Transformation of Social Security: Pensions in Central-Eastern Europe

In the past decade, the countries of Central and Eastern Europe have witnessed sweeping changes in their economies and societies. Compared with this, the area of social security has long remained exempt from structural change, with the exception of the introduction of unemployment benefits - a reaction to open unemployment, so far unknown in Central and Eastern Europe (cf. Götting 1996).

The transition from a socialist planned economy to a capitalist market economy is all about private property, money, and markets - elements of the economic order which were more or less absent under socialism. Socialism is all about distribution and social security. Hence the old system must have been well equipped with social policy institutions. Transformation of social security seems to be less urgent. This hypothesis is borne out if we look into the early literature on transformation (e.g. Gros and Steinherr 1995;Lavigne 1995;Balcerowicz 1995) and if we observe transition policy in Central and Eastern Europe. Typical steps of transformation are: price liberalisation, external liberalisation, macroeconomic stabilisation, privatisation, financial sector reforms. The intermediate effect of transformation policy is seen in the efforts to restructure the economy, while ultimate success is measured by sustained welfare growth. In some instances the social safety net is mentioned as necessary for the acceptance of reform, but during the first phase of transformation it seldom deserves an own chapter either in reform literature or in reform policy programmes.

In all systems of social protection, an inherent tension exists between the financing (who pays, how much, on what basis and through what institutions), and the coverage and extent of benefits (who receives, how much, for what contingencies, for how long and according to what criteria). Developments in the transition economies of Central and Eastern Europe have significantly altered the previously established balance between these opposing pressures (cf. ILO 1995: 39).

Reforms of the existing public pension systems are now being discussed in many industrial nations. Especially in countries with pronounced below-replacement fertility, such as Italy and Germany, the present mode of pay-as-you-go (PAYG) financing is seen by many observers as not suited to provide an adequate level of retirement income at acceptable costs for the working generation, just as soon as the “baby-boom” generation starts retiring in the third decade of the next century. Some are even convinced that a radical change of the system is urgently required since they see it as already being “on the verge of collapse” (cf. Börsch-Supan 1998).

Pension reform is a topic discussed all over the world, in industrialised countries, in developing countries and in former socialist countries. Since the collapse of the economic and political systems of the countries that were “behind the Iron Curtain”, discussions are focused more and more on basic questions of designing pension protection. Especially the public-private mix has become a central topic of debate. In many countries the privatisation of pensions is proposed. In economic journals a shift from pay-as-you-go (PAYG) financing to capital funding is the major topic when dealing with pension schemes. However, there are more topics to discuss and instruments to cope with the problems to be solved.

During the last four decades, Latin America has been an interesting and dynamic object of study as far as its efforts in stabilisation and development are concerned. Different schools of economic theory were able to test their recipes against chronic inflation and budget deficits, balance of payment crises, weak currencies, underdeveloped product and financial markets, and poor living conditions of the countries’ populations - unfortunately without much success.

After a long-standing debate and the presentation of diverse pension reform proposals, a new pension system is now due in 1999. This will comprise the introduction of a completely new pension formula; the current defined benefit scheme will be replaced by a defined contribution one. The method of system financing will be changed. The obligatory pension pillar will be split in two, with the first pillar remaining pay-as-you-go (PAYG), as before, and the second now fully-funded.¹

In Poland, similar to other countries in Central and Eastern Europe, the transition from a centrally planned economy to a market economy with its economic and political problems caused a situation that made a pension system reform necessary.

The issue of actors and paradigms of old-age security reforms undertaken in states which went through several years of substantial system transformation - from the céntrally-governed economy to the market economy - is a difficult subject. The image is obscured by difficult political processes in these countries. The formation of political parties with clear-cut programmes does not live up to social expectations. It is also too slow in Poland (in February 1995 there were 265 political parties registered in this country), which has been distinguished among other Central and Eastern European states as a country with an organised political opposition since the mid-1970s.¹

The Hungarian pension system changed significantly in 1998, when the national assembly introduced a mandatory funded scheme, thus combining a well-matured national pay-as-you-go (PAYG) system and a still young and thin pillar of mutual benefit funds. The purpose of this paper is to give an outline of the major trends in pension issues prior to the reform. Surprisingly, literature offers a rather one-sided picture. Whereas the analysis of the underlying trends that increased expenditures on pensions has been well documented, little has been done on issues that usually precede such reforms: the incentive effects of a social security pension system on savings, labour supply and fertility. Whereas we know much about the institutional and financial history of the introduction and maturation of the first national pension scheme, our systematic knowledge is rather limited when it comes to individual responses to such developments.

The Pension Law of 1997 has aroused the interest of the public as well as the experts in the Hungarian pension system. But the Hungarian pension reform is an ongoing process. From my point of view it is enough to go back to 1992, when the present institutional framework of the Hungarian pension system was set up, and, however imperfectly, the valorisation of assessed earnings and indexation of pensions were introduced. A second important stage was 1996 when the long-delayed but unavoidable rise of the pensionable age was enacted. Currently we have arrived at the third stage: the partial and step-by-step funding and privatisation of the pay-as-you-go (PAYG) public pension system, and the concomitant modernisation of the public pillar.

The history of the Hungarian public pension system started in 1912 with a budget-financed scheme for civil servants. It continued with a more general scheme (Act XL of 1928) for employees and workers in trade and industry, but not in agriculture. This system was funded and operated with a governing board until 1950.² It had hardly started to pay benefits before it was transformed into a pay-as-you-go (PAYG), state-managed system soon after the war. The coverage of those in the `active age groups’ was under one third in 1940. It increased steadily from 1950 onwards. Pensions only reached relatively acceptable levels, however, from the mid-seventies onwards. The replacement rate increased from 22% in 1950 to 56% in 1985, reaching a peak of 66% in 1990. Since then it has slowly been declining again (being 61% in 1995).

In the Czech Republic, economic reforms were started at the beginning of the nineties. At the same time fundamental social reforms were launched. The aim of this transformation process was to create a social security system that would correspond to the needs of the market economy, i.e. a system able to absorb the social risks accompanying the free market (e.g. unemployment). Another objective of the social security reform consisted in stimulating individuals and social groups to assume greater responsibility for their own social situation without relying on state benefits. Furthermore, in the context of Czech international relations policy, it was important to adapt the social security system to international conventions and to harmonise the legislation with European social insurance systems.

The Czech Republic, as well as other transition countries, has been undergoing a fairly rapid process of ageing, since mortality has decreased - and life expectancy thus increased - in a context of diminishing fertility. This relatively fast change in age structure undermines the predominant pay-as-you-go (PAYG) pension systems in transition countries and leads to growing budget deficits in Hungary, Poland and Slovakia. So far, the Czech Republic has been spared this development, since it has kept unemployment extremely low, and has reformed the PAYG system thoroughly. Nevertheless, the growing budget strains and increasing ranks of pensioners are bound to put the Czech pension system under pressure, as well. If, as now seems likely, the current working generation cannot rely on the state to provide for its pensions by taxing future workers, it will become crucial to understand whether private voluntary pension funds can substitute the public pension system. An increase in private savings for retirement may represent an important factor in abating future problems in financing pensions.

Our basic question is whether old-age pensioners are among the losers or the winners of economic transition in Central-Eastern Europe (CEE). Here, we focus on the distributional effects of the recent pension reforms in Poland, Hungary and the Czech Republic. In addition, the financial situation of public pension schemes and their fiscal consequences are considered.

Ageing populations and public pension schemes that are in financial trouble, as well as a novel wave of pension reforms in Latin America, have triggered off renewed debate about the need to reform old-age security schemes in many parts of the world. Is it sufficient to adapt technical parameters - such as coverage, eligibility, benefit formulas and retirement age -, while basically maintaining a public pay-as-you-go (PAYG) system? Or is a private, fully funded (FF) pension scheme, such as the one introduced in Chile² in 1981, a more appropriate solution to short-and long-term problems?