became 1.6 (in the fund of the employed in Serbia). Such a situation presents two possibilities to ensure the stability of the system: increasing the contributions for PIO or reducing the pensions. We have practiced the first one, which imposed a heavy fiscal burden on the economy. However, this merely postponed the problem without solving it. Other East European countries with the same problem have already undertaken measures to reform their systems because it was clear that they could not support the systems in their previous form. We are several years behind.

And that is not all. The picture become more serious with the deterioration of the economy which occurred in the early 90s. The gross national product rapidly decreased due to the war, sanctions and bad politics; productivity, real wages and employment levels have decreased. In respect to the decrease of production and the growth in the number of pensioners, the expenses for PIO in the last few years have engaged more and more of the national product: in 1995 it was 13.8%, to reach even 15.8% in 1996, which is a percentage rarely to be found anywhere in East Europe. If certain steps have not already been undertaken, the expectations for 1997 are very somber. It is certain that the number of pensioners will grow and the number of employed will fall, and the growth of production will not be sufficient. The realistic estimate is that the ratio between the number of policy holders and users will fall to 1.4 or 1.5, and that the participation of the PIO expenses in the national product will grow close to an unbelievable 18%. In 1998 and 1999 the trend of decrease of employment is to be expected (due to the extensive over-employment in industrial and non-industrial sectors) and the growth of the number of pensioners (due to the age distribution of the employed). Since it is already clear that the announced spectacular growth of the national product will not happen, the regular financing of the PIO expenses will become nearly impossible. Since currently the pensions are on the average three months behind schedule, it can easily be imagined what the situation will be like in the future. The conclusion is that the longer the permanent solutions are delayed, the solution for the crisis will be more difficult and will take longer and will therefore be more painful not only for the existing pensioners but also for all of those who are to retire within the next twenty years.

Since the reform of the entire pension and disability insurance system is a very long process, which is also confirmed by the experiences of other East European countries, the existing situation needs to be addressed and preparation for serious reforms have to be initiated immediately. The reform will probably need two phases. The first phase, enabling the PIO system to finance itself (from contributions and taxes) and to operate without losses, will take from a year and a half to two years. The second phase will be gradual and will take from four to five years. The goal of this phase will be to bring down PIO expenses and their participation in the national product, and to lower the taxes and contributions from which those expenses are financed. This means that the recovery process for the PIO system can be expected to be completed somewhere near the beginning of the next millennium and the conditions for the far reaching reform will then be established, enabling the introduction of a second layer into the pension insurance system.

In order to determine which measures can be carried out in a short period of time, it is absolutely necessary to identify the negative factors which led to the current situation. First of all, the number of pensioners compared to the number of employed population is too big for the PIO system to function normally based on its current principles. However, this can not be changed in a short time, because even if all of the unemployed were to find jobs, the total number of the employed would not be sufficient to return to the ratio of policy holders to users in 1980. All that can be done is to make retirement unattractive and to raise the age limit for retirement. The fact is that people live longer today, and logically enough, work longer. This measure would prevent further rapid growth of the number of pensioners and therefore prevent further worsening the situation.

Second, the average pension is too high compared to the average salary (it was 88% in 1996). According to some calculations, if the average pension is reduced to 65% of the average salary (as it was in the early 80s), this level of pensions can be financed from the current revenue (from taxes and contributions). The reduction of the pensions would encourage the employed to work longer and therefore longer earmark the contributions for PIO. The question is how to reduce the average pension without leading a great number of old people below the existing minimum. The pensions that are close to the minimum must not be lowered, but the maximum pension should be limited, for instance, to the amount of 2.8 of the last year's salary. This way, the gap between the pensions and the mass of pensions and expenses of the PIO system would be reduced.

Third, the expenses of the PIO system are not the only ones which compare disproportionately to the national product; the expenses of all other categories of public expenditures, especially the healthcare, military and police expenses, have similar problems. Decreasing the expenses of the PIO system should be accompanied with other a recovery programs for other areas of public expenditures in order to reduce the fiscal burden. This would lower expenditures in industry and allow the recovery of production and accelerated growth.

So far, the state has regulated in word only the domain of social care, and it transferred most of the regulation of this sector to legal entities and pension funds. This could function in a system of social ownership, when available resources belonged to everyone and no one.

However, now that we have begun the process of ownership transformation, such an approach is no longer acceptable. In all modern societies the function of protecting the entire population, therefore also of pensioners, is the responsibility of the state, and the state finances these expenses from its own budget.

Once the pension funds are freed from the burden of social protection, their financial situation will certainly improve, and the only uncertainty that remains is to what extent. In any case, the pension funds would exclusively be responsible for obtaining pensions, which in fact is the task they were established for in the first place. And that is not all. Numerous other social handouts financed by the industrial entities, the greatest among them being payments for labor surpluses, would be overtaken by the state. This would lessen the fiscal burden on the industry and enable the growth of production. Of course, if the financing of all the major social expenses were to be transferred to the state budget all at once, the budget would have to be much bigger than it currently is. Since it is not possible to change this in the near future, the reform of the budgeting system requires a special program, with a gradual approach.