The responsibilities of the World Bank in the current Pension Crisis need to be stressed. Over the last twenty years the Bank continuously, persistently and relentlessly advocated and promoted the transition from a dominant Pay As You Go to a dominant “funded” pension system, in its countries of operation and – through its general influence on government policies – worldwide. Such a move – wrapped up nicely, sealed and delivered as a “multi-pillar” package – transformed part or all of a virtual public debt, implicit in pension rights matured under the old PAYG system but sustainable in a continuing system, into an explicit real public debt that put a heavy strain on the fiscal resources of reforming countries. The move to a funded system also exposed old age pensioners to the risks of fluctuations and trends in the price of pension funds assets.
The World Bank now says little about its own performance in pension reform, apart from the bland criticisms, mostly on the ground of “overselling” funded systems, voiced in its own “independent” assessment.
The official World Bank position is summarized in a “Note” issued by its Human Development Network and published on 10 October 2008 [prepared by Mark Dorfman, Richard Hinz and David Robalino under the direction of Robert Holzmann]: The Financial Crisis and Mandatory Pension Systems in Developing Countries.
“The note discusses the potential impacts of the financial crisis on fully funded and pay-as-you-go retirement-income systems in World Bank client countries, and identifies key short- and medium-term policy responses. The note does not go into depth on the issued [sic] identified. Stand-alone technical notes will be prepared subsequently. This note itself will be updated and refined as new issues emerge”.
But repeated searches on Internet cannot find any such stand-alone technical notes, or updating, or refinements. Non-quotable papers originated in the Bank circulate informally but do not seem to add much. The valiant officials that drafted that Note did the best of a bad job, but the end result is a feeble, defensive, obfuscating collection of half-truths.
Seven Half Truths: 1. “No pension system is immune”
Half Truth n.1: Both funded and PAYG pension systems are in a crisis: “The international financial crisis has severely affected the value of pension fund assets worldwide. The unfolding global recession will also impose pressures on public pension schemes financed on a pay-as-you-go basis, while limiting the capacity of governments to mitigate both of these effects” (p.1).
The missing, other half, of the truth is that, as a result of the crisis, the additional pressure on funded systems is about ten times larger than on PAYG systems. The pension contributions of a PAYG system fall roughly at the same rate as GDP (a bit more or a bit less according to whether the wage share and/or the pension contribution rate fall or rise, or retirement age rises or falls), i.e. a few percentage points. Whereas the fall in the value of pension funds assets in 2008-2009 has been of the order of magnitude of 30-50 per cent or more. In a presentation to AARP (American Association of Retired Persons) International Section, on 16 December 2008, Robert Holzmann acknowledged that:
“Over the last 12 months, retirement accounts have lost $2 to $3 trillion in value. Between the 2nd quarters of 2007 and 2008, private pension fund assets declined by over half a billion dollars while state and local pension funds declined at rate of nearly $350 billion”... “rates of return for client countries with funded systems have decreased in value from a low of 8 percent to a high of more than 50 percent.”
This was at end-2008; the situation has much worsened in the first half of 2009 and will not improve until 2010.
2. Small Numbers
Half-Truth n.2: “… only a small number of retiring individuals are affected by the crisis”.
How could it be otherwise? “The other, missing, half of the truth is that this is not thanks to World Bank promoted reforms, but because of lateness, slowness or incompleteness in their implementation.
Many countries still have a dominant PAYG system, which is unaffected by asset values. In the EU, for instance:
“In the majority of member-states PAYG provides almost all the pension income for those retiring today and there are only five member-states where funded provision is above 10% (these are Denmark on 16%, Slovenia and UK both on 22%, Ireland on 54%, and the Netherlands on 60%). A further three member-states are at, or slightly below, the 10% level (Germany, Cyprus, Belgium)” (Jerome Vignon [unsigned] “Non Paper – Pensions and the Financial Crisis – Informal Background Briefing Note”, European Commission, Directorate for Economic and Financial Affairs, December 2008).
Moreover, most of the countries that have implemented the transition to a funded system have done it too recently, and gradually enough, to have a significant impact – also due to exempting older workers or even leaving the change voluntary instead of mandatory. See the Table below (Vignon, cited). Even Mexico, that made the change twenty years ago, excluded the over thirty.
3. Multi-pillar diversification
Half-Truth n.3. “The current crisis strengthens the need for a diversified multi-pillar system” (from the World Bank “Note” cited above). Next to a first pillar of PAYG or anyway a defined benefits system, a second “fully funded” pillar of defined contributions, a third pillar of voluntary savings, in that “Note” the World Bank now advocates as well even a “zero pillar” (sic), of non-contributory public pensions to take care of poverty amongst the aged. Which is fine, there is nothing to prevent individuals from saving or governments from making transfers to the poor. Except that diversification of pension systems is only needed to reduce the riskiness of the second and the third “fully funded” pillars, for both the first and the zero pillar do not depend on the price of financial assets.
If anything diversification is needed within the second pillar (and the third, but that is a matter for the individual saver not for public policy other than for tax incentives). So much so that the Bank advocates a “life-cycle” approach reducing the share of equities and raising that of government bonds in individual portfolios with the nearing of retirement age, and “the development of phased transitions to the payout of benefits that limit the impact of short term financial volatility” (Holzman, quoted above). Which is also fine, except that one wonders what has become of the presumed advantages of funded systems in terms of “choice”, reliance on stock markets rather than the state, and the enhancement of financial markets. What difference do pension funds make if they just intermediate between pensioners and the state?
4. Smoothing
Half-Truth n. 4. Governments should reconsider “the valuation rules applicable to pension fund assets in the context of the extreme current volatility in financial markets”, namely relaxing mark-to-market rules and allowing some “smoothing” valuation in order to:
“more accurately reflect the true underlying values and avoid the possible adverse reactions to large changes that prove to be very short run” (the “Note” cited).
This of course would be beneficial to pension funds valuation but at the cost of the associated loss of transparency and disclosure. We know that banks have often abused of the relaxation of accounting rules in the valuation of their toxic assets; why tempt pension funds? It would be a high price to pay for a mostly cosmetic improvement.
5. Black Swans
Half-Truth n.5. “The current financial crisis is a rare “extreme” event” (from the World Bank “Note” cited above). Robert Holzman (in the presentation cited above) sticks his neck out further:
“the current financial crisis is an extremely rare event, similar to those that have taken place every 50, 80, or 100 years in the past”.
Well, 1929 was eighty years ago; even a single major crisis every eighty years means that everybody will be affected, either directly or through their parents or children. Nassim Nicholas Taleb’s bestseller, The Black Swan – The Impact of the Highly Improbable, (Random House, 2007) should be mandatory reading for the World Bank “Human Development Network” officials.
6. No Shocks
Half-Truth n.6. “Abrupt policy changes in response to the immediate circumstances should be avoided”. Compared with World Bank advocacy of shock therapy in post-socialist economies in the 1990s, this call for gradualism, experimentation and reflection is only to be welcomed. As long as this does not involve a state of denial – which is what the Note suggests – and a failure to learn from current events.
7. No Reversals
Half-Truth n.7. “Governments should avoid short-term reform reversals that have not been properly assessed and that may come at a high price for future retirees” (from the “Note” cited). In the unlikely event that current contributions, instead of accumulating in individual accounts, were simply diverted towards the payment of current pensions, this would be highway robbery, of course. But let us suppose a 100%, 180 degree reversal of the pension reforms implemented in the last twenty years, from fully-funded back to PAYG.
During this reversal, or re-transition, current employees would keep their entitlement to the pension they have already matured corresponding to their cumulative investments up to the time of reversal. Their ailing, undervalued if not toxic investments would be transferred to the state, and for the rest of their working life they would mature an entitlement to a full PAYG pension minus what they would have matured in the years before reversal. The reversal would raise over time the virtual, implicit pension debt of the state (negligible in the literal sense that it can be neglected in a continuously operating system, as long as the system is balanced or its possible imbalance is affordable) but would decrease the explicit state debt by the value of pension funds transferred to the state. It would also eliminate completely pensioners’ exposure to financial markets risk.
State bankruptcy and Armageddon would remain uncovered, but the first presumably would affect also financial markets and funded pensions, and its impact would be temporary (see Russia in the 1990s); while the second would not be a problem but a solution.
Half-Truth n.3. “The current crisis strengthens the need for a diversified multi-pillar system” (from the World Bank “Note” cited above). Next to a first pillar of PAYG or anyway a defined benefits system, a second “fully funded” pillar of defined contributions, a third pillar of voluntary savings, in that “Note” the World Bank now advocates as well even a “zero pillar” (sic), of non-contributory public pensions to take care of poverty amongst the aged. Which is fine, there is nothing to prevent individuals from saving or governments from making transfers to the poor. Except that diversification of pension systems is only needed to reduce the riskiness of the second and the third “fully funded” pillars, for both the first and the zero pillar do not depend on the price of financial assets.
If anything diversification is needed within the second pillar (and the third, but that is a matter for the individual saver not for public policy other than for tax incentives). So much so that the Bank advocates a “life-cycle” approach reducing the share of equities and raising that of government bonds in individual portfolios with the nearing of retirement age, and “the development of phased transitions to the payout of benefits that limit the impact of short term financial volatility” (Holzman, quoted above). Which is also fine, except that one wonders what has become of the presumed advantages of funded systems in terms of “choice”, reliance on stock markets rather than the state, and the enhancement of financial markets. What difference do pension funds make if they just intermediate between pensioners and the state?
4. Smoothing
Half-Truth n. 4. Governments should reconsider “the valuation rules applicable to pension fund assets in the context of the extreme current volatility in financial markets”, namely relaxing mark-to-market rules and allowing some “smoothing” valuation in order to:
“more accurately reflect the true underlying values and avoid the possible adverse reactions to large changes that prove to be very short run” (the “Note” cited).
This of course would be beneficial to pension funds valuation but at the cost of the associated loss of transparency and disclosure. We know that banks have often abused of the relaxation of accounting rules in the valuation of their toxic assets; why tempt pension funds? It would be a high price to pay for a mostly cosmetic improvement.
5. Black Swans
Half-Truth n.5. “The current financial crisis is a rare “extreme” event” (from the World Bank “Note” cited above). Robert Holzman (in the presentation cited above) sticks his neck out further:
“the current financial crisis is an extremely rare event, similar to those that have taken place every 50, 80, or 100 years in the past”.
Well, 1929 was eighty years ago; even a single major crisis every eighty years means that everybody will be affected, either directly or through their parents or children. Nassim Nicholas Taleb’s bestseller, The Black Swan – The Impact of the Highly Improbable, (Random House, 2007) should be mandatory reading for the World Bank “Human Development Network” officials.
6. No Shocks
Half-Truth n.6. “Abrupt policy changes in response to the immediate circumstances should be avoided”. Compared with World Bank advocacy of shock therapy in post-socialist economies in the 1990s, this call for gradualism, experimentation and reflection is only to be welcomed. As long as this does not involve a state of denial – which is what the Note suggests – and a failure to learn from current events.
7. No Reversals
Half-Truth n.7. “Governments should avoid short-term reform reversals that have not been properly assessed and that may come at a high price for future retirees” (from the “Note” cited). In the unlikely event that current contributions, instead of accumulating in individual accounts, were simply diverted towards the payment of current pensions, this would be highway robbery, of course. But let us suppose a 100%, 180 degree reversal of the pension reforms implemented in the last twenty years, from fully-funded back to PAYG.
During this reversal, or re-transition, current employees would keep their entitlement to the pension they have already matured corresponding to their cumulative investments up to the time of reversal. Their ailing, undervalued if not toxic investments would be transferred to the state, and for the rest of their working life they would mature an entitlement to a full PAYG pension minus what they would have matured in the years before reversal. The reversal would raise over time the virtual, implicit pension debt of the state (negligible in the literal sense that it can be neglected in a continuously operating system, as long as the system is balanced or its possible imbalance is affordable) but would decrease the explicit state debt by the value of pension funds transferred to the state. It would also eliminate completely pensioners’ exposure to financial markets risk.
State bankruptcy and Armageddon would remain uncovered, but the first presumably would affect also financial markets and funded pensions, and its impact would be temporary (see Russia in the 1990s); while the second would not be a problem but a solution.
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