24 March, 2019

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Towards National Pension Framework

By Hema Senanayake

Hema Senanayake

Hema Senanayake

National Pensioners’ Day – 2015 was celebrated on October 08th. My attention was particularly drawn to the event theme and the symposium held after the official ceremony. The theme of this event is very interesting and is important as well. The caption of this article “Towards National Pension Framework” was the theme of this year’s National Pensioners’ Day.

From the event theme it intimates that pension planning is not a job done already; instead there is something more to do. This is why the symposium held after the main inauguration, has become appropriate. It has become a brainstorming session which provided an opportunity for the participants to air new ideas as to how Sri Lanka should design a National Pension Framework. The Pension Department itself reported it as follows: “After the official inauguration, heated debates could be seen in the second session which made arena for the discourse on National Policy on Pensioners.”

I have a few ideas on this subject but I approach this subject from a macroeconomic perspective. Therefore, I intend to take part in the discourse of this subject through this article.

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 the distribution of distributable output. Is the problem of distribution 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. Let me give you a quick example.

Several financial institutions have started offering contributory pension schemes. Nishan de Mel, Executive Director and Head of Research at Verité Research told to the symposium that, “Most schemes offer only payments for a limited period of time,”… “It can be called a pension only if it offers payment till death,”… “The use of the term pension is not regulated in the island,” (EconomyNext, Oct. 12th). This intimates the failure of at least one investment-based pension model.

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. The current wellbeing of the members of society depends on the volume of consumable products (or 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. 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.

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 the 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.

However, before the end of the previous regime the government had two different opinions on the subject of pension planning. One view was held by former President Mahinda Rajapaksa. His view was documented in the government budget which was passed by the Parliament in the later part of the year 2014. He suggested 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. Yet, this program is continuing under the present government with paying 15% interest instead of 12% interest.

The second opinion was expressed by Dr. P.B. Jayasundera the former Secretary to the Ministry of Finance. He knows well that 12% or 15% of interest rate which is an administrative rate of interest, based on whims and fancies of government politicians 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.

Both above ideas are still official and are adopted. You may easily see that both ideas are microeconomic or business solutions.

Especially 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 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.

The concept behind pension funds is a myth. In Sri Lanka we have such funds. Most popularly known such funds are 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 made from consumable income. Consumable income must be spent fully to have steady economic 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. Without further delay Sri Lanka needs to have a universal pension scheme for both the government and private sector employees. Investment based pensions if needed must be complimentary.

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Latest comments

  • 2
    0

    The irony with development is younger working force diminishes over time.

    As society gets more affluent it produces less brood. In the end it leaves an aging population.

    The govt then faced with an affordability issue of pensions. How to you raise taxes to look after the aging population?

    In some countries the pension has 2 components. A statutory and voluntary contributions. The statutory payment is made by the employer. The voluntary contribution is obviously decided by the citizen.

    There are tax incentives to encourage higher level of contribution. The flip side is that financial institutions who manage these funds end up with large cash reserves for large scale investing that is excellent for the economy overall. These are problems that are already solved by many countries already.

    He suggested 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.

    Why restrict pension funds to Bank of Ceylon only? Any institution should be able manage pension funds that are regulated by the Treasury.

    The 15% high interest rate is very generous too, perhaps too generous. The way it works in some countries is that the interest income gets taxed at a lower personal tax rate.

  • 0
    0

    What is necessary is a Contributory Pension, which will apply to all citizens of Sri Lanka.
    This was foreseen in the UK and implemented by the National Assistance Act of 1948 – later modified and updated many times – to which ALL citizens contributed – and which built up to many billions, from which all social services including health and old age pensions were/are financed, even today.

    http://www.legislation.gov.uk/ukpga/Geo6/11-12/29

  • 2
    0

    Excellent write up.

    What is required is a contributory pension scheme. Unfortunately we Sri Lankans want everything free or subsidized, hence no one wants to pay for it.

    Our current pension bill is Rs 200 bn and our tax income is Rs 1,000 bn which amounts to 20% and it is not sustainable. From every one Rupee of taxes collected we pay 20 cents to the pensioners. Absolutely crazy situation.

    We need to do away with non contributory pension schemes. Unfortunately our politicians such as MR and our economist PBJ did not understand this. Look at the type of pensions talked about in the past.

    1 pensions for farmers
    2 pensions for three wheeler drivers
    3 pensions for fishermen
    4 pensions for middle east workers

    Etc etc

    Private sector has understood the problem and almost all have done away with non contributory schemes other than 1-2 private banks.

    Hope RW has a back bone to tackle this issue

  • 0
    0

    Excellent idea! And the taxes for retired people will not get lost to some foreign land, but be recovered in the local economy as goods and services.

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