Greek central bank governor Nicholas Garganas caused a stir last week by advocating reform of the country’s pension system, mainly by increasing the retirement age, less than a year after the government passed relevant legislation to make the current system viable in the medium term. He was articulating what many others, including high-level government officials, admit in private; that is, last year’s reforms are not enough and more fundamental changes are needed. These unpopular measures will most likely be taken by the new government that will be elected in the next general elections scheduled for the spring 2004. The reform of the Greek pension system has taken center stage in the reports of all international organizations and credit agencies as well as prominent foreign investment banks. All of them state that Greece is facing a much bigger challenge than its European counterparts in tackling the problem because of its adverse demographic prospects in the years ahead, its high current pension expenditure and its high public debt as a percentage of GDP. Almost all reports link the issue of pension reform to broader medium-term concerns about Greece’s public finances and ensuing credit rating. The gravity of the situation is described in a couple of studies. According to one produced by the Center for Strategic and International Studies in cooperation with Citigroup Asset Management, Greece’s public pension expenditures as a percentage of GDP will reach 19 percent by 2050 while the sum of pension and health expenditures will amount to 44 percent by then. The respective figures for Spain are 16 and 37 percent of GDP. In the British Government Actuaries’ report, commissioned by the Greek government and completed in 2001, the deficit of the pension system will rise to 9.1 percent of GDP in 2025 and 16.8 percent of GDP in 2050 from around 4.8 percent at end-2002 in the absence of reform. Faced with the reality of growing pension deficits and Greece’s obligation to stick to the European Union’s Stability and Growth Pact on one hand and stiff resistance by labor unions, a traditional ally of the Socialist government on the other, the government last year passed legislation aimed at reconciling both sides. It came after years of so-called social dialogue between the government, the unions and other interested parties, which was interrupted in some cases by general strikes. In passing that legislation in 2002, the government secured funding for IKA, the country’s main pension fund, and called for the consolidation of numerous pension funds. According to the law, budget sums amounting to 1.0 percent of GDP will be committed each year to finance IKA’s deficit starting from 2003 through 2032. The State will also provide IKA with a sum of 9.6 billion euros to finance past state obligations to IKA as well as cover IKA’s obligations to other state entities. The money will come from the securitization of future pension contributions and the issuance of government bonds. The State will also build up a reserve fund for IKA to help meet future obligations by issuing non-marketable, zero-coupon bonds, offering a real return of 3.0 percent, averaging 1.0 billion euros per year from 2008 onward. These bonds will start maturing in 2023. The same law also provides for the consolidation of numerous existing pension funds for salaried workers into IKA by 2008 and that of associated supplementary funds into a single fund in a bid to reduce administrative expenses and bureaucracy. Last year’s pension reform had some positive aspects to it, including greater transparency in financing IKA and making the current system of numerous funds more manageable. However, it was criticized mainly on the grounds that the reform will lead to larger actuarial deficits beyond 2008 because benefits will rise for all workers. This includes those who joined the labor force after the previous reform in 1992, and is only partly offset by gradually falling benefits to employees in the broader public sector who comprise a relatively small portion of the work force, estimated at between 10 and 20 percent. By raising the issue of pension system reform, central bank governor Nicholas Garganas has obviously sided with those who say that funding the deficit of the main pension fund, IKA, does little to control Greece’s rising pension expenditure as a percentage of GDP, and thus does not seriously and effectively address the problem. Putting aside the discussion about the principle of equality of treatment across generations, which was supposed to be one of the main aims of the 2002 reform, and claims that IKA funding will be exhausted after 2032, there is no doubt that Greece will face significant financing problems ahead. This is especially the case given the unfavorable demographic trends with the ratio of working to retired population estimated to fall to 1:1 by 2050 from the current ratio of 2:1. Although it is taking slow-working measures to help reverse the country’s rapidly declining reproduction rate and increase employment, Greece has no choice but to do what technocrats and politicians suggest in private but forget in public: either to cut public pension benefits or increase the retirement age in line with rising life expectancy. Increasing contributions is generally and rightly ruled out, because of their adverse impact on employment and Greece’s already high contribution rates compared to other EU countries. The creation of fully funded private pension funds would also help reduce the pain of meaningful pension reform, but is more a complementary measure than a solution to the existing problem. Garganas may be right after all, given the fact that increasing the retirement age seems to be politically more feasible than cutting benefits in the current pay-as-you-go system. Of course, the current system will have to be complemented with privately funded schemes similar to those seen in other continental countries such as Germany that partially substitute for the current pay-as-you-go systems. Everybody knows, however, that such fundamental reform of the pension system is going to be very unpopular and entail a very high political cost. That’s why it requires a great deal of political courage and capital, which only a newly elected government can afford.