Colombo Telegraph

Old-Age Income Insecurity: Reforming Pensions

By Hema Senanayake

Hema Senanayake

Global Economic Revolution Is Overdue; Part 5

New employees of the government who would be recruited from January 01st 2016 onwards will have to pay for their pension, in order to receive their pension entitlements when they retire. So, it is going to be a contributory pension program. This has been proposed in the Budget 2016.

The JVP has already denounced this proposal strongly. The National Trade Union Centre (NTUC), affiliated to the JVP stressed that, “the Budget 2016 had betrayed the working class, the NTUC has vowed to thwart controversial proposal to introduce a contributory pension scheme for those joining the public sector with effect from Jan. 1 next year.” (The Island, Nov. 24, 2015).

JVP is not alone in denouncing contributory pension scheme. Former President Mahinda Rajapakse too had rejected the proposal. He said that, “I am also opposed to bringing new recruits to the government service under a contributory pension scheme from 2016 onwards. The pension is a privilege that the government servants enjoy and it should continue.” (Colombo Telegraph, Nov. 29, 2015).

Whatever the case is, let us try to understand what kind of pension program is best for the people and the country. In this series of articles through which I have been discussing about a new economic model, pension planning is one of the items on which I wanted to discuss about, because there is a strong macroeconomic reason for it. Therefore, I approach this subject from a macroeconomic perspective not as a budgetary issue of the government.

What is a pension? A pension is an arrangement that is designed to prevent old-age poverty of the work force. Any issue or problem of poverty is a problem of income redistribution or more accurately, it is a problem of the distribution of distributable income (output). Is the problem of redistribution of income falls into the category microeconomics? No it is not; rather it falls into the category of macroeconomics. Businesses, investments and investment models do fall into the category of microeconomics. This means that pension planning cannot be resolved through business or investment models or in other words there is no market based solution in order to resolve the question of income insecurity during old-age.

Usually economic theory gives us more clarity to put new policies and programs in place. Hence, let us investigate the issue of old-age poverty or income insecurity with a little bit of economic theory.

At any given time, the economic system produces two kinds of products. Those are: (1) products for consumption and (2) products for the use of production. The current wellbeing of the members of society depends on the volume of consumable products (goods and services) that are produced at present. These products are needed to be distributed among the members of the society. Part of it should go to retirees.

According to the basic economic principles, total revenue in the country is generated by the current workers and not retirees. Therefore, what is supposed to be distributed for consumption, in fact, should be distributed among the current employees. And they are supposed to take care of their elders and this does not happen to the satisfaction of elders or to the satisfaction of present employees. Therefore, the solution is to allocate part of the consumable income to retirees by a mandate. The mechanism for such an allocation of consumable income is popularly known as pension.

Once we agree on the above said principles of pension, we need to devise a methodology to allocate part of the consumable income of the system to retirees. The first economic truth in regard to an efficient pension scheme is that, you can’t save for your retirement. Many economists still believe that “the best social security is for the young to save for the future.” The notion that you can save for your retirement and by investing those savings “wisely” you can have a rich retiree life is a big illusion.

The reason is that the modern economic system does require, time to time, to deflate systemic debt through wage increase bound moderate inflation. If we did not do it proactively, the economic system would crash wiping off most of the savings in pension funds. This point we will discuss in a separate article. For the time being let us assume that “wage increase bound moderate inflation” is a systemic need. Therefore inflation is an unavoidable phenomenon in any economy. On the other hand the productivity of the economy will ever be increased. Therefore, there are two important parameters namely inflation and ever-increasing-productivity, which are needed to be incorporated in designing any successful pension scheme.

Further, these two parameters must automatically be adjusted in calculating present-day retiree benefits during the continuing economic evolution. These two adjustments do not happen automatically in “save-for-your-pension” programs. Then what is the solution?

The solution must be to have a pension program under which the above said two parameters are automatically adjusted. Therefore we need to develop a basis/principle for such a pension scheme. The best basis is that “you pay for the pension of current retirees and in turn, your pension will be paid by the future generations of the work force.”

Under the above principle, the two parameters are automatically adjusted in calculating the present-day retiree benefits. Again, those two parameters are (1) adjustment for inflation and (2) adjustment for ever increasing productivity. These two adjustments do not happen automatically in “save-for-your-pension” programs.

Forget about the government employees for a moment, could the JVP and Former President Mahinda Rajapakse agree on the above principle in designing a national pension scheme? Perhaps, readers might wish to hear the answer.

So, how do we allocate part of the consumable income to retirees under the principle that “you pay for the pension of current retirees and in turn, your pension will be paid by the future generations of the work force.”? The only way to do it is the collection of “tax” from current employees to pay for the retirees of today. It is a welfare tax paid by all employees of today to pay for the retirees of today. Current employees will get it back in the future when they retire. When this “tax” is related to a percentage of earned income of present employees, they will have their benefits in future automatically adjusted for any possible inflation and increase of productivity.

By any means, a pension is a “tax” on current employees that requires in distributing part of the present consumable output to retirees as deemed fit by social norms. However, we can make this “tax” appear to be as a saving of the payee but it is not factually a saving because what is allocated for consumption by way of salaries, wages and distributable profits etc. must be used for consumption. Therefore, you have to use the consumable income for your consumption or to pay somebody else’s consumption on real time. This plays a role in ensuring the demand-and-supply equilibrium. This means macro economically prudent and efficient pension schemes are those where inflow equals the outflow of pension money.

In short, any efficient pension reform would reduce the present contributory burden on both workers and employers and would offer more benefits than the current EPF and ETF system. Perhaps employees would demand to keep the EPF and ETF intact. But I am sure once the modalities of truly beneficial pension program is developed and explained to them with a correct perspective, the workers and employers would support for such a system.

Without further delay Sri Lanka needs to have a national pension scheme for both the government and private sector employees and the basis of contribution (tax) should be common to both sectors. The real reform is needed for the revenue generating private sector. Hence, I do not see much prudence in proposing a contributory pension for those joining the public sector from next year onwards without proposing a national pension program.

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