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FISCAL IMPACT OF PENSION
REFORMS
Luis Fernando Alarcón Mantilla
PRESIDENT
ASOFONDOS DE COLOMBIA
Kiev, May 2004
AGENDA
1. The Problem
2. The Cash–flow Impact
3. The Implicit Pension Debt
4. The Political Economy of Pension
Reforms
THE PROBLEM
• “Defined Benefits (DB) Systems” become
financially unbalanced, and require transfers
from the Central Budget.
• The Reasons:
Design Problems
Demographic Change
Institutional Rigidities
Legal Considerations
Political Pressures
• These, and equity
motivated reforms.
consideration,
have
THE PROBLEM
• To create “Defined Contribution (DC) Systems”
which, by definition, are financially balanced.
• However, the so called “fiscal impact” or “fiscal
cost”, has become the main obstacle to pension
reforms.
• What is the problem?
AGENDA
1. The Problem
2. The Cash–flow Impact
3. The Implicit Pension Debt
4. The Political Economy of Pension
Reforms
THE CASH–FLOW IMPACT
•Ft: Transfer from the Central Budget to the
pension system, in period t.
THE CASH–FLOW IMPACT
•At the beginning, Ft increases because:
It´s necessary to pay people already
pensioned.
New Contributions go to DC system.
Recognition Bonds are fully paid when
people become pensioned.
THE CASH–FLOW IMPACT
•However, which curve has a higher PV
depends on:
Discount rate (interest on Government
Debt)
Assumptions
on
salaries,
coverage,
demography, etc.
How unbalanced the DB system is.
Time Horizon.
THE CASH–FLOW IMPACT
• Tipically the incremental cash needs require:
Stronger fiscal adjustment and issuing new
public debt.
• New sources to buy the new debt: Savings of DC
system.
• For the economy as a whole, the short-term
scenario may be quite similar.
• The choice for the Government is.
Implicit vs. Explicit financing.
Implicit debt vs. Conventional debt.
THE CASH–FLOW IMPACT
• Conventional practices
Pension Reforms:
are
biased
against
“the current accounting systems can be said
to unjustly penalize reformer countries when
multilateral institutions such as the IMF
focus on current déficit and convencional
debt targets”.
(Holzmann, Robert Palacios, y Asta Zviniene.
“Implicit Pension Debt: Issues, Measurement and
Scope in International Perspective”, The World Bank,
Social Protection Discussion Paper 0403, March
2004).
AGENDA
1. The Problem
2. The Cash–flow Impact
3. The Implicit Pension Debt
4. The
Political
Reforms
Economy
of
Pension
THE IMPLICIT PENSION DEBT
• IPD: Present Value of pensions to be paid, based
on accrued rights.
• According to present practices IPD is not
recorded in the public sector balance sheet.
• However, usually IPD >> Public Conventional
Debt.
THE IMPLICIT PENSION DEBT
Public Debt, Pension Spending and Implicit
Pension Debt.
% GDP
COUNTRY
Brazil
Slovenia
Romania
Poland
Ukraine
Hungary
Argentina
Mexico
Colombia
Chile
PUBLIC DEBT PENSION
IPD (4%)
1999/2000
SPENDING
33
25
18
43
59
59
53
19
24
9
9
11
6
12
9
9
5
1
2
7
330
298
256
261
257
203
85
65
56
60
Source: Holzmann, Robert Palacios, y Asta Zviniene. “Implicit
Pension Debt: Issues, Measurement and Scope in
International Perspective”, The World Bank, 2004
THE IMPLICIT PENSION DEBT
• There is an ongoing discussion on this issue:
FMI - “the treatment of pension Schemes in
Macroeconomic Statistics: And Electronic
Discussion Group”.
• Central Topic: the nature of pension debts.
THE IMPLICIT PENSION DEBT
• According to the Government Finance Statistics
Manual:
“ it is considered that social security schemes do
not result in a contractual liability for the
government, i.e., there is no direct link between
the contributions made and the benefits eventually
paid. Indeed, it is not uncommon for governments to
change unilaterally the structure of benefits (e.g.,
by changing the circumstances under which the
benefits become payable or the amount of the
benefits)”.
THE IMPLICIT PENSION DEBT
• As one contributor to the EDG puts it:
“... Pension obligations are not like debt,
because pensions can be changed by
statute at any time... Stick with what is
legally required, such as paying debt...”
(Henry Aaron, the Brookings Institution)
• More attention is needed on
characteristics in different countries.
specific
THE IMPLICIT PENSION DEBT
• In Colombia, when somebody fulfill the
requirements to get a pension (DB System)
acquire a right, Constitutionally protected.
• That means that the Minister of Finance can go
to jail if defaulting on those payments.
• It would be easier
Government Bonds.
to
default
on
the
• When legal adjustments have been made on DB
System parameters, the changes apply far into
the future.
AGENDA
1. The Problem
2. The Cash–flow Impact
3. The Implicit Pension Debt
4. The
Political
Reforms
Economy
of
Pension
THE POLITICAL ECONOMY OF
PENSION REFORM
• To reform DB System in developing countries is
becoming harder.
• There are strong pressures to reverse reforms
already made.
• For developing countries, to agree on an
Economic Program with IMF is life or death.
• To have acces or not to the financial markets.
• Higher or lower spreads.
THE POLITICAL ECONOMY OF
PENSION REFORM
• But current practices imply:
Stay on DB pension systems
Reform priority: short term cash, e.g.
increase contributions
For already reformed systems partial or
total reversal is a magnificent way to
“improve” fiscal position
Not to make the true fiscal adjustments.
• On my view point this is the single most
important issue for pension reform.