Cause and Effect in European Politics and Law

Accounting lifting in exchange for pension reforms

Ralitsa Kovacheva, Adelina Marini, August 23, 2010

How much does a pension reform cost and could these costs be "deducted" from the budget deficit and the public debt? This is the question that the letter of 9 mostly Eastern European EU Member States, among which Bulgaria (Latvia, Lithuania, Sweden, Bulgaria, Slovakia, Hungary, Romania Poland, the Czech Republic), has raised. The letter, initiated by Poland, is in fact a proposal to the task-force, headed by European Council President Herman van Rompuy, which has to develop the new rules for European economic governance. It is expected the final report of the task-force to be discussed (and probably endorsed) at the European Council in October.

Maybe this is why the letter of the nine countries has appeared in this very moment - in order to be included in the common package of ideas, being discussed by the task-force. And as its task is mainly to tighten control and sanctions over countries, violating the Stability and Growth Pact, with a special focus on indebtedness, when if not now any potential violators can negotiate an "opt-out" in order to insure themselves against punishments in the future?

The offer

In their letter the nine countries propose a change in the method of calculation of budget deficit and indebtedness in a way that the costs for pension reforms could be deducted. The idea is that the transfer of part of the costs to private funds has opened a deficit in the social insurance which is being filled with budgetary funds, thus leading to a jump of deficit and debt.

According to the economic analyst from the Institute for Market Economy (IME) Petar Ganev, the letter is an expression of those countries' aspiration to implement their promises for pension reforms but without this to have an impact on their deficit and debt indicators: "The more contributions are being redirected from the solidarity model to private pension accounts, the more difficult it becomes the state to finance the current pensions - this is often called costs of the reform, but in fact it is the costs of the old inefficient system. If there is no reform, these costs would exist again and would grow higher and higher. These pension payments are a burden for the budget which often leads to deficit and additional borrowing. This is what this letter is about. These countries most likely realise that the reform is inevitable and they seek ways to avoid the burden of already made promises - from the burden of the old system. There is no way these promises to be kept because this would mean not only a fall of the government but also, most probably, of the building where it is situated".

To what extent the wish of the nine the expenses for pension reforms to be deducted from debt and deficit is realistic and well founded? Poland, for example, has estimated that the annual contributions to private pension funds are worth 2% of GDP. If the costs for the pension reform are to be deducted, the Polish debt would drop by 10 per cent - from 50% to 40% of GDP, according to the estimations of the ruling party Civil Platform.

But for Petar Ganev "debt is not just a forfeited indicator, used only for euro area accession, it also shows what the indebtedness of a country is, to what extent its public finances are sustainable, to what extent it is solvent, etc. It does not matter what justification (pension reform) you have for a commitment, the commitment itself is what is important. Even some expenses to be omitted from the calculations when the implementation of the Maastricht criteria is being monitored, this would be a political act far from the area of economy - such expenses would again weigh and would have a real impact on a country's solvency".

In their letter the nine countries claim that the current method of calculating debt and deficit will lead to unequal treatment of Member States and would practically punish the reforming countries. Quite the contrary is the position of the German financial ministry, which has announced that it was "skeptical" toward the idea and that any different treatment would make it even harder to compare the budgetary policies of Member States. Although in the letter the nine explicitly state their support for the German proposal for automatic sanctions against members, violating the Stability and Growth Pact, this is obviously not convincing enough. According to the German financial ministry, allowing such an exception would open Pandora's box for special requests which would make the European rules for national budgets pointless in time when Germany wants them tightened.

The economist Petar Ganev says that unburdening the debt and deficit criteria (because the deduction of pension reforms costs would be defined exactly like this) would deprive countries of a stimulus to lead a reasonable budgetary policy, to cut spending and to seek efficiency. No less important is how it would be determined which expenses are related to the reform and which not, what part of pensions payments should not be taken into account and what part will be calculated?

The horse trading

The economist from the Open Society Institute in Sofia Gheorghi Anghelov shares the thesis that the wish of the nine countries is part of the big horse trading in the framework of the negotiations for new rules of the Stability and Growth Pact, a form of pressure of small states on big ones for some concessions in return for support for tightening of budget policy: "After saving Greece and the creation of a Rescue Fund worth nearly 1 trillion dollars, the pressure for tightening of rules is huge and obviously this is the road to be taken. As with every big change this one also creates opportunities for trade and negotiations - but only if you gather enough support. Small countries could hardly have any influence separately but together 9 countries could achieve something".

Gheorghi Anghelov offered a very interesting idea, quite the opposite to the proposal in the letter of the nine members: "all commitments (current and future) of the pension systems of all countries to be estimated and included in some kind of a more broader indicator of public debt. Thus, markets would be aware of the burdens of the future pension commitments in all countries, and those performing pension reforms and increasing the capital pillar would be in a better situation, because their long-term debt indicators would be better". Gheorghi Anghelov fears with reason that such a proposal would probably meet opposition from the countries with unreformed pension systems.

The Bulgarian lead

In this entire context Bulgaria is a very interesting case. First of all, unlike most of the other countries that have supported the initiative, Bulgaria has a very small debt (around 15%)* and it is not threatened by sanctions related to debt. The new ideas of the task force envisage keeping the ceiling of public debt to 60% of GDP in the Stability and Growth Pact, but with stricter control over trends of debt increase and imposition of preventive sanctions on countries that do not demonstrate satisfactory levels of public debt reduction.

In fact Bulgaria is getting into debt, but with an "invisible debt", as the economist Gheorghi Stoev from Industry Watch has commented for euinside. Many Bulgarian governments have promised people for years that they would get certain amounts of money, without clarifying where the money would come from, which is debt - fiscal pressure and potential incapability to meet such commitments, he says. Similar thesis presented above the economist from IME Petar Ganev.

The problem of Bulgaria however is the deficit because the country is with an already initiated excessive deficit procedure and is obliged to reduce it to below 3% of GDP yet this year. Sofia is interested in taking part in the group of the nine because of higher budget deficit which would increase significantly if the country would undertake a more radical pension reform. The same applies to the opposite scenario - if the country does not undertake reforms and the problem would deepen further.

Nonetheless, real measures cannot be seen on the horizon. The latest amendments to the Social Insurance Code, approved by the government but yet to be voted by Parliament, provide for an increase of contributions period, aimed at the future pensioners to pay contributions longer and to receive pensions for a shorter period. But nothing is being done about transfer of more money (and covering of more people) in private pension accounts in private funds which would be a real beginning of the reform of the pay-as-you-go model and the creation of a sustainable capital pillar in parallel with the social one. It is such a measure that could increase the deficit and probably the debt.

It is interesting that since Bulgaria has signed the common letter, how would the country defend the costs of a pension reform that it would like to be deducted, in terms of deadlines, measures and numbers. For now, according to euinside's information, such an analysis has not been made so far and there is no clarity about any future actions on the reform nor about its time horizon. What is clear is that the attempt to disguise problems with accounting tricks and the curling of budgetary indicators might earn more time for the government but against the backdrop of the real situation of the pension system and the bad demographic perspectives, such attempts look ridiculous.

The Ministry of Finance specified that Bulgaria had signed the letter only to apply for being included in any future discussions on the matter - something which Gheorghi Anghelov from the Open Society Institute suggested. According to the Ministry, it is still not clear what the time horizon of such a discussion would be because the assessments are yet to be made and every Member State has a separate approach toward its pension system.

Interesting times

For now the concise comment of Brussels is that the proposal is being analysed and would receive a response in the beginning of September. It is curious that Bulgaria is also expecting answers in the same period: whether the European Commission agrees Sofia to absorb loans from the World bank for infrastructure projects in return for higher budget deficit. And also whether the Bulgarian statistical data and methods for estimation of budget forecasts and admissions, fit in the standards of Eurostat. As the Chinese say, interesting times are to come.

*Eurostat data for 2009 on public debt and budget deficit (the first number is the debt level and the second the budgetary deficit):
Bulgaria - 14.8%, 3.9%
Latvia - 36.1%, 9%
Lithuania - 29.3%, 8.9%
Hungary - 78.3%, 4%
Poland - 51%, 7.1%
Slovakia - 35.7%, 6.8%
Sweden - 42.3%, 0.5%
Romania - 23.7%, 8.3%
Czech Republic - 35.4%, 5.9%