Opinion

What pension model should Georgia have?

by | Aug 19, 2013
nino evgenidze

Nino Evgenidze is Executive Director of the Economic Policy Research Center.

We often hear pre-election promises of various political parties that envisage increasing pensions to equal the subsistence minimum. Such promises enjoy a positive reaction from society, however the necessity of a pension reform in the country is underestimated and is only discussed in expert circles.

International best practice has shown that without such a reform, it is impossible to meet ever increasing social obligations even for countries with much stronger economies than that of Georgia.

Food for thought: 682.9 thousand people are pension receivers in Georgia. This number is persistently increasing and is directly associated with an increase of life expectancy in the country. It might be unethical to say that an increase of life expectancy all around the world has increased the pension burden and has created basis for social problems. Even in conditions of pension reforms due to economic recession and high levels of unemployment, the employed individuals find it harder to finance pensioners.

As of today 1,1146.7 million GEL is spent annually on financing pensions, and this number is increasing from year to year. To put it otherwise, this number is 256 GEL per capita and 1,731 GEL annually per employed (hired) individual. To put it more simply, one employed (hired) individual finances more than 1 pensioner per month (monthly burden 144 GEL). The larger the number of pensioners, if we keep employed individuals constant (which unfortunately is the case) the tougher the burden for each employed person. These circumstances will either lead to an increase in taxes or to a compulsory pension reform. Therefore, when talking about a pension increase the society should be informed about these tradeoffs to be made.

As we have mentioned Georgia is not alone facing this problem, moreover that the world is dominated by increased leftwing tendencies. Therefore, quite notable international experience has accumulated during the course of the second half of the 20th century in regard to various pension reform schemes. With some minor differences these models can be grouped in three main directions, we shall briefly discuss each of them.

Solidarity based Pension Scheme

According to this scheme, pensions are financed through taxes paid by the working population. In conditions of inflation and economic growth, labor remuneration and subsequently pension funds increase. Pension indexation is made through an increase in the total taxes collected from the working population.

However this model is associated with a number of risks, firstly in the conditions of aging population ratio of the working population and pensioners change considerably. Therefore, total sums accumulated for paying off pensioners decrease, indexation is no more possible and pensions decrease in relation to labor remuneration that is the basis for decreased pensions.

At the same time, experience from various countries has shown that political populism from the political parties is often directed towards pensions for gaining political support. Therefore, the governments appoint or increase pensions without determining its long-term financing capabilities and risks.

Accumulative Pension Scheme

This scheme envisages individual accumulation; therefore amount of pensions is dependent on the pension contributions and success of investment strategy and financial indicators implemented by the pension funds.

In conditions of economic growth and developed financial institutions, accumulative pension scheme is characterized by sustainable growth, i.e. when the interest received is greater than inflation and an increase in salaries.

Moreover, this increase in the share of “accumulation” in GDP creates strong stimuli for economic growth. However, we should also mention risks associated with this pension model as well. Firstly, economic growth is never stable. Due to economic slowdowns and crisis periods, accumulated resources can depreciate in value. Therefore, participants in the accumulative pension scheme are vulnerable towards markets risks and inflation.

The so-called Mixed Scheme

This model represents a mixture of solidarity and accumulative pension schemes, thus decreasing risks and increasing flexibility by defining the role of the state and private sectors in the pension provision process.

In time of crisis the mixed scheme makes it possible to diversify risks in between the pension schemes. Although this model is also associated with a number of risks of its own. It is a problem effectively determining the activity of the participants and proportion of responsibility and hence state expenditures and the private sector contributions.

In case of conflict of interest between the state and the private sector, the mixed model loses its flexibility and efficiency.

Based on the above mentioned three models, different types of pension schemes function in a number of countries. Georgia will have to make a choice, and before doing so all risks should be taken into account and the society should be informed with due diligence. Readiness from the society is a major prerequisite for the success of any type of reform.



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