Making Sense of Pension Reform

WARSAW – Pension reform has become one of the most troubling fiscal dilemmas facing developed countries, especially those with a shrinking workforce and an aging population. The issues are both complex and controversial, while seeming quite dull to much, if not most, of the public. As a result, serious discussion is too often hijacked by those with an ulterior motive.

Consider the intemperate responses to recent proposals by Poland’s government to resolve its pension system’s problems. The proposals have been disparaged as the “nationalization of private assets,” a “pension swindle,” and “an asset grab worthy of Lenin or Stalin.” In fact, the reforms are a sensible and sustainable response to the fiscal squeeze that many other developed (and some developing) countries are facing.

Since the mid-1990’s, many countries in Central and Eastern Europe have adopted the so-called three-pillar pension system, comprising a publicly managed, pay-as-you-go (PAYG) pillar; a privately managed, mandatory, defined-contribution pillar; and a supplementary, voluntary private pillar. Like many pension schemes, compulsory employer and employee contributions underpin the system.

In 1999, Poland replaced its defined-benefits system, which sets pensions as a percentage of final salary at retirement, with one in which pensions are based on the accumulated value of contributions during a person’s working life. This allowed the government to cap the system’s liabilities while reducing expected final-salary replacement rates by about one-half. The fiscal position was further strengthened when the government raised the retirement age to 67.