Urgency for social security reform keeps growing stronger

Greece’s public debt/GDP ratio, well in excess of 100 percent, is expected to be revised upward to reflect the deterioration in public finances, while pension spending keeps on crawling higher and is projected above 12.5 percent of GDP this year. Yet there seems to be no sense of urgency among officials in tackling the pension problem. Although everybody recognizes its importance in the country’s long-term economic growth and fiscal consolidation, few are willing to touch the politically hot potato called social security reform. As a result, Greece’s pension time bomb keeps on ticking, pointing to an unavoidable rise in either debt or taxes in the medium term. Other EU countries face problems in their pension systems, but Greece appears to be in the worst of all possible situations. It has fallen behind in reforming its public as-you-go pension system while experiencing a sharp deterioration in its dependency ratio and participation rate. The dependency ratio is defined as those aged over 65 to the working age population aged 20 to 65, while the participation rate is estimated by dividing the labor force by the working-age population. In addition, it has one of the highest debt-to-GDP ratios in the EU, one of the highest pension spending-to-GDP ratios and has failed to take advantage of high GDP growth rates since the mid-1990s to put its public finances in order and drastically cut its public debt ratio. Fully aware of the seriousness of the problem, the EU Commission, in its Broad Economic and Policy Guidelines (BEPG) for 2003-2005, advised member states to take steps toward reforming their pension systems. In the case of Greece, it urged an overall reform of the social security system, including the introduction of a uniform method of pension calculation and the creation of occupational funds. But Greece’s response so far has been very little at best. Sensing it had fallen behind in the polls last year, the previous Socialist administration went the other way, raising pensions, offering more favorable employer terms for the early retirement of their employees and even making it possible for certain categories of public sector employees to retire at an earlier age. This contrasted sharply with measures taken in other EU states with a much lower public debt burden. In Germany, the authorities introduced a law raising the early retirement age from 60 to 63 between 2006 and 2008. In addition, it linked future pension benefits to the dependency ratio and changed the taxation of pension benefits. In France, the conservative government took the politically difficult step of harmonizing the pension benefits of civil servants, introduced financial benefits for late retirement and financial penalties for early retirement, and paved the way for linking the duration of contributions required for full pension benefits, currently at 40 years, to changes in life expectancy in the future. In Italy, which had already raised the legal retirement age to 65 years and indexed benefits to prices rather than wages under the Amato reform in 1992, and tied benefits to work-life contributions rather than a reference earnings period under the Dini reforms in 1995, measures were taken in July to raise the effective retirement age by offering tax incentives while imposing stricter criteria for seniority pensions from 2008 onward. In Greece, only last week large companies, such as National Bank of Greece, pushed ahead with a voluntary early-retirement scheme in a bid to cut costs and bring down its domestic banking operations’ cost-to-income ratio, estimated at over 75 percent compared to its major competitors’ 49-to-60 percent. Even though the bank decided to assume the full cost of the voluntary retirement scheme, it highlighted the problem as other listed companies reportedly study similar schemes in view of the introduction of IFSR (International Financial Reporting Standards) next year and the restrictions on redundancies placed by labor market legislation. Finance Minister George Alogoskoufis is fully aware of the problem, but like the rest of the government does not appear to want to make pension reform a central piece of the government’s economic agenda in its first four-year term. Barring minor changes to the public pension system bearing little political cost, it is obvious that the authorities are not willing to open Pandora’s box. This means the deterioration in the pay-as-you-go system is likely to continue, demanding the imposition of stricter measures down the road given the number of years it usually takes for the full effect of any reform to kick in. This comes at a time when Greece’s projected ratio of pension expenditure to GDP is seen rising from 12.5 percent or higher in 2004 to 19 percent by 2050, according to a study by the Center for Strategic International Studies in cooperation with Citigroup, with the sum of pension and health expenditures rising to 44 percent by then. This means Greece will have to make some hard choices to avoid an unsustainable rise in public debt or the crippling effect of higher taxation on economic growth. Raising the participation rate can work toward relieving the public pension system. A recent OECD study suggests the full removal of the implicit tax on continued work to increase the participation rate of older workers aged 55 to 64. The study predicts that the removal of the implicit tax, defined as the difference between foregone pension revenues and additional accrued benefits plus contributions paid when a person delays retirement, could increase the participation rate in most eurozone countries considerably by 2025. This is also important because declining older employees’ work is estimated to have contributed to the decline in total hours per capita directly linked by an IMF study to slower potential GDP growth in the EU. Although Greek politicians like to say the public pension system is sound and can last for another 8 to 10 years, adverse demographics and deteriorating key economic variables point to ominous developments much earlier than the period wished for by politicians. To help reverse this trend, reducing the size of the average pension, tightening access to benefits by raising the legal retirement age and laying the groundwork for shifting from an earnings-based system to a contribution-based model look unavoidable. The question is not whether the problem of unfunded pension liabilities and falling workforce participation will be tackled, but when. With the time bomb ticking, the sooner the better.