The Bank of Estonia, presenting its initial effects analysis regarding Estonia’s planned pension reform on Monday, pointed out several ways the government’s plan of making the second pillar of pension voluntary could backfire. Politicians pushing the reform describe the analysis as nothing new.
The analysis presented yesterday, the full version of which the central bank promises to publish in late October, concludes that potentially lower future pensions could force politicians to look to tax hikes.
“If it [the second pillar] disappears, it means lower pensions that will in turn create strong political pressure to help those with very modest pensions. It will translate into pressure to hike the social tax rate,” said Martti Randveer from the central bank’s monetary policy and economic research division.
The conclusion was drawn by looking at people’s financial behavior. For example, 5,000 people were asked about their willingness to take financial risks. It turned out that 77 percent of people were not willing to take any risk. “If a person is averse to taking risks, their pension savings will grow that much slower,” Randveer explained.
The bank also compared those who have made payments to the second pillar over the years and those who haven’t. “Pension assets of people who joined the second pillar are considerably bigger. Savings of people who decided to put money aside themselves are modest,” the central bank expert said.
Asked whether making funded pension voluntary could also have positive aspects, Randveer hesitantly offered that perhaps it would be so in cases where people have serious health problems. “Generally speaking, this kind of mandatory saving is better at ensuring sufficient pension in the future,” he said.
Increased poverty risk
This is why the analysis forecasts greater risk of poverty for retirement-age people if mandatory funded pension is abolished. “People will be given the chance to spend their pension savings in a very short window,” said Governor of the Bank of Estonia Madis Müller.
The government is planning to make mandatory funded pension voluntary from 2021. The central bank’s calculations suggest Estonian pension funds will hold €5 billion by then. It is believed around 10 percent of that will be withdrawn and spent in a short time. That said, the Bank of Estonia finds that people’s behavior cannot be reliably forecast, which is why actual sums might be bigger and come to affect economic growth.
The central bank perceives a danger here – a lot of people withdrawing their pension funds in a short time could deliver a temporary growth spurt coming down from which would hurt the economy. “This temporary boost would be followed by a slump or even recession that would hurt people’s standard of living,” Müller said. Increased consumption would bring price and salary advance; however, once the money is spent, consumption will fall, and jobs created in the meantime will disappear again.
This kind of momentary growth would hurt exporting companies’ competitive ability for a long time. “Temporary growth created by a spike in consumption would slow, while labor costs would remain high,” the central bank forecasts.
Banks invest the lion’s share of Estonian’s pension money abroad because of better productivity of shares there and the fact they are easier to sell. Liquidity is poorer when investing in the Estonian economy – this means that shares of Estonian companies are more difficult to unload than Apple’s for example. The situation has started to improve in recent years and banks have found the courage to invest in local ventures. The Bank of Estonia effects analysis finds that if pension savers are given the right to withdraw their savings at any given time, risks will grow and send banks looking abroad once more.
Taking into consideration all of the aforementioned dangers, the central bank concludes that making funded pensions voluntary might not be a good idea and recommends the government not to move forward with the plan. However, political pressure to make the change is considerable. Minister of Finance Martin Helme (EKRE) said at a Bank of Estonia seminar a few weeks ago that critics of the pension reform are fighting a lost battle as the government has made up its mind.
The government plans to pass the pension reform this year, with it taking effect in 2021. Neither ministers, MPs nor the Bank of Estonia have seen a specific bill, however.
“The government has made known the reform’s primary starting points, also as concerns pension investment accounts. Provided there will be no great surprises, we are aware of the primary parameters,” Randveer said, adding that there being no draft legislation was not an obstacle in terms of the analysis.
Government in a hurry
The Bank of Estonia finds it insensible the government is rushing the reform. “If at all possible, changes this big should be carried out based on broad-based social contracts. It would be sad indeed to see every new coalition amend the pension system. It would be naive to think this change will remain the last,” Randveer said.
Madis Müller also said that a pension system at the mercy of political winds could end up harmful. “The pension system should not be reshaped every four years as it makes it very difficult for people to put faith in it,” the central bank governor added.
The Bank of Estonia presented its initial analysis to the government last Friday. Neither Prime Minister Jüri Ratas (Center) nor Minister of the Interior Mart Helme (EKRE) were up to speed on it by yesterday afternoon and refused to comment.
Chairman of the Isamaa party, the election program of which included the reform promise, Helir-Valdor Seeder described the central bank’s conclusions as nothing new and said fears are unfounded as people are very unlikely to withdraw and spends pension savings all at the same time. Seeder said he believes making funded pension voluntary will have no great effect on the economy. The politician added that the Ministry of Finance and other institutions will definitely put together further effects analyses of the reform.