Contributing to the Pension Reform Debates

April 15, 2011

Volodymyr Mykytovych is a 75-year old pensioner residing in Lyutizh village near Kyiv. Volodymyr Mykytovych lives in his own house and has a vegetable garden. It feeds not only him, but gives him an opportunity to sell some of the products at the local marketplace.

”Look, my pension, when I retired, was 132 hryvnas and I could buy near 640 loaves of bread. Today my monthly pension is UAH 860, but I can buy just 230 loaves. Is it better or worse? I think it's much worse,” – says Volodymyr Mykytovych. To a large extent the story of Volodymyr Mykytovych and many other pensioners is that inflation has eaten away the purchasing power of pension payments. Inflation, in turn, has been partly worsened by populist fiscal policies in the past that among other increased nominal pensions without thinking of unintended consequences.

" The pension fund is unbalanced. This is for a number of reasons; for example the state undertook social obligations for which there was no funding... "

Ella Libanova

Director of the Institute of Demography and Social Studies of the Academy of Sciences of Ukraine.

All this is compounded by a bad and worsening demographic profile and large deficits in the system. Our estimation suggest that in 10 years there will be one pensioner for every single contributor to the system and this ratio will worsen sharply after that due to the country’s aging population. Ukraine has the highest share of pension spending in GDP in the world, 18% in 2009. Ukraine also has one of the highest total contribution rates to the pension system in Europe at 35% of gross salaries. The total rate of contribution to all 4 social insurance funds can go beyond 41%. Despite of this, the pension fund ran a broad deficit of almost 7% of GDP in 2010.

Part of the problem the pension system faces today is related the underreporting of wages that reduce the system’s revenues. Indeed, high pension expenditures as percent of GDP have obliged successive government to keep contribution rates high. But high rates, in turn, have encouraged employers and employees to hide wages, resulting in a larger shadow economy. This vicious circle can only be broken by initially containing expenditures from the pension fund so that contributors can be confident that they will receive something back from the pension fund one day.

To ensure that pension spending is brought in line with available revenues, the government can follow three possible routes: (i) pensions need to be cut, or (ii) contributions need to be further increased, or (iii) workers need to be encouraged to have a longer productive life in the labor market. Since many pensioners already struggle to make ends meet, cutting pensions is not a solution. Increasing contribution rates is also not an option, because they are already so high and would further encourage growth in shadow economy.

Many Ukrainian experts agree with this conclusion. “The pension fund is unbalanced. This is for a number of reasons; for example the state undertook social obligations for which there was no funding. Now we have to adjust liabilities to our financial capacities. It is impossible to change the pension age of current pensioners. People who get pensions today cannot be deprived of their rights, which are in fact constitutionally guaranteed. Something can be done only with regard to the working population,” says Ella Libanova, Director of the Institute of Demography and Social Studies of the Academy of Sciences of Ukraine.

World Bank experts have helped the authorities address this conundrum with a set of parametric changes to the pension system contained in draft law #7455. The measures proposed include: (i) gradually increasing retirement age for women from 55 to 60, by 6 month every year, (ii) increasing the qualification period required for minimum pension (by 10 years), and (iii) taking initial measures to start the harmonization of special pensions with the regular system. These measures have been taken several years ago by neighboring countries like Poland, the Czech Republic, and Bulgaria, among others. More recently, France, the UK, Greece and Spain have further increased the retirement age and contribution periods from the already higher levels they had compared to Ukraine. This trend is driven not only by fiscal pressures but also by the demographic profile of European countries

Despite these examples from other European countries, in Ukraine the increase in the retirement age remains hotly debated. In this debate, basic facts are often not taken into account. For instance, a general criticism of the reform is that because of low life expectancy in Ukraine, an increase in the retirement age would mean that few people would live to enjoy their pension. Clearly, if spending is 18 percent of GDP today this cannot be the case. Indeed, few commentators and even fewer citizens in Ukraine realize that Ukraine’s women retire almost 10 years earlier than their counterparts in western Europe, although they can expect to live almost as long once they reached retirement age. No wonder then that with a shorter contribution period, and an equivalently long period in retirement, there is not enough money to pay a decent pension.

On February, 16th, the World Bank Country Director for Ukraine, Belarus and Moldova Martin Raiser emphasized this point during parliamentary hearings on pension reform. “One often hears the view in Ukraine that if the pension age is 60 and the average life expectancy is only a few years more, then people will have no time to enjoy the old age. This is not correct. Life expectancy of an average women at the age of 60 is actually 80 years, which means the average women can expect to live a full 20 years after retirement. This level is very close to the average of other European countries, although life expectancy at birth is far lower in Ukraine,” – said Mr. Raiser.

So clearly, there is a lot of need for further explanation and argument. To increase awareness of the need for reforms, and the main proposals under discussion, the World Bank has participated in a series of debates on television, in universities, in the print media, as well in the context of the Bank’s own network of Centers of Innovative Knowledge (CIK, formerly known as Public Information Centers or PICs).

For instance, in February the Odessa Institute of Public Administration, one of the four Bank sponsored CIKs in Ukraine, hosted an expert round table discussion on pension reform in Ukraine with two guest speakers: Yulia Smolyar, World Bank social protection specialist and Lidia Tkachenko, leading expert at the Institute of Demography and Social Studies of the Academy of Sciences of Ukraine. Participants represented academia, local NGOs, government officials, experts and media.

“Public awareness is a prerequisite for the success of pension reform. In January this year I took part in the government working group to discuss the bill on pension reform measures in Donetsk and Simferopol. It is good that the World Bank initiated the extension of this discussion in other regions. Meetings with experts and journalists in Odessa showed that both professionals and the public are actively involved in discussion of pension issues. Although opinion on the reform measures often differ in such professional discussions, such meetings are extremely important for all participants,” said Lidia Tkachenko.

The round table was followed by a press conference organized at the “Kontekst Media” Odessa Media Center. The local media was widely represented by print media, TV channels and radio. Journalists showed a keen interest in the topic of pension reform in Ukraine and appeared to be well informed. One theme that resonates strongly in the public debate as well as in media reports is the need for greater balance in the adjustments of the social welfare system in Ukraine. Many journalists criticize a reform that seems to impose costs on ordinary workers but fails to fully tackle the special pensions of public officials, members of parliament or the judiciary. This echoes a point the World Bank made in the recent Country Economic Memorandum, published in the Fall of 2010: reforms of social insurance, transfers and public services are needed in Ukraine, but they need to form part of a new social contract that also tackles the privileges of the rich and addresses the deep-rooted corruption at all levels. While reform of the pension system cannot be delayed, there is an urgent need to tackle these broader issues.

“I do not accept social and economic determinism according to which some countries are doomed to prosperity and others to problems and poverty. That is why I think that everything can be reformed, but we should remember that the later we start the reforms the more difficult it will be to implement them, and thus society will pay a higher price for this,” points out Igor Burakovsky, Director of the Institute for Economic Research and Policy Consulting.

The reformers are facing an uphill battle to convince the public of the need and ultimately of the significant benefits of pension reform. Even among the younger population, who stand to benefit from a financially sustainable pension system in the future, the reaction is often indifference. “At my age it's bit early to think about pension. After retirement I don't want to be maintained by the state in the form of pension. Let it be paid to the people who really need it. I'll be able to independently maintain myself by the money I will earn. Sure, there are quite a few people who are not able to do this. I do not rely on pension and state subsidy after retirement,” – says Kostiantyn Sheygas, a senior student from the Kyiv Food Industry University.

It seems that the Government of Ukraine will prolong its public campaign to engage more citizens in this debate on their future. It is well advised to do so and the World Bank will continue to offer its expert advice. Pension reform may never become hugely popular, but people can learn to see its necessity and place it in a broader context of balancing the costs of the necessary adjustment. To this effect, already several compensation mechanisms have been introduced into the draft law.

As Martin Raiser stressed in his address to the parliament:“There is in our view no alternative to the measures proposed in draft pension law. These measures are fiscally responsible, socially balanced and lay the foundations for pension system that guarantees a living pension not just to today's pensioners but also to tomorrow's”.

Volodymyr Mykytovych will not see the benefits of this reform immediately. But, if it is postponed, he may soon find that his meager pension has been further reduced as the costs of an unsustainable system weigh ever more heavily on Ukraine’s budget.