Fair Pensions in an Ageing World

This contribution is published as part of the Think Piece Series The Road To Addis and Beyond, launched to coincide with the third and final drafting session of the outcome document of this summer's Third International Conference on Financing for Development. In this Series, global experts discuss a range of topics complementary to the UNRISD research project on the Politics of Domestic Resource Mobilization on how to fund social development and raise provocative or alternative perspectives that can generate further ideas and debates. Please share your thoughts on this article in the comments space below.

Longevity without misery has always been mankind's dream. Modern technology and political will can make that dream come true. Fair pensions for everybody are possible and affordable, when compulsory contributions from wages and salaries are topped-up or complemented with tax financing. No formal earmarking is recommended, but an explicit political consensus on linking pension and tax reforms can help for acceptance on both fronts. Pension systems follow a special financial and administrative logic. They are inherently different from the financial sector, because they rely on compulsory contributions and they cover most, if not the whole of a country's population; they are different from non-financial business, because it is national legislation which governs their structure and their benefits rather than the fate of the businesses or their pension funds, as is the case with most company pensions; finally, they are markedly different from finance ministries which take tax money without any specific counter-claim. Pension insurance also differs from social assistance schemes, which are means-tested and care for the needy. Distinct from finance ministries and the financial sector, their governance structure often includes national employers, pensioners' associations and trade unions. Increased labour migration flows make the international mutual recognition and portability of pension rights an urgent issue for global UN conventions, ILO standard setting, and bi- or multilateral treaties.

Manfred Nitsch is emeritus professor of economics and political economy of Latin America at the Freie Universität Berlin.

Fair pensions in an ageing world

Demographic change and modern lifestyles make pension reforms a permanent and global topic for politicians, administrators, trade unionists, business people and—last but not least—every family and every individual. Experience shows rather mixed results from the array of different pension schemes for the wage- and salary-earning classes, peasants and farmers, informal-sector employers and employees as well as civil servants, public employees and business owners. The broad spectrum of products for voluntary savings for old age offered by the financial sector are not included in the following considerations. And company pensions and their rather complicated regulation in a business world of mergers and acquisitions around the globe are also left out. But the sometimes rather lavish public pensions of high-ranking civil servants, judges, military personnel and politicians are also under reform pressure so that a think piece trying to resume some of the lessons learned from a wide array of research on public pensions should be in order as a contribution to the forthcoming UN Conference on Financing for Development in Addis Ababa on July 11-12, 2015.

Fiscal traditions and public pension rules have often been based on grossly outdated data on life-expectancy and health expenditures so that many social security agencies as well as ministries of finance and their counterparts in the provinces, municipalities and related public agencies are overloaded with pension liabilities. Necessary adjustments often require difficult political decisions on who pays more and who gets less. Privatization seems to be an easy way out; however, whether private or public, pensions are always paid out of the current national income. There is no panacea. That is why fiscal problems because of generous public pension promises are not solved but rather augmented through the diversion of contribution payments to private pension funds while the benefits still have to be paid from public coffers. Emitting public bonds to be held by private pension funds in order to pay the current pensions only means converting implicit into explicit debt without alleviating the general public finance problem stemming from ageing.

The following guidelines and principles for designing fair pension systems in an ageing world focus on public pensions financed mainly on a pay-as-you-go basis, with current workers and employees financing current pension outlays through their contribution payments, complemented by increasing tax financing. Following these guidelines and principles would lead to more equitable and sustainable outcomes in pension systems, compatible with UN declarations on human rights and the pertinent ILO conventions:

1. Separate pensions from the financial markets

Public debt is composed of explicit debt in the form of bonds and other instruments of monetary public finance on the one hand, and the often ignored implicit debt in the form of liabilities toward pensioners and others entitled to monetary claims when in need of social assistance on the other hand. The mass of implicit monetary claims from legally anchored pension schemes, most of which is acquired through compulsory contributions, and the corresponding public or semi-public debts in most countries with long-established social security schemes are three or more times bigger than the explicit public debt. Not only should pensions for the working classes be protected from the whims of the financial markets, but also vice versa: these fragile markets should be protected from the mammoth volumes of wealth which are built up and swirled around in the course of political reforms of pensions, health and old-age care provisions. Inheritance laws and their incentive effects can also affect huge amounts of assets and liabilities for pensioners and their prospective heirs in the always uncertain world of the future, but this topic alone would justify another think piece.

2. Stick to the usual institutional separation between social security agencies and ministerial forms of administration

Compulsory public pension schemes are inherently different from the “normal” tax-and-spend set-up run by parliaments and ministries, where taxes are paid without any link to those public services which are provided without or with only symbolic monetary fees. On the other side, pension claims or “credits” are acquired through contributions, and pension agencies keep track of those individual claims, similar to savings accounts at a bank rather than to records at the internal revenue system of the Ministry of Finance. The value of those pension credits should be indexed in some way, for example against the minimum wage, or the average wage, or social assistance standards, or at least linked to the inflation rate.

3. Keep the governing bodies of social security agencies at arm's length from governments and parliaments

Because employers transfer their own and/or their employees' contributions to pension agencies, it is widely seen as legitimate for employers’ associations and trade unions to participate in the governance structure. However, one also finds pensioners, government representatives, academics, outstanding public figures and non-governmental organizations in the governing bodies of pension agencies. Since large sums of money always attract corruption, guaranteed access for the media and researchers are essential to ensure accountability and transparency.

4. Separate pensions from means-tested social assistance

Pensions should remain non-negotiable regular monetary claims and, as such, property rights of the elderly individual. For good reasons, social assistance grants are often related to households or families rather than individuals, and they can take the form of food stamps, housing vouchers and so forth. Furthermore, they follow a different logic, since they are not related to previous contributions but directed toward the needy, usually regardless of age.

5. Finance for pensions has to come from various sources

Demographic change, with increased longevity and longer periods spent in education, makes it impossible to finance pensions for the elderly exclusively through contributions from the generations currently in work. The resulting pensions would be so small that the whole scheme would lose its justification, legitimacy, and attractiveness. That is why money from taxes is already used in many cases, particularly for pensions in the public sector and to maintain the pension contributions of women with babies while they are not participating in the labour market. Formally earmarking taxes on fossil fuels, natural resources, oil rents and so on cannot be recommended, because the highly esteemed principle of non-affectation in public finance makes sense, since it avoids rigidities and ensures space for democratic change. However, whenever a major pension reform requires additional tax money, an informal political link, or even an explicit consensus of linking pension reform with “green” or other tax increases can ease parliamentary acceptance.

6. Give everybody over 65 years of age a modest pension

Universal coverage is a human right and a goal long-aspired to by social security reforms. It is achieved in some countries through a pension for every person over 60 or 65 or 70 years of age, paid from general tax money and easily accessible. The poor can apply for a top-up grant to reach social assistance levels, and the middle and upper income classes pay taxes on that pension as on every other type of income so that the net tax burden for the Ministry of Finance is not too heavy. As a symbol of citizenship for every elderly person, the introduction of such a scheme makes very good sense, because demographic change makes structural reforms unavoidable, involving massive tax money injections into public pension systems. Harmonizing a universal basic pension scheme with existing pension systems is, however, a sensitive issue, since low pensions from contributions would exist side by side with pensions from the universal scheme which do not require previous sacrifices. The new scheme would have to be introduced smoothly and over time to ensure a sense of fairness and justice for all pensioners.

7. Stick to the insurance principle of pensions

In an individualistic modern world, pensions are an appropriate form of old-age insurance. Except for dependent spouses and children, the individual loses her or his right to a pension on her or his death, which is different from many pension savings in the financial sector. On the other hand, “insurance” also means that premature loss of the ability to work entitles the individual to an early pension. These rules are generally accepted as fair and sustainable, if they are not overextended and misused.

8. Stick to the compulsory contribution from wages as part of pension finance

The monetary contribution, deducted from the individual’s monthly or weekly salary and handed over to the respective pension administration by the employer, should remain an essential part of any scheme, even if the amount of money that can be mobilized in that way is shrinking with demographic change and changing with labour market volatilities in relation to other sources of finance. The acquisition of individual pension credits should raise the public profile of the public pension administration, and the link between work, salary and pension reflects the high regard for work as a human right, and a source of self-esteem and human dignity. Compulsory contributions from wages also strengthen the responsibility of every individual to prepare financially for her or his own old age. It is an open political question whether voluntary contributions from the insured to acquire additional pension credits should be permitted or even be encouraged—but it is recommended here.

9. Open the way to pension credits for women

Unpaid care work, mostly provided by women, reduces pension entitlements when these are only based on contributions paid when in formal employment. Some countries already recognize bearing and raising children and care for the elderly and the disabled as equivalents to monetary contributions from wages. That should become the rule rather than the exception.

10. Pension claims should be honoured globally

Global businesses and international migration of wage- and salary-earners require that claims from pension schemes, particularly the ones resulting from compulsory contributions, are honoured and paid out regardless of where the persons are living when they retire. Some kind of international convention or treaty might be needed to avoid the confiscation of highly valuable claims gained by hard work from wage- and salary-earners with employment histories in different countries.

Financing “development” in the sense of a good life for everybody on our planet, implies providing finance for a decent life in old age. Fair pensions, based on the above guidelines, could make mankind's dream of a longer life without misery come true.

ABOUT THE AUTHOR

Manfred Nitsch is emeritus professor of economics and political economy of Latin America at the Freie Universitaet Berlin. His areas of research, teaching and consulting include: International economic relations, development cooperation, monetary theory and reforms, banking, microfinance, pension reforms, biofuels, Amazonian Studies, sustainability, and Catholic social doctrines in Latin America. He studied of economics, business education, sociology and languages in Goettingen (Germany), Geneva (Switzerland), Middlebury College, Vt. (USA) and Munich (Germany); he took a Doctorate in economics at the Ludwig-Maximilians-Universitaet in Munich in 1968, and conducted post-doctoral research and academic teaching at the Max-Planck Institute for Intellectual Property Law, Munich, and Stiftung Wissenschaft und Politik (Research Institute for International Relations and Security), Ebenhausen/Munich prior to becoming a professor in Berlin.