Central Europe’s Pension Pyramid Schemes

Following controversial private pension fund takeovers in Hungary and Poland the World Bank has issued a regional report on the longer-term danger of the “inverted pyramid” with not enough workers to support retirees absent major eligibility and funding changes.  The labor force could be more active old age, VAT and other taxes could supplement social security contributions, and the financial sector should offer a range of new savings instruments, according to the recommendations. Transition countries had full elderly payouts as formal employment disappeared and fertility rates dropped after communism’s end. They experienced minimal immigration outside Russia and the recent European financial crisis dealt another blow even as life expectancy rose. The combination of dwindling contributors and longer lives has strained systems with the typical projected deficit at 7 percent of GDP by 2050. Faced with the “demographic onslaught” governments have enacted reforms with numerous designs. However early retirement remains a burden with half of beneficiaries under age 65, and inflation-adjusted indices may not curb spending. When cuts are imposed, offsetting handouts like the additional month salary “bonus” have neutralized the impact and fiscal sustainability is remote in the coming decades as only a few countries mainly in the former Yugoslavia foresee lower pension costs. The study finds that the cohort retiring between 2020 and 2030 will not have paid in to a large degree and will need income support as well from other sources. Individual savings accounts have proven effective in multi-pillar schemes but cannot compensate for the loss of traditional revenue streams. With its budget crunch, Hungary decided to eliminate the portfolios to achieve short-term public pension funding “at the expense” of broader rationalization. Its fiscal gap exceeded the EU 3 percent of GDP standard for a decade excluding these account liabilities and more “politically difficult” reductions were an alternative, the Bank comments.

The region’s “tax wedge” is due primarily to high social security demands hurting job creation and competitiveness and fostering low compliance trapping countries like Romania and Ukraine in particular. Consumption, property, and natural resource levies could be revenue backstops but VAT in the 20 percent range is already steep across the area. An easier fix is keeping employees from 55-65 at their positions longer with continued training and health and benefit accommodations despite cultural reservations about the practice. Interviews among this group in Poland and Russia show determination to stay active but pessimism about elderly job prospects. Immigration should also be encouraged, and better controls can eliminate abuse and fraud. The public spending load can be cushioned through a private savings link to previous earnings through mechanisms such as automatic enrollment and life-cycle portfolios, the review points out. A modern institutional structure for the pension fund industry can ensure comfortable retirement despite the discomfiting recent shifts in Central Europe which pioneered the transition, it implies.