The pension reform debate

97 NFT 2/2004 K O M M E N T A R E N The pension reform debate by KG Scherman Over the last decade an intense debate has been going on about pension reform. Follow- ing political problems in reforming traditional DB systems, but also for a variety of other reasons, new models have been introduced and intensely advocated by their respective proponents. After a reform in Chile in the early 1980s, the “Chilean model”, a funded system based upon mandatory individual ac- counts, became the centre of the debate. Now, the recent reform in Sweden is subject to much comment, and the “Swedish model” is being recommended by the World Bank, the European Commission and numerous finance ministries. Swedes are saying: “With so much international praise, it must be a good reform we have implemented”. We must sort out what this new “Swedish model” really is. After all, the Swedish reform is a complete overhaul of most of the basic features of the former public pension system with a switch from the traditionally accepted solidarity concept to what the Swedish Gov- ernment calls “actuarial solidarity” which is the guiding principle behind the reform. What do the proponents of the Swedish model really mean when they refer to it? There is a wide range of possible elements to consider. From a pension system point of view, there are the following features: • The introduction of a funded pension com- ponent alongside the PAYG part; • A completely changed PAYG scheme, end- ing up in the “notional defined contribu- tion” (NDC) model; • A successive phasing out of the minimum pension in the face of economic growth. From the point of view of outcomes, the following are particularly relevant: • Life-time earnings as the basis for the level of retirement pension; • Abolishing the “normal pension age”; • Taking increasing life expectancy into ac- count in the calculation of pensions, thereby steadily raising the age when a person can retire with an adequate pension. From the point of view of pension politics, yet other features come to the fore: • There was a broad political consensus be- hind a reform that effectively reduces pen- sions and pension expenditure; • There was no public opposition despite reductions in future pensions. • Sweden’s reputation as an advanced wel- fare state makes it useful for politicians elsewhere to refer to their reform proposals as following the Swedish model. Given the above aspects of the Swedish re- form, it is clear why it is claimed that many reforms follow the Swedish model. Indeed, this can be claimed for every successful re- form which reduces pension expenditure. Sec- ond, it can be claimed for every reform that, in KG Scherman is Honorary Pre- sident of the International So- cial Security Association (ISSA). He was Director General of the Swedish National Social Insurance Board 1981-1996. KG Scherman holds degrees as Master of Engineering from The Royal Technical High School in Stockholm and as Master of Business Admini- stration from The Stockholm School of Economics. kg.scherman@swipnet.se 98 the face of raising life expectancy, increases retirement ages and/or accomplishes a corre- sponding result by reducing benefits drawn at a certain age (such as has happened in Finland and is proposed in Germany and Norway). Third, such a resemblance can be claimed following the introduction of a funded com- ponent in the public pension arrangements (for example, in Poland, Hungary and in the voluntary scheme in Germany). Finally, it can be claimed whenever an NDC approach is adopted (such as in Latvia, Poland and Italy) Clearly there is a need to know what a reference to “the Swedish model” really means. To which of all the features enumerated above does a reference to “the Swedish model” re- fer? This is needed in order to avoid confusion that otherwise might arise from an association of various features of the new Swedish model with what Swedish welfare arrangements have traditionally stood for, but which does not apply to this pension model. And such a clarification it is needed for Swedes better to understand the reasons for the international praise of our reform. It is also worth phrasing a question based on a concern shared by many international ex- perts, when considering the distribution of risks in different pension models: Is there any truth to the allegation that in choosing among pension models, the NDC model is popular, not necessarily because it is a good system, but because it is not possible for the general public to properly understand the implica- tions of the system, and hence it can be intro- duced without public opposition? I am happy to note that many outstanding international experts have accepted the invita- tion to come forward and help to investigate these matters. In this issue, Bernard Casey of the London School of Economics and the Pensions Institute, Cass Business School, brings to us his views. He writes about the need to take a whole range of policy areas into account when making a full assessment of a pension system, discusses terms such as secu- rity, equity, effectiveness and solidarity, pro- vides a framework for assessing how vulner- able pensions systems might be, and analyses the reform processes, including the why and how governments might try to avoid political responsibility for making unpopular change. In subsequent issues we will have the op- portunity to read articles addressing topics including: • the economics of public pensions and their social objectives, and how well the NDC model can create an appropriate balance between social goals and financial con- straints; • a need for a closer coordination of European pension systems and for them to adopt a more actuarial approach - an approach where a NDC system would be a good alternative; • retirement ages and the consequences for individual retirement decisions and the na- tional economy of an actuarial approach to retirement age, as well as the political impli- cations of such an approach; • a German perspective on the Swedish pen- sion reform; • whether the NDC model is really new or a variation of the traditional DB model; • an overview of the pension debate where the NDC model is put into perspective along with other approaches to public pension reform. From this series of articles, and the preceding articles in the series, beginning with Messrs Hagberg and Wohlner in no. 2/2002, and followed by articles by Messrs Settergren, Könberg and Scherman, it is planned to fur- ther clarify matters and to make Swedes aware what the Swedish pension reform really is all about. As a part of this information dissemina- tion, an international seminar may be held during 2005, and other events will also be held.