Cangiano, C., C. Cottarelli, and L. Cubeddu (1998): “Pension Developments and Reforms in Transition Economies”. IMF Working Paper 98/151 (October).
Cubeddu, L. (1998): “The Intragenerational Redistribution Effects of Unfunded Pension Programs”. IMF Working Paper 98/180 (December).
de Castello Branco, M. (1998): “Pension Reform in the Baltics, Russia, and other Countries of the Former Soviet Union (BRO)” IMF Working Paper 98/11 (February).
Fischer, S., R. Sahay, and C. Vegh (1998a): “From Transition to Market: Evidence and Growth Prospects”. IMF Working Paper 98/52 (April).
Geanakoplos, J., D.S. Mitchell, and S.P. Zeldes (1998): “Would a privatized Social Security System Really Pay a Higher Rate of Return?” NBER Working Paper No. 6713 (August).
Griffith-Jones, S. (1998): “Reforms of the Pension System and National Savings”. Czech National Bank Institute of Economics Working Paper No. 84.
Koch, M., and C. Thimann (1997): “From Generosity to Sustainability: The Austrian Pension System and Options for its Reform”. IMF Working Paper 97/10 (January).
Ministry of Labor and Social Affairs, Czech Republic (1998a): “Pension System in the Czech Republic” (Pamphlet) and various background material.
Ministry of Labor and Social Affairs, Czech Republic (1998b): “Analysis of Pension Insurance and Proposed Conceptual Scenarios”. Working document submitted to Cabinet (March).
Ruggiero, E. (1996, 1997): “Structural Pension Reform in Hungary”. In “Hungary: Selected Issues”, SM/97/218 and SM/96/207 (August).
Van den Nord, P. and R. Herd (1994): “Estimating Pension Liabilities: A Methodological Framework”. OECD Economic Studies, No. 23 (Winter).
This paper has benefited greatly from discussions with representatives of the Czech Ministry of Labor and Social Affairs and Ministry of Finance. Helpful comments have also been provided by colleagues in the European I department, the Fiscal Affairs Department, and the World Bank.
This was motivated to a large extent by the demographic outlook, with retirement of the 1940s baby-boom generation from early next century, the low birthrates in recent decades, and increasing life expectancy, as well as a secular decline in the female labor participation rate.
The labor force participation rate remained broadly constant at 73-74 percent reflecting an increase of 4 percentage points for men and a similar decline for women (OECD 1997).
Defined as the number of (old age) pensioners in relation to the number of contributors to social insurance.
Early retirement was permitted for structurally unemployed two years prior to the statutory retirement age at benefits superior to unemployment compensation. There was also a withdrawal from the labor force of persons above retirement age, some of which had earlier deferred benefits at an enhanced rate of accrual (IMF 1995a).
Defined as the average (old) age pension relative to the average gross wage in the economy.
The declining replacement ratio reflected only partial and discretionary indexation of pensions; new pensioners were particularly affected owing to the lack of indexation of the earnings base and wage brackets (which translate earnings into benefits at a declining marginal rate) used to assess pensions.
The share of pension expenditures to GDP is determined by the dependency ratio, the replacement rate, and the share of labor in output (see Appendix 1; a detailed account of pension system economics can be found in OECD 1988).
Defined as the number of persons above retirement age in relation to the number of persons of working age.
During 1990-97, the replacement rate increased from 56 percent to 65 percent on average in all Central and Eastern European (CEE) countries, but declined from 53 percent to 45 percent in the Czech Republic. However, (gross) replacement rates are not directly comparable across countries due to differences in tax treatment of both wage income and pensions. In the Czech Republic, social security contributions are not tax deductible and benefits are by and large tax exempt, whereas in many other countries (e.g., Hungary) contributions are tax exempt and benefits taxed.
Although several EU countries (e.g. Germany, Austria, France, and Italy) operated more generous and costly pension systems, most of these countries have subsequently undertaken comprehensive reforms aimed at ensuring sustainability and improving efficiency.
Total social security contributions (including to health and unemployment) amount to 34 percent of gross wages, of which 8 percent are paid by the employee.
The “net” replacement rate (pensions net of tax in relation to take home wages i.e., after employee social security contributions and taxes) is significantly higher, e.g. 63 percent for a person with an average income tax rate of 20 percent.
Specifically, the macroeconomic assumptions were a gradual decline in inflation to 2 percent and in nominal wage growth to 4 percent, stabilization of the unemployment rate at 6½ percent, and a gradual easing of interest rates to 7 percent.
See e.g., Fischer et. al. 1998a and 1998b that link long term potential growth rates for transition economies to the initial level of per capita income, investment in human capital (proxied by primary and secondary school enrollment), capital investment, government consumption, and population growth in accordance with neo-classical and endogenous growth models. While the Czech Republic ranks in the top among transition economies both in terms of the initial level of per capital income and macroeconomic and policy convergence, and further compares favorably in terms of education standards, capital formation and exports with countries that have grown rapidly in the past, the recent lackluster growth performance suggests that such high rates of potential output growth will require a substantial deepening of structural reforms, including bank privatization and enterprise restructuring, and a recovery of the investment/GDP ratio.
Inflation could be somewhat higher (3-4 percent) with continued faster productivity growth in the traded goods sector relative to non-traded goods (Belassa-Samuelson effect). Also, initial participation in the ERME rather than EMU would allow for some continued exchange rate flexibility to offset potential losses in competitiveness.
Such a disturbing outlook for the pension system is by no means unique to the Czech Republic (see e.g., Chand and Jaeger 1996 for an analysis of the financial prospects for pension systems in G7 countries and Koch et al. 1997 for the Austrian system).
In Western Europe, reforms proposals have generally centered on modifications to the PAYG system while there has been resistance to more systemic reforms such as partial prefunding of the PAYG system or mandatory private pensions savings (see e.g. IMF 1997c for a discussion of reform proposals in Germany).
The current provisions favor early retirement. If retirement is taken two years prior to the statutory retirement age, total lifetime pension is approximately 10 percent higher than would otherwise be received, while if retirement is taken three years prior, the benefit is 5-8 percent (MLSA 1998b). In the latter case, pensions should have been reduced permanently by around 1 percent rather than the prevailing 0.3-0.6 percent for each three months of early retirement.
As pre-funding represents intergenerational transfers, the Ricardian effect may be limited in the absence of a perfect intergenerational link by an operational bequest motive (see e.g., Sadka et. al. 1998). However, higher national savings could depress the rate of return on pension fund assets, depending on the openness of the capital market.
Private schemes are usually fully funded, defined contribution schemes, but this need not be the case (see e.g., Geanakoplos et. at 1998 for a discussion of the various alternatives). Such schemes have been particularly popular in Latin America, including Argentina, Peru, and Colombia (see e.g., Clavijo 1998 for the latter).
In principle, a higher rate of return in a private scheme is offset by a higher tax liabilities (the need to pay interest on the realized, accumulated pension liabilities), unless the private investment funds diversify into higher yielding stocks to which private access has for some reason been restricted.
For an in depth discussion of the pros and cons and other aspects of pension system privatization see e.g. Chand and Jaeger (1996), Hemming (1998), and Heller (1998). Chand and Jaeger show—using a stylized, dynamic life-cycle model—that net welfare gains from the transition to a privatized pension system depend on the contribution structure and link between benefits and contributions in the PAYG system as well as how transition costs are financed. Hemming notes that the main argument in favor of mandatory over voluntary private savings rests on adverse selection and myopia, and Heller notes that the problems with FF, DC schemes suggest that it is better to reform PAYG systems, including through pre-funding and strengthening the link between contributions and benefits.
Also, there is a large stock of contingent liabilities related to guarantees etc. whose expected present value amounts to about 15 percent of GDP, and public debt will rise further over the medium-term as sizeable fiscal deficits are expected to continue not only because of the pension system (see IMF 1999).
In this case, one would specify a certain (e.g., 2 percent) rate of contribution to the private pension funds while maintaining balance as you go in the public system. Benefits to existing retirees would be paid entirely from the public system, while future retirees would be paid first from the private pillar and topped up from the public pillar to maintain prevailing replacement rates. To the extent that the return on privately invested assets exceeds the implicit return in the PAYG system, the combined contribution rate will gradually fall below that of the pure PAYG system. Clearly, the impact on national savings would no longer be neutral (would be expected to rise), and the current working population would bear the brunt of the adjustment burden.
In contrast, the Hungarian shift is entirely voluntary, but the formula used to convert past contributions means that it is unlikely be attractive for workers above 35-40 years of age.
The more radical alternative of full privatization as in Kazakstan or Chile is not examined here.
Of course, one could also examine a sudden transition to the new multi-pillar system in which all persons were required to shift immediately, or alternatively a slower transition in which only new entrants to the job market would be required to join the new scheme. Such arrangements would not be materially different from the scenarios outlined above, although of course the timing and magnitude of cost would vary.