Economic Policy Review ISSN 1313 - 0544

The “Hidden” Debt of Pension Promises

Author: Petar Ganev / 08.11.2010
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In August became clear that nine member states of the EU, and Bulgaria among them, had sent a letter to the European Commission and to the president of the EU Herman van Rompuy in which they had launched the idea “the extra expenditure needed for reforming the pension system” of the member states to be excluded in calculation of the level of the government debt and deficit which is valid under the monitoring of the implementation of the Maastricht criteria. The letter has occurred in a moment when the pension payments increasingly outweigh the budgets of these countries and meanwhile there are rumors for strengthening the control and the sanctions when there is lack of budget discipline and non-compliance of the mentioned above criteria. In this letter one of the biggest problems of pay-as-you-go model was exposed – giving empty promises and gaining “hidden” debt. And now the “hidden” debt of the solidarity model is becoming much more visible and much bigger problem for the governments of these countries.

The pension reform does not bring debt with itself, this debt already exists and it is caused by the old pension system. This model – “the contract between generations”, means that one generation pays the pensions of the other generation. I.e. when you pay your pension contributions they are used for the pensions of the current pensioners and you get a promise from the government that you will get a pension from the state in the future – this promise is a future expenditure and it comes with government debt. This system fails everywhere and for the government is increasingly difficult to fund its promises. Now when the governments start to refuse this “solidarity” model increasingly bigger part of the pension contributions do not go for funding the pensions of the pensioners but go to personal accounts of the insured (the 5 percent for the second pillar in Bulgaria). The more pension contributions are redirected from the solidarity model toward personal pension account, the harder is for the government to fund current pensions – this is often called the price of the reform, but in fact this is the price of the old not working system. If there is no reform, this price still exists and it becomes bigger.

These pension payments perplex the budget which often leads to deficit and to accumulating debt. This is what the letter refers. The governments realize that the reform is inevitable but they seek a way to escape from the gravity of the given promises – from the gravity of the old system. That is why the states seek a way to fulfill the given promises but without outweighing the indicators of the budget discipline. This is possible to happen on paper but this means to escape from reality.

The budget deficits or debts are not just trumped indicators which are taken into consideration by the bureaucrats in Brussels. These indicators exist to reflect the reality and to show what the indebtedness of a single country is, if its finance is stable, if it is solvent, etc. There is no matter what the excuse for specific obligation would be (in this case – the pension reform), what matters is the obligation itself. Even some expenditure not to be calculated under the monitoring of the implementation of the Maastricht criteria this would be a political act far away from economics – this expenditure still weights and influences the solvency of the country.

Similar arithmetic would give very poor stimulus to the governments. If this expenditure was not measured because of Maastricht criteria, the governments would not have stimulus to be reasonable. There will no stimulus to cut expenditure and to seek effectiveness. The methodology according to which the pension payments do not reflect to the budget balance or the level of debt would lead to serious real imbalances. The reality is not affected by the methodology; it is such as it is.

Despite all these the letter clearly shows what is happening with the pension systems in these member states – the solidarity model is being refused and a change is taken toward personal pension accounts. The empty promises accumulated debt which all of us would pay. The question is not how we would measure this debt but how to stop accumulating it – the answer is with substituting the empty promises with real savings.