Greek social security system requires a new mix

eKathimerini – The pension system has been behind Greece’s fiscal derailment and the piling up of large public debt. Therefore, a substantial decrease in annual pension expenditure is important in achieving fiscal consolidation in the medium-to-long run and cutting into the large stock of debt. Despite progress made since 2010, the numbers of the pay-as-you-go pension system do not add up. However, the solution is not just some parametric changes and further rationalization of the system, but the gradual, perhaps lengthy transition into a new one.

Tasos Giannitsis, the former minister who tried to overhaul the pension system about 15 years ago, could not have said it better. In a speech last January, he said the ailing social security system was the most important factor behind Greece’s economic crisis. It is reminded the country sought a bailout from the EU in May 2010 after being shut out of the markets on the back of a budget deficit in excess of 15 percent of GDP in 2009.

To support his view, Giannitsis said the cumulative, state spending on the social security system amounted to 71 billion euros from 2006 through 2009. This accounts for 83 percent of the cumulative budget deficits, amounting to 80 billion euros, during the same period. According to him, state expenditure on social security accounted for 83.6 percent of the increase in public debt between 2000 and 2009. “Without this effect, the country would have ended up with a debt in 2009 which would not have created such as a serious problem,” he noted.

True, the country legislated major pension reforms in 2010 and 2012 and to a lesser extent in 201,5 but some of them have not being implemented. Moreover, the sharp drop in the Gross Domestic Product (GDP) since 2008, barring a rebound of 0.7 percent in 2014, has pushed public expenditure on pensions from 12.3 percent of GDP in 2008 to more than 17 percent in 2015. Therefore, it does not come as a surprise that IMF’s Poul Thomsen remarked that the sustainability of the Greek debt requires both a substantial reduction in annual pension expenditures and significant debt relief.

As the OECD’s March report on Greece points out, the government has presented a pension reform plan that seeks “to abolish all special pension regimes, restructure the supplementary pension and create a general common defined-benefit pillar, and a basic pension financed with general tax revenues”. Of course, details of the plan are being negotiated with the creditors with the goal of producing savings equal to 1 percent of GDP. And the government wants to push some cuts in main existing pensions beyond 2018 to minimize the political cost.

Certainly, there are a number of ways to get there. One way is to adjust the gross replacement rate lower. In 2008, Greece had the second highest replacement rate in the OECD since gross pension entitlements represented 90 percent of the gross pre-retirement earnings. The replacement ratio had come down considerably to around 68 percent in 2014 but was still above the OECD average of around 52-53 percent.

However, people who are familiar with the pay-as-you-go pension system, where the contributions of the employees are shared between the retirees, argue that only a magician can find a solution given the structure of the system. Although pensions have suffered several cuts since 2010, they are still, on average, generous. They point out the average pension was around 960 euros per month in 2015, citing the estimate in the 2015 budget, which is slightly lower than the average salary of 987 euros declared by full-time employees in 2014. In other words, you need the contributions of three salaried workers to pay the average pension, which includes both the main and the supplementary components.

According to these experts, things are bound to get worse since the population is aging. Greece is among the top five countries of the OECD with the highest proportion of 65-year-olds and above in the population. It also has 2.66 million retirees and about 3.6 million workers but some of latter do not pay social contributions because they cannot afford it or other reasons. The ratio of employees, who pay regularly contributions, to pensioners is estimated around 1 to 1.1 according to these experts.

Even if the pensions fall further, the contributions will have to go up significantly to preserve the current system, hurting the employees, some of whom will likely collect peanuts when they retire. However, an increase in contributions will hurt employment, encourage work in the black market and certainly undermine intergenerational solidarity. Already, a growing number of young people seem to understand the stalemate and do not trust the pension system.

There is no doubt that the rationalization of the current pension system will breathe some life into it and contain old-age expenditure, helping fiscal consolidation. However, the real, sustainable solution is to change regime, i.e. to gradually move from the current, distributive pension system into a mixed one where state expenditure on pensions is getting smaller while benefits from occupational and funded private schemes are gaining ground. It is reminded contributions in a fully funded scheme are saved in a fund and blocked until retirement.

The transition to a mixed pension system could take place in one or two decades but the process has to be initiated as soon as possible. Utopian? Perhaps, since the previous Greek governments were hesitant to initiate it and the current, leftist government opposes it on ideological grounds. Still, this is necessary for sustainable fiscal consolidation and debt reduction.

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