OREANDA-NEWS. February 16, 2011. Why Ukraine must immediately reform the pension system?

There is no alternative to government measures.

Pension reform - one of the priorities of the Ukrainian Government in 2011. Such attention to this issue is quite justified, because financial reform is necessary now. In addition, it is also a matter of social justice and long-term competitiveness of Ukrainian economy.

Ukraine has the world's largest share of spending on pensions - 18% of GDP in 2010. Moreover, one of the highest levels of pension contributions in Europe, representing 35% of gross salary. In addition, despite that in 2010 an amount equivalent to 7% of GDP was transferred from the budget to the pension fund.

Transfer of huge funds from the budget to cover pension payments leads to a reduction of the amount needed to improve the quality of education of Ukrainian children, and quality of medical care. It also reduces the opportunities for investment in infrastructure to improve the competitiveness of the economy, creating jobs and raising income levels of all citizens.

If you do nothing, the situation would be worsened further. In 10 years for each worker there will be one pensioner, and according to forecast the share of working population in future would only diminish. Without necessary adjustments the current pension system remains financially viable.

There are three possible solutions to this problem: either to cut pensions or increase the size of pension contributions, or to encourage employees to remain longer in the labour market. Given the small size of the average pension, the reduction of pensions is not an option. Increasing the size of contributions is also unacceptable, because they are already quite high and it will further enhance the growth of the shadow economy.

The way to solve this problem would be to encourage employees to work longer, and reduce costs associated with payment of special pensions, which are transferred from the budget. These are the actions included in legislative proposals drafted by the Government, which include:

* gradual increase in retirement age for women from 55 to 60 years, 6 months each year;
* length of service increase for minimum pension allocation (for 10 years);
* implementation of the initial steps towards the harmonization of the special pension schemes with the general system.

Starting 2012 the measures proposed by the government will allow annual savings on pension costs amounting to about 1.5% of GDP. And till 2015 Pension Fund deficit budget financing will disappear.

During public discussions that are ongoing in Ukraine, concerns are expressed that the proposed reform imposes too heavy social burden on the population. It is not like that. In many European countries under the pressure of demographic and fiscal problems, the governments were forced to pension reform. The reform proposed by Ukraine is one of the most socially balanced in the region. Women who are directly affected by it will receive during the transition period the supplement to pensions and budget sector employees also will receive additional compensation. In addition, the reform will take place very slowly: the process of raising the retirement age will end only in 10 years, and it should start now.

During public debates a concern was also expressed that if the retirement age increased to 60, and the average life expectancy of only a few years longer, people would not have time for life in retirement. This is not entirely correct. In fact, the average life expectancy of women aged 60 is 80 years, an average woman can live another 20 years after retirement. This level is very close to the corresponding rate in other European countries, although one must admit that life expectancy at birth in Ukraine will remain much lower.

Another point of view, that you can hear during the debate on pension reform, links the current problems of the pension system with lowering the declared wages. But, it does not fully reflect the real state of things. Too large expenses for retirement forced all the previous governments to maintain high levels of contributions. However, large contributions, in turn, prompted employers and employees to hide the real wage, thus expanding shadow economy. This pernicious circle can be broken only at first reducing pension contributions and thereby balancing pension finance. Once this is achieved, you can take additional measures to strengthen the administrative influence, and establish a more direct link between contributions and pension benefits, thus creating incentives for employees to report their income.

In this regard, an opinion that the introduction of so-called "second level" within which the workers pay contributions to personal savings accounts and then in the future will receive pension proportional to contributions made, will create incentives for honest reporting of wages and improve discipline to pay contributions. This can become a reality, but only if the contributors are confident that their accumulation is not in danger and they are invested properly. This in turn requires the creation of appropriate institutional conditions and functioning of capital markets. Experience to implement multi pension systems in the world shows that there are significant risks associated with the premature introduction of mandatory funded pension schemes. However, whatever is the prospect of the next phase of pension reform, without the first steps aimed at balancing the budget of the pension fund, no reform can be successful.

Finally, in our opinion there is no alternative to the activities offered by the Government. They are financially responsible, socially balanced and laid the foundations for the pension system, which allows to pay pensions not only for current but also for future pensioners.
 
Martin Raiser, World Bank Director for Ukraine, Belarus and Moldova.