Download Reforming Social Security in Economies in Transition: Problems and

Reforming Social Security in Economies in Transition:
Problems and Policies in the Former Soviet Republic of Moldova
Deborah Mabbett
Department of Government
Brunel University
Uxbridge, UB8 3PH
England
Acknowledgements: This paper is a substantially revised version of Social Insurance in the Transition to a Market
Economy: Theoretical Issues with Application to Moldova, Policy Research Working Paper No 1588, Country
Department IV, Europe and Central Asia Region, The World Bank. The views expressed are the author's and
should not be attributed to the World Bank or to its member countries. I am grateful for material provided by and
helpful comments from Philip Goldman, Tom Hoopengardner, Monika Huppi and Helen Sutch. Responsibility for
any remaining errors is, of course, my own.
Reforming Social Security in Economies in Transition:
Problems and Policies in the Former Soviet Republic of Moldova
I. Introduction
The process of reforming the social insurance systems of the countries of the Former Soviet Union (FSU) has
yielded insights into a number of issues of general interest about the design of social security systems. At the heart
of the reform process has been the removal of universal subsidies on basic consumer items and their replacement
with 'targeted' cash benefits. The Soviet welfare system can be thought of as comprising not only (or even mainly)
transfer payments, but also the provision of various goods and services free or at subsidised prices. These included
health services, education, transport, housing (including heating costs) and some food items. While governments in
many market economies also provide or subsidise some goods and services, subsidisation in the FSU encompassed
some expenditures which could not be defended on public good, merit good or externality grounds, and these have
been the focus of reform.
It was recognised that sharp rises in the prices of key consumer goods would exacerbate the problem of low living
standards and poverty, but many commentators argued that it was efficient to counteract this through social
assistance. Available studies (and a priori reasoning) suggested that the bulk of subsidy expenditure went on
consumption by the non-poor (see, e.g. McAuley, 1991, p.100-1; IMF, 1992, p.30). Overall social expenditure
could be reduced without an increase in poverty if increased cash transfers were targeted to the poor. This rationale
for an enhanced 'social safety net' became a standard part of economic reform proposals put forward by the IMF in
FSU republics (see, e.g. IMF, 1993a, p.7; IMF, 1993b, pp. 5-6).
The problems which have arisen with the provision of a safety net yield interesting insights into the nature of the old
Soviet 'income system' and the political economy of reforming it. They also highlight some issues in cash benefit
provision which are of wider significance. In particular, problems in structuring the relationship between 'insurance'
and 'assistance', or, to put it another way, between the first (minimum-income) and second (earnings-related) tiers of
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the social security system have come to the fore.
This paper examines these issues with specific reference to the former Soviet republic of Moldova. All the
republics inherited similar social insurance systems with the break-up of the Soviet Union. Since then, they have
pursued somewhat different paths in the face of a common set of problems: high inflation, poor revenue collection
(particularly once anti-inflationary policies are implemented) and conflicting claims from 'old' insurance
entitlements and 'new' needs to improve minimum income provision. Where the republics differ is in the particular
set of alliances which may form around the management of the Social Fund, which is the main source of revenue for
cash benefits. These depend on the degree of separation between the Social Fund and the general government
Budget, the relationships between the Ministries of Finance (MF) and Labour and Social Protection (MLSP) and the
Government, Presidency and Parliament, and (in some republics more than others) the alignment of local
governments with these different power blocs.
This paper is organised as follows. Section II outlines the theoretical problems which arise in operating social
insurance in a market economy. From this discussion, three criteria are derived for the successful operation of a
two-tier system of earnings-related benefits (tier 2) supported by some sort of minimum income guarantee or basic
level of provision (tier 1). Section III introduces the Moldovan situation, and the subsequent sections examine the
factors militating against meeting the three criteria in the Moldovan context. The extent to which the findings can
be generalised to other former Soviet republics depends on their specific economic and institutional conditions, but
the findings from Moldova suggest that adapting the Social Fund system for a market economy faces a number of
difficulties, some of which were not anticipated when reform proposals were first formulated in the early 1990s.
II. Theoretical Issues
The process of transition to a market economy in Eastern Europe and the Former Soviet Union has seen Western
economic advisors engaged in formulating prescriptive analyses in which the central institutions of a market
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economy are identified and described. Social security has found a place in these analyses, albeit usually in the
concluding paragraphs. One particular task of the social security system is to allow consumer subsidies to be
'cashed out' and replaced with targeted compensation payments. The existing social security systems of these
countries have proved to be poorly designed for the functions envisaged in these prescriptions (Ahmad, 1992).
They devote the bulk of their resources to earnings-related old age pensions and neglect 'targeted' interventions to
aid the losers from the transition. This is because they pay benefits on the basis of work history rather than on the
basis of need.
At the same time, the relationship between the insurance contributions paid by employers and the benefits received
by workers on reaching pension age is not close enough to enable the system to operate as social insurance in a
market economy (Kopits, 1992). The transition to a market economy means that more attention has to be paid to the
potential impact of high payroll taxes on employment than under central planning. This has led commentators to
argue that countries should structure their contributory systems so that contributors (future pensioners) perceive their
insurance contributions as 'saving' (Barr, 1994). This entails strengthening the insurance characteristics of the
earnings-related system.
Economic theory provides two main models for conceptualising the operation of an old age pension system. One
model is that of a savings contract, whereby people give up current income during their working lives in order to
smooth their consumption into retirement. The savings model is most closely complied with where contributors pay
into individual accounts in a funded pension scheme. However, it is possible to emulate the savings model in a payas-you-go (PAYG) system. Benefits can still be related to contributions (individual accounts can be created to make
this apparent). The rate of return to participating in the PAYG scheme will be determined by different factors to the
funded scheme (the 'biological', rather than the financial, rate of return) and different factors also affect the
credibility of the scheme. In the PAYG system, political commitment is critical, whereas in the funded system the
fiduciary characteristics of the financial system are central.
An alternative model is that of deferred compensation. Here, the driving motive for the scheme is employers' desire
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to structure their workers' compensation packages to promote long job tenures. In a market economy, deferred
compensation finds expression in employers' willingness to contribute to occupational pensions, but the deferred
compensation motive cannot sustain a general pension system, because there is an incentive for employers to freeride. While all employers benefit from the work commitment engendered by a pension which depends on years of
service, a general pension does not encourage long tenure in a particular job. Furthermore, failure on the part of one
employer to make contributions to a general scheme will not affect the work motivation of his or her workforce.
Free riding was not a problem under central planning, and it is fruitful to see Soviet pensions as a form of deferred
compensation. The State as employer promised pensions to those who worked: initially in industry, later in
agriculture. A close relationship between pensions and work was built into the formulae by which pensions were
calculated, but this relationship could also be adjusted in accordance with labour allocation objectives. Planners
could use pension rights to vary the attractiveness of jobs. Low and differential pension ages could facilitate
changes in the allocation of labour across occupations. Significant cross-subsidies between sectors of the economy
arose as a result of variations in pension rights (Fox, 1994, p.10).
The 1990 USSR State Pension Law established an autonomous financing structure for pensions, separate from the
general government budget. It established a Social Fund into which employers pay a percentage of payroll. The
Fund finances pensions and various other benefits for disability, sickness and maternity. There were several
possible motives for the establishment of a separate Social Fund. During the previous two decades, pressure for
improved living standards for workers and measures to increase enterprise autonomy had seen planners ease their
once-tight control over wages.
Since the results of efforts to improve the supply of consumer goods were
disappointing, inflationary pressures arose.
These were 'repressed' by controls on consumer prices, but the
repression of inflation adversely affected the government budget, by dampening turnover tax receipts and increasing
subsidy expenditure. A payroll tax was a more secure method for financing pensions than general budget revenue,
as payroll tax revenue was linked to the flow of credit to enterprises to pay wages. Furthermore, the Social Fund
was put under the control of the Minister of Labour and Social Protection in the Council of Ministers, who was in
turn directly answerable to Parliament. The Fund was thereby guarded against competing claims on government
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financial resources.
The transition to a market economy has been accompanied by major changes in the macroeconomic environment,
which are intended to impose a 'hard budget constraint' on enterprises. Ultimately, the hard budget constraint should
allow the wage share to rise, with household consumption increasing through productivity gains arising from
curtailing the wasteful use of resources by enterprises. Household saving could also rise, with improvements in the
rate of return coming from the development of markets to mediate financial flows between the household and
enterprise sectors.
One expected short-term consequence of the imposition of hard budget constraints on enterprises was that the
demand for labour would fall. Furthermore, demand would become sensitive to labour costs, of which the payroll
tax is a component. No individual employer has an incentive to contribute to a nationwide 'deferred compensation'
pension scheme, as noted above. With the development of a labour market based on profit-maximising employers
acting atomistically and self-interestedly, there would seem to be two options for the pension system. One is to
reform it along the lines of the savings model; the other is to break it up into an enterprise-based (occupational)
pension system, in which employers do have an individual incentive to pay pensions as deferred compensation.
The key idea of the savings model is that people have an incentive to pay insurance contributions (or to ensure that
employers pay contributions on their behalf) in so far as they value the expected future benefit - the insurance cover
- which they are purchasing. The incentive to pay contributions is the key element in minimising the distortionary
effects of the insurance levy or payroll tax. If contributions are seen as bringing corresponding future benefits, these
benefits then constitute part of the remuneration package from working. As a result, labour supply does not fall (or
the reservation wage rise) as it would in response to the imposition of a tax (Barr, 1993, pp.230-1).
The remarkable thing about introducing the concept of pensions-as-saving into the post-Soviet countries is that the
existing system appears to provide an institutional infrastructure for this type of social insurance, even though it has
its origins in a completely different approach. For example, the insurance principle provides a rationale for the
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payment of payroll taxes into a separate fund dedicated to the financing of earnings-related pensions (hypothecation
or earmarking). If the hypothecated revenues are credibly protected from other claims on government funds, then
contributors can make an informed estimate of the expected rate of return on their investment, even though the
underlying financing of the system is PAYG. This rationale for hypothecation is completely different to that which
inspired the 1990 system. However, members of Parliament and those involved in Social Fund administration have
been quick to see that the savings model protects Social Fund independence, and many have lent their support to its
principles.
However, some serious questions must be asked about the suitability of the insurance approach to post-Soviet
conditions. Is the savings model really viable, or is it merely an instrument in the struggle for resources between
different arms of government? In the remainder of this section, three criteria are identified for successful operation
of a social insurance system based on contributions-as-savings. Subsequent sections show that there are some
problems with meeting these criteria in the case of one former Soviet republic, Moldova.
The savings model is based on matching expected future benefits to current contributions. The stronger the
relationship between contributions and benefits provided in the rules for calculating benefits, the greater the
incentive to contribute and the more effective the model. This means, inter alia, ensuring that contribution revenue
is spent on these 'insurance' benefits and not diverted to finance other benefits to deserving groups. For example,
provisions for war veterans and their families, 'hero' mothers with many children, Chernobyl victims and emergency
service workers, or those who experienced political persecution should be charged to the government budget rather
than the insurance fund. In the following discussion, this condition of ensuring that the insurance fund is used for
insurance benefits is referred to as 'secure hypothecation'; secure hypothecation is the first criterion for making the
savings model work.
One of the main potential competing claims on the resources of the Social Fund comes from social assistance. It is
usually assumed that a system to meet urgent needs is necessary to complement insurance, if only because otherwise
insurance benefits will be appropriated to meet assistance objectives (Kopits, 1992, p.305). However, if a country
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has a social assistance system as well as a social insurance system, it is only worth contributing to the insurance
system if the expected future income for the contributor exceeds the assistance level. If people use the present as a
guide to the future, they may ask whether those who have experienced the contingency for which they are buying
insurance (i.e., the current elderly) are major recipients of social assistance. If they are, then, unless the situation is
thought to be only transitional, the incentive to insure is reduced. The exact effect depends on the design of social
assistance. Clearly if assistance takes the form of flat-rate supplements for pensioners, the effect on the incentive to
insure is less than if assistance is inversely related to insurance (e.g. if it is means-tested).
It follows from this that a second criterion for successful implementation of the savings model is that insurance
recipients should only exceptionally be in receipt of social assistance. If this criterion is not met, it is necessary to
convince contributors that this is only a transitional situation.
The logic of the savings model is that the claim for a pension is based on previous payment of contributions, while
an assistance claim is based on current needs. These two alternatives do not exhaust the set of possible grounds for
claiming a pension or benefit. In the deferred compensation model, the root of the right to benefit lies in the work
history of the claimant, rather than in his or her contributions record. Since work is accompanied by the payment of
wages, and the payment of wages is accompanied by the payment of contributions, the distinction between work
history and contributions may be assumed to be unimportant. (This assumption is reinforced by the result from
economic theory that the effect of a payroll tax on wages and employment is unaffected by whether the worker or
the employer pays.) However, the difference between a claim based on work history and a claim based on
contributions can become important if there is a breakdown in the chain of legal obligations so that contributions are
not received for the whole work history. In a work history system, the worker retains his or her rights to a pension
regardless of whether contributions are actually paid; in a contributions-based system, he or she does not.
In the deferred compensation model, the worker has a claim against the employer upon reaching pension age. In the
Soviet system, where the employer was the State, the worker has a claim against the State. In an economy in
transition, with the former state sector in decline, it is important to the financial viability of the Social Fund to attract
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contributions from the private sector. If workers believe that the basis of a claim for a pension is work history in the
state sector, they will be deterred both from working in the private sector and from making contributions if they do
take up such work.
From this we can conclude that a third criterion for successful operation of the savings model is that benefits should
be based on contributions rather than work history. One difficulty in putting forward this criterion is that a social
insurance system may operate successfully on a work history basis if payments discipline is adequate to ensure that
all 'recognised' work is also accompanied by the payment of contributions. However, the importance of the third
criterion in an environment where payments discipline is weak will become apparent in the discussion which
follows.
III. Social Security in Transition in Moldova: Introduction
With the breakup of the Soviet Union, Moldova experienced one of the worst terms of trade shocks of any of the
FSU republics. Moldova is totally dependent on imports for its energy. As Russia pushed oil and gas prices up to
world levels, the value-added of major Moldovan production activities in both agriculture and industry collapsed
(World Bank, 1994, p.6). The terms of trade decline directly affected the government's budgetary position. In the
social sector, housing, health and education costs increased via the direct impact of higher energy costs on schools,
hospitals and the provision of communal services.
Subsidy expenditure also increased, because subsidy
arrangements often committed the budget to meeting the gap between variable producer prices and a fixed consumer
price. As the effect of higher prices for imported inputs fed through the economy, producer prices soared, and
subsidy commitments increased accordingly.
The dismantling of the universal welfare system constituted by consumer subsidies was one of the main measures
taken by the government to reduce real incomes in the face of the deterioration in Moldova's terms of trade. It is
important to note that reduction in subsidies was undertaken for macroeconomic as well as microeconomic reasons,
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as this affected the form which compensation could take. Average incomes had to fall if the process of subsidy
reduction was to lead to macroeconomic equilibrium (bearing in mind that the burgeoning cost of subsidies reflected
the deterioration in Moldova's terms of trade). The macroeconomic imperative was that only the 'most needy'
households could be compensated.
One possibility was to replace subsidies with noncategorical, means-tested social assistance. However, this proved
to be beyond the institutional capacity of the social security system. The institutional problem was to create a social
assistance system which had clear and fair rules for entitlement but at the same time was sufficiently calibrated and
controlled to ensure that entitlements could be met out of the available budget allocation. One difficulty with a
means-tested system is to predict how many people will qualify, in the absence of good information on household
incomes. Furthermore, lack of information presents not only a budgeting problem, but also an administrative
problem. It is tempting to empower local administrations to use local knowledge to ascertain informal income, but
this then means that the central financing body must find a way to prevent overspending due to liberal decisions by
local administrations. A block grant system can get around the problems which arise from local adjudication with
central financing (Sipos, 1994, p.246). However, this control is achieved at the cost of clear rules for entitlement.
In Moldova, there is a structure of local Social Support Funds (SSFs) which control small budgets and devise their
own ways of accomplishing the best distribution of the money they can manage. However, to channel large amounts
of subsidy compensation money through SSFs would mean that a great deal of attention would focus on the
composition of the SSF committees and the justice and fairness of their decisions. The allocation of central
government money between localities would be contentious and potentially politically divisive (for a review of the
rather arbitrary allocation of social protection funds between regions in Russia, see Liu, 1993, p.74).
An alternative approach to implementing means-tested social assistance is to specify detailed qualification
conditions which can be monitored and audited by central government. Central government thereby maintains
control over the system. Provided it calibrates the qualification conditions correctly, it can avoid excessive
expenditure. In Moldova, this approach was attempted in September 1993. Under the September measures,
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pensioners were eligible to receive different amounts of compensation according to three income bands, while
families with children would receive compensation only if the family's per capita income was less than the minimum
wage. The Ministry of Finance formulated very tight controls, requiring extensive documentation pertaining to
family composition, all incomes of family members, and private plots of land owned by the family. For children
over 13, the benefit was also conditional on their school attendance.
These control mechanisms proved to be too rigorous to implement. Very little money was paid out for children
under the September compensation arrangements. Pensioners also found the procedures difficult to negotiate. In
the end, the Ministry of Finance and the Ministry of Labour and Social Protection agreed to simplify the
arrangements for pensioners, abandoning the comprehensive income test and basing compensation payments on the
amount of work pension alone. This approach was continued in May 1994, when bread and milk subsidies were
finally removed. Three rates of compensation to pensioners were provided, inversely related to the work pension.
Clearly these arrangements had the effect of flattening the pensioner income structure.
This flattening was compounded by measures taken in association with uprating the minimum wage. The minimum
wage has not been fully indexed to inflation, but since January 1994 pensioners and budget sector workers on low
incomes have been provided with additional supplements. The cumulative effect of successive compensations and
supplements was that, by mid-1994, pensioners who qualified only for the minimum 'work' pension were receiving
two-thirds of their total income from various 'social assistance' compensations and supplements, while the average
pensioner received one-third of his or her income from these sources.
This structure has remained fairly stable since June 1994, when the minimum wage was last increased. The
minimum wage is the 'numeraire' for the work pension, so freezing the minimum wage has, in principle, frozen the
pension, although in practice various ad hoc adjustments have been made to pensions. The structure in place at the
last revision, in February 1996, is not at first sight highly compressed: maximum pensioner income is 3.4 times the
minimum, compared to 1.9 in Russia in early 1994, for example (Mikhalev, 1996, p.13). However, the numbers on
high pensions are small: 75% of pensioners receive less than twice the income of the worst-off pensioner.
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It is important to note that the compression of the pension structure was not driven by a shortfall of Social Fund
resources. Indeed, for reasons which are explained further below, the incomplete indexation of the minimum wage
was initially accompanied by a financial surplus for the Social Fund. Compression was the result of the process of
removing subsidies and replacing them with 'targeted' compensations. The administrative difficulties of operating
social assistance meant that most of the compensation expenditure went to social insurance recipients, i.e. to the
existing 'clients' of the social security system. The result of this process is that the second criterion outlined in
section II is not fulfilled.
If contributors take the current pension structure as an indicator of their future
entitlements, it is evident that higher contributions do not bring benefits which are significantly above the base level
for those with a minimum qualifying period of work.
IV. The Financial Situation of the Social Fund
Some insight into the first criterion outlined in section II (secure hypothecation) can be gained by tracing through
the evolution of the financial situation of the Social Fund. Protection of the hypothecated revenues of the Fund fell
foul of the adverse financial situation of the general government budget in 1992-3. During this period, the budget
was very short of money while the Social Fund was awash with funds, and the government could not resist drawing
on the Social Fund's resources for noninsurance purposes.
The Social Fund is the revenue-collecting organisation for three constituent funds: the Pension Fund, the
Employment Fund, and the Social Insurance Fund (SIF). The SIF pays sickness and maternity benefits and is
administered by the trade unions at the place of work. Its financing is quite autonomous: enterprises pay their SIF
contributions into a separate account. By contrast, the Employment Fund notionally receives an earmarked tax of
1% of payroll, but in practice its financing is integrated with the Pension Fund. Employment Fund and Pension
Fund revenue goes into the same account, and the Employment Fund is managed by the Employment Department,
which is within the Ministry of Labour and Social Protection. When government decisions refer to finance coming
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from the Social Fund, in practice this means the combined resources of the Pension Fund and the Employment
Fund.
While in principle this structure could present problems with the allocation of payroll taxes between the constituent
funds, in practice this has not been very important. One potential problem is that the Employment Fund could
gradually require more funds as unemployment increases, and, if the government tries to control the overall payroll
tax rate, this would reduce finance for pensions. On this scenario, rising unemployment could undermine incentives
to contribute to the Pension Fund, if contributors believe that future pensions will be reduced because of
unemployment. In practice, the opposite situation appears to have occurred: unemployment has not emerged (for
reasons discussed further below) and the Employment Fund has spent less than its notional allocation of 1% of
payroll.
The tax base for the Social Fund is enterprise payrolls, which can be measured as average wage (AW) times
employment (E). Focussing on the Pension Fund, its budget balance condition is:
t.(1-n).AW.E = AP.N .... (1)
or
t = AP/(1-n).AW . N/E
where 't' is the payroll tax or contribution rate, 'n' the nonpayment rate, 'AW' average wage, 'AP' average pension, 'N'
number of beneficiaries, and 'E' is the number of workers employed. It can be seen that the Pension Fund can
finance a stable replacement ratio (AP/AW) with a stable tax rate, provided the dependency ratio (N/E) and the
nonpayment rate are stable. During the period of hyperinflation (1991-94) the payment rate was high, although cash
shortages which occurred as the ruble zone collapsed occasionally caused problems with the delivery of pensions.
However, the imposition of a tight monetary programme in 1994 saw enterprise arrears on payroll taxes rise
substantially (i.e. 'n' rose from less than 10% to 30-40%).
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During the hyperinflationary period the financial situation of the Social Fund actually improved, because the
replacement ratio fell. As noted above, work pensions were uprated in line with the minimum wage (MW), which
fell considerably in real terms. While the wage 'tariff' for those in employment was also based on the minimum
wage, pressure on real wages led to 'drift' of wages above tariff levels. While the average wage remains strongly
linked to the minimum wage, it has increased more than the minimum wage, as shown in Table 1. This meant that
real pensions fell more than real wages, because the real minimum wage fell more than the real average wage. In
this sense, pensioners bore the brunt of hyperinflation. (For a discussion of a similar pattern in Russia, see Liu,
1993, pp.67-9.) The rise in AW/MW meant a financial windfall for the Pension Fund.
Table 1
The Minimum Wage at Uprating Dates
Date
Min
wage
(Lei)
Av wage/
Min wage
Mar 92
Apr 92
0.4
0.85
3.97
2.00
Oct 92
Nov 92
0.85
1.7
4.55
3.34
Feb 93
Mar 93
1.7
3
4.28
3.29
Jun 93
Jul 93
3
7.5
5.70
3.66
Oct 93
Nov 93
7.5
10
5.44
5.19
Dec 93
Jan 94
10
13.5
9.80*
5.01
May 94
Jun 94
13.5
18
6.25
5.93
* This figure is affected by the payment
of annual bonuses in December.
_______________________________________
With the government budget seriously in deficit, the Ministry of Finance was very interested in policies which
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would enlarge the areas of social expenditure covered by the Pension Fund. The first area of expenditure to be
affected by this pressure was family allowances. Family allowances have been administered by the Pension Fund
since their inception, but in Moldova the budget was initially assigned responsibility for financing. Enterprises
made the payments to their eligible workers, and then netted the amounts paid out of their contributions to the
Pension Fund, which was then reimbursed by the Budget. In 1991, the Pension Fund received this reimbursement.
In 1992, the reimbursement was budgeted for, but not paid in full, and in 1993, no provision was made in the
Budget for reimbursement of family allowance expenditure. The procedure for payment and reimbursement of
family allowances made it easy for the government to shift their financing, by failing to make reimbursements.
This shift in the financing of family allowances obviously undermines the insurance principle, because contributions
to the Pension Fund are not hypothecated to pension payments only. It also illustrates a general point about the
relationship between administration and financing. It is administratively efficient to use the network of offices
managed by the Ministry of Labour and Social Protection to administer all social security receipts and payments,
both those relating to 'insurance' and other benefits. In principle, joint administration should not preclude the
operation of separate financing arrangements.
However, in practice, administrative arrangements can affect
financing in a situation where budgetary control and financial management is weak.
Another issue in maintaining an insurance rationale for pensions concerns the financing of the minimum pension.
To the extent that a minimum pension is provided out of insurance funds for those with inadequate work histories or
earnings records, the insurance principle is weakened. In Moldova, there are two minima in operation: a minimum
'work' pension, which equals the minimum wage, for those with enough years of work to qualify for a pension but
insufficient entitlement to cross the minimum threshold; and a 'social' pension, for those with insufficient years of
work, which has been variously set between two-thirds and three-quarters of the minimum wage. Both these
pensions are financed by the Pension Fund. The amounts involved for the social pension are small, but about 25%
of pensioners receive only the minimum 'work' pension. As was noted in the previous section, the Presidential
Decree which increased the minimum wage at the beginning of 1994 provided for higher increases for workers at
the bottom of the wage tariff, and for special supplements for the worst-off pensioners. These supplements are also
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financed by the Pension Fund.
The same Decree contained measures to try to deal with the rise in the price of gas. Since household energy
subsidies were mainly off-budget (being partly charged to the profits of the energy utilities, and partly crosssubsidised by industry), the rise in energy prices did not release resources to finance compensations.
The
government therefore looked to whatever sources of finance were available. Since compensations were largely
directed to pensioners (given the institutional barriers to any alternative arrangements, as discussed in the previous
section) the Pension Fund was a natural target to bear part of the cost of financing. Fifty percent of the cost of
energy compensation payments introduced in winter 1993/94 was charged to the Fund. The same pattern was
adopted in subsequent winters, and in the 1996 budget the Social Fund has been made responsible for financing all
compensation payments arising from the removal of subsidies.
It is apparent that the Pension Fund is not securely hypothecated, and the first criterion outlined in section II is
therefore not fulfilled. To some extent, the same factors which have led to an increase in the importance of
'assistance' payments for pensioners (as outlined in section III) have also undermined hypothecation, as the
government has used Pension Fund as well as budget financial resources to combat poverty. However, assistance
could have been increased without undermining hypothecation if the financial position of the general government
budget had been stronger, and if social security had been better placed to claim budgetary resources.
Arguably, the latter factor is the critical problem. Not all government expenditure is equally under the control of the
Ministry of Finance, with the result that the government's command over resources is not properly regulated through
the budget process. Some ministries are better placed than others to conduct their affairs on a debt-financed basis,
subsequently presenting the Ministry of Finance with obligations as a fait accompli (expenditure incurred as a result
of default on government-guaranteed loans is a prime example). Social security, by contrast, is entirely dependent
on the release of tightly-controlled cash. It must compete with other very pressing claims on cash, notably the
payment of public sector wages.
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Given the weakness of budgetary management and the strength of the 'economic' ministries relative to those
undertaking social functions, it might be thought desirable for both social insurance and social assistance costs to be
met from a separate fund. However, this hypothecation would have to be based on public choice logic, rather than
on the insurance principle. Hypothecation on public choice grounds evades the real issue, which is that the
government has not established control over all its branches and has not been able to set and enforce priorities in
determining their command over resources (Allan, 1994).
V. The Informal Economy and Insurance
Under central planning, the incentive to contribute to insurance was not an important issue in the labour market. So
long as enterprises operated under accommodating credit conditions, the demand for labour was not sensitive to
labour costs. It was therefore not necessary that workers should see pension rights as part of their 'remuneration
package', and allow their take-home pay to be lowered accordingly. If anything, the important constraint was on the
supply side, and pension rights constituted an incentive to maintain a full work record.
With economic reform, the expectation was that the labour market would become demand-constrained. It would
become very important that the expected value of future insurance benefits matched the current cost of
contributions. Otherwise, the payroll tax, by increasing labour costs, would reduce employment. If wages were
flexible, take-home pay would be depressed and labour supply would fall. If wages were rigid at some target level
of take-home pay, involuntary unemployment would emerge.
High levels of involuntary unemployment have not emerged. Wages have proved to be very flexible, and, in
addition, enterprises have gone into arrears in their payments of wages (and taxes and suppliers' accounts),
apparently in preference to dismissing workers. The arrears problem reflects the tightening of monetary policy after
the establishment of a separate currency in November 1993. One might expect that, as the flow of cheap credit to
enterprises was curtailed and some enterprises found that they could not pay their workers, the next step in the
17
adjustment process would be that unemployment would increase. This would worsen the financial situation of the
Social Fund by reducing the payroll tax base and expanding unemployment benefit payments, but arrears would
stabilise. However, open unemployment has not increased, and payroll tax arrears have continued to grow. As a
result, payments to pensioners have also slipped into arrears. Outside the main cities, pensions were paid 3-4
months late in 1995, and there are no signs of improvement in 1996.
The flexibility of wages itself raises some issues and problems. The formal basis for wage-fixing appears to
generate a subsistence-related floor, because the minimum wage is meant to be based on the 'minimum consumption
basket' (MCB) of goods needed for living, and other tariff wages are determined as multiples of the minimum wage.
(The Moldovan MCB suffers from the deficiencies of other Soviet consumption baskets, as it is based neither on
actual consumption patterns nor on nutritional and other requirements of life (McAuley, 1994, p.32). However, this
does not detract from its political importance.) In practice, the minimum wage has fallen to a fraction of the MCB.
The average wage fell below the MCB in 1992 and has stood at less than 40% of the MCB since 1994.
With such flexibility in wages, one would expect that labour supply might be affected, if only because the low level
of wage income means that people must engage in various sidelines in order to get by. With the legalisation of
private economic activity and the termination of the requirement to work for the State, people could leave their jobs
in the former state sector. However, an alternative pattern has developed, whereby people retain their jobs in the
former state sector while also engaging in other, informal, activities.
The problem of informality is most apparent in the increased importance of the household sector. As a result of
privatisation and the development of markets in inputs as well as consumer goods, households now have more
productive resources and are able to utilise those resources more effectively than under central planning. But
households have a choice of modes of saving, and are unlikely to choose the Social Fund as a reliable repository.
Indeed, the use of financial institutions generally is at low levels in Moldova. One reason may be that much
household activity is not monetised, such as work on private plots of land. The accumulation of assets from
household-based activities may therefore be concentrated on augmenting household resources through land
18
improvement and housebuilding.
While the growth of the household sector is the most obvious and predictable form for informal economic activity to
take, it may not be the most important non-market channel for the distribution of resources in the post-Soviet
context. An indicator that something else is going on is the extraordinarily low share of wages in GDP. In 1994, the
ratio of the wage bill to GDP was only 39% in Moldova; in 1995 this dropped further to 33%. Obviously this low
wage share has a particular signficance to the Social Fund, because of its dependence on payroll taxes.
The GDP estimates are constructed using output measures. The low wage share could reflect household production,
but only a small proportion of the GDP measure is accounted for by the household sector. The more likely
explanation is that the output measure includes enterprise value-added which is not distributed as wages nor
recorded as profits. Anecdotal evidence suggests that enterprises are important sources of resources. For example,
an enterprise may give workers materials or output, or sell to them at a low price. This behaviour is not typical of a
market economy because the owners of the enterprise would aim to prevent the diversion of profits in this way. In
this post-Soviet model of enterprise-based welfare, those employed by the enterprise are its 'members'. They hold
property rights in its assets and operate the enterprise as a unit of consumption as well as production; a large
household, in effect.
This pattern of enterprise behaviour presents enormous problems for the Social Fund. By remaining formally
engaged in the old state sector, workers secure future pension rights, which can be complemented by the
accumulation of assets from informal activities. One can go so far as to suggest that the effect of current pension
arrangements is to generate an incentive to remain employed in the former state sector, boosting its labour supply.
This paradoxical situation turns the whole logic of the savings model on its head. In the savings model, the payroll
tax has a negative effect on employment which is countered by ensuring that the payments are seen as 'contributions'
which bring corresponding future benefits. In a situation of mounting payroll tax arrears, it would appear that the
payroll tax does not have a negative effect on employment, for the simple reason that it is not being paid.
Furthermore, the expected value of future social insurance benefits actually exceeds current contributions, reducing
19
the need to undertake other saving. Prospects for collecting social insurance contributions from new activities,
thereby formalising the informal sector, would appear to be remote so long as most people remain formally
employed.
Enterprises owe the Social Fund the contributions which are the counterpart to these rights, but these contributions
are heavily in arrears. The Social Fund is accumulating future liabilities without receiving the corresponding current
revenue. Another way of looking at the situation is that the future liabilities of the Social Fund are matched by
current assets in the form of payroll tax arrears. It is tempting to argue that neither the assets nor the liabilities are of
any value, but this is to oversimplify the political pressures generated by the existence of both. The pressure
generated by arrears on contributions is that the Social Fund, being organised on a pay-as-you-go basis, cannot pay
current pensions. If there is a sanction against non-payment of contributions in the savings model, it would appear
to be the denial of future benefits. This does not resolve the Social Fund's current problem.
The severity of the arrears problem for the Social Fund can be seen by comparing wage arrears with payroll tax
arrears. It is natural to think of payroll tax arrears as the counterpart to wage arrears: if workers are not being paid,
payroll tax is not remitted. However, if enterprises' failure to pay payroll tax was solely a reflection of the
nonpayment of wages, then payroll tax arrears would be about one-third of wage arrears (given the payroll tax rate
of 35%). This is not the case. Payroll tax arrears are greater than wage arrears, standing at 485 million lei at the end
of 1995 compared with wage arrears of 227 million lei. (This latter figure represents about one month's wages over
the whole economy.)
One explanation of this pattern is that a high proportion of wages are being paid in kind. When wages are paid in
kind, payroll tax is assessed, but tax is not paid until the enterprise has money in its bank account. Workers may be
paid in the output of the enterprise (especially in agriculture) or in goods obtained through barter transactions. It is
possible that some enterprises are finding ways to obtain cash to pay workers without using their bank accounts (the
banks automatically remit payroll tax when cash is withdrawn to pay wages), but such transactions are illegal.
20
Faced with enterprises accumulating debts to the State while 'looking after their own', the government has pursued a
variety of responses. One approach has been to tighten external control over enterprises, for example by compelling
them to use the banking system for all transactions, and by appointing local commissions to undertake close scrutiny
of enterprise affairs. This approach has the effect of partially reinstating the instruments of central planning. In
March Prime Minister Sangheli expressed his opposition to proposals to toughen administrative and criminal
responsibility for untimely payments to the Budget and Social Fund, and for wage arrears, arguing that such
measures were reminiscent of the Soviet system. However, the government has responded to the pressure from
Parliament to take some administrative action. A recent government decision envisages the receipt of payroll taxes
in the form of consumer goods, and establishes a structure to distribute produce to pensioners.
Another approach is to restructure enterprises to put them on a proper commercial footing. The programme of
enterprise restructuring in place in Moldova is basically designed to move enterprises into profitable trading by
imposing moratoria on their accumulated debts. Since the government is a major creditor, it is the function of the
government, in the form of the Committee of State Creditors, to determine whether a moratorium is appropriate in
each case. The restructuring process means the state suspends the exercise of its claims against the enterprise, in the
hope of exercising future claims more effectively through taxation.
The effect of a moratorium for an enterprise with payroll tax arrears to the Social Fund is to postpone any prospect
of collection until the enterprise is trading profitably, or at least has a positive cash flow. Widespread use of this
mechanism would mean that the Social Fund could not hold out the prospect of settling pension arrears by collecting
payroll tax arrears. Arrears would be frozen, and ultimately some might be written off. One reason why there is
considerable resistance to this option in the Social Fund (bearing in mind that each individual creditor tends to resist
an overall creditor settlement) is that payroll tax moratoria mean that pension arrears will have to be settled from the
general government budget, compromising the independence of the Fund.
Resistance to enterprise restructuring in the Social Fund, and the Ministry of Labour and Social Protection (MLSP)
which administers the Fund, is often framed in terms of 'enterprise responsibility'. It is argued that forgiving the
21
nonpayment of wages and taxes, and allowing other restructuring measures such as severance of workers, departs
from the principle of enterprise responsibility (which translates concretely into a responsibility on enterprise
directors to meet the claims of both the State and the workforce on enterprise resources). The concept of enterprise
responsibility is clearly problematic for the economic transition. It has a great deal of popular resonance, as workers
look to the enterprises of which they are 'members' to provide security.
Enterprise responsibility also has quite specific and problematic consequences for the pension system. The MLSP
has applied the doctrine of enterprise responsibility by linking payment of pensions to enterprise payments
discipline in the locality, so pensions are paid first in the districts where the flow of contributions is adequate. A byproduct of this strategy may be to strengthen the perceived link between enterprises and 'their' pensioners (i.e. those
who used to work for them). Enterprises pay often top up the incomes of their pensioners already. In agricultural
districts, pensioners may be recipients of allocations of food, while urban enterprises distribute Christmas bonuses.
The logical extension of this process is that the national pension system is gradually eroded, contributions are not
pooled nationally, and the system evolves into an occupational or enterprise-based system. This in turn implies that
enterprise restructuring, bankruptcy and closure will not be counteracted by State measures to protect pensioners
previously employed by those enterprises. The more enterprise-based the welfare system becomes, the more
adverse the social consequences of restructuring, and the more intense the political opposition to restructuring.
One implication of this discussion is that the medium-term prognosis for the Social Fund is worse under the current
pattern of adjustment than if open unemployment had emerged. While open unemployment would have presented
financial difficulties (a fall in the contributions base, and a rise in benefit claims from the Employment Fund), the
gap between workers' accumulation of pension rights and the flow of contribution revenue to the Social Fund would
not have opened up. Those who left the former state sector would have an incentive to make pension contributions
from their new areas of work, and the Social Fund would have had the opportunity to establish a system of
contribution accounts so that the benefit calculation could be based on contributions rather than work history. As it
is now, the accumulation of arrears and the heated political contention over their settlement makes an unpromising
22
environment for the reorientation of the Social Fund from paying deferred compensation to state employees towards
the provision of contributory insurance as envisaged by the savings model.
VI. Conclusion
It is evident that social insurance in Moldova is a very long way from being restructured in accordance with the
basic principles of social insurance in a market economy. The effect of the weakness of payments discipline on
Social Fund revenue is the most striking problem, although there are also other issues around the impact of
assistance on insurance and the security of the hypothecated revenue of the Social Fund.
In reality all these problems have their roots in the fundamental issue of credibility in the operations of the Social
Fund. Credibility is obviously connected with payments indiscipline because there is no confidence that the
payment of contributions will secure future benefits. Less obviously, the issue also cuts the other way: there is no
confidence that failure to pay contributions will lead to future denial of benefits. The attempt by the Social Fund
and the MLSP to promote a territorial connection between the payment of contributions and the receipt of benefits
does not resolve this problem: on the contrary, it jeopardises the whole basis of the national social insurance system.
Credibility also affects the insurance/ assistance problem. An insurance claim is based on past payment of
contributions; an assistance claim is based on current needs. A question for any prospective buyer of insurance is:
which type of claim is more secure? Both have uncertainties attached to them. In Moldova, the situation is
complicated by the apparent possibility of making a claim based on work history without having paid contributions.
It appears that a claim based on rights stemming from attachment to an enterprise may be more secure than rights
derived from insurance or those based on needs. However, it also seems that, in the future, the claim may have to be
made directly to the enterprise, rather than to the Social Fund.
The issue of which type of claim is more secure is closely connected with the issue of hypothecation.
23
Hypothecation of insurance contributions into a fund which pays only insurance benefits is meant to lend security to
the contributions-as-savings model. The diversion of insurance contributions to pay assistance benefits reduces the
credibility of the savings model.
These arguments suggest that technical efforts to strengthen the insurance characteristics of post-Soviet Social Fund
systems may be wasted, because the underlying conditions for operation of the savings model are absent. The
counter-argument is that any social security system is better than none. Promoting Social Fund autonomy from the
general government budget at least secures some resources for social security, and the time may come when the
institutional infrastructure of social insurance can be used effectively.
The biggest social security problem facing Moldova, a problem shared by many other republics, is the tendency
towards a system of enterprise-based welfare. Combatting this problem depends on the whole nexus of policies for
enterprise restructuring. To the extent that the Social Fund promotes the doctrine of 'enterprise responsibility' and
maintains and enforces workers' future claims against their current employers, it is an impediment to voluntary
quitting and an obstacle to restructuring. If the Social Fund could offer a degree of income security independent of
enterprise attachments, it may help to facilitate restructuring. In Moldova, one has to conclude that the current
strategies of the Social Fund contribute to the difficulties of enterprise restructuring.
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