By Hema Senanayake –
A pension is an arrangement that is designed to prevent old-age poverty. Maithripala Sirisena now promises to pay pensions for private sector retirees during their old age. He made this promise in a city call Hettipola during an address of a public rally held on December 12th.
President Mahinda Rajapaksa has a different view. His view was documented in the government budget which was passed by the Parliament in a few weeks ago. He suggests that workers should save for the retirement and deposit it in Bank of Ceylon (or government bank) and he would ensure that the Bank would pay 12% of interest while the market rate of interest for deposits is much lower. The retiree must live on interest income. The plan is simple but economically it is the most ludicrous one I ever heard of.
For a moment forget about the President’s plan. Dr. P.B. Jayasundera the Secretary to the Ministry of Finance also has a plan. He knows well that 12% of interest rate which is a directive rate of interest based on whims and fancies of government bureaucrats cannot prevail for long. Therefore he suggests that workers should try to invest their savings in the Stock market and to make money during their old age. In fact this was what was done by EPF and ETF as institutions during past few years and have recorded severe losses by now.
Is the proposal made by Maithripala Sirisena a viable one? This must be the question that you have in your mind. 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 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 (for example capital goods etc.).
The current wellbeing of the members of society depends on the volume of consumable products 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. But 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 senior citizens by a mandate. The mechanism for such an allocation of consumable income is popularly known as pension and this is why we need pension programs.
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 seniors. The first economic truth in regard to an efficient pension scheme is that, you can’t save for your retirement, instead you pay for the pension of retirees of today and in turn your retirement benefits would be paid by future generations of work force. Under this principle, two important parameters are automatically adjusted in calculating the present-day retiree benefits in the process of economic evolution. 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.
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 proponents of this idea including Dr. P.B. Jayasundera usually say, “let the pension savings come to the financial market, and the market will grow benefiting prospective retirees. Globally this illusion came to a virtual end after evaporating the pension savings with the Great Financial Crash of 2008 in the United States and Europe.
Let us come back to the allocation of funds to seniors. 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 distributing part of the present consumable output as deemed fit by social norms. However, we can make this “tax” appear to be as a saving of the payee (as we do in EPF or ETF ), but it is not factually 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 to put the economic system into equilibrium in regard to demand-and-supply. This means macro economically prudent and efficient pension schemes are those where inflow equals the outflow of pension money.
The concept behind pension funds is a myth. In Sri Lanka we have two such funds popularly known as EPF and ETF. Both employers and employees contribute to those funds. You can’t build up a pension fund if inflow equals outflow at any given time period. There should be a surplus to build a fund. Such surpluses are always excessive savings. Excessive savings are bad for the economic growth. Consumable income must be spent fully to have steady growth.
In short I would say that any efficient pension reform would reduce the present 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. However, these two funds (EPF & ETF) cannot be sustained anymore with reduced rate of market interests. Market rates for deposits are well below 5% by now. Without further delay Sri Lanka needs to have a universal pension scheme for both the government and private sector employees.
Therefore, Maithripala Sirisena’s promise is much more sensible than the existing ideas of the Ministry of Finance.