Correct Premises, Wrong Conclusions

The Economic Council to the Prime Minister of Poland has published its comments about the changes in the Open Pension Fund (OFE). Because the professors have subscribed to them, we cannot say that they are another act of audacity, but quite a reasonable analysis. The only problematic thing is the fact that from correctly diagnosed premises, the professors draw quite puzzling conclusions, which are difficult to agree with.

„In a long period of time, it is economically crucial to make our pension scheme balanced and credible for citizens. The main problems of the pension scheme stem from demographic changes. Whether the premium is transferred entirely to the Social Insurance Institution (ZUS) or divided between ZUS and OFE, public pension scheme (charging an obligatory premium of 19.52%), will ensure in the future solely low pension payments.”

Absolutely, but what’s next? 

„That is why, it is crucial to intensively create in the society readiness to put aside money for old age independently in the 3rd pillar, which is the only part of the pension scheme in which there are real savings.”

First of all, there are real savings also in OFE. Even if we wrongly assume that they are financed from the debt, they are still savings.

Secondly, general money saving in the 3rd pillar will not improve pensioners’ situation at all – at most, it will improve the situation of those who saved more money at the cost of the situation of the people who saved less money, or at the cost of young generation’s standard of living. This is crucial to the understanding of the situation of the pension scheme. Let us do a mental experiment:

Let us imagine that we have retired. In this time, 2000 loaves of bread were produced – let us assume that it is the only production in the country. Now, it is time to make a decision how many loaves of bread should fall to the employed and those who don’t work (pensioners). How can I improve my personal situation as a pensioner? I can do it with the help of political methods (e.g. forcing laws) and opt for the situation when most of the loaves fall to pensioners (at the expense of young working people). But when this proportion is already fixed – e.g. 1,000 loaves of bread for pensioners – all I can do is to try to get as many loaves as possible from the pensioner pool. I can do it e.g. with the help of funds gathered in the 3rd pillar, but only on the condition that other people do not have such savings. If saving money in the 3rd pillar was popular, then my bargaining power is not higher.

This is the most important lesson: in principle, quantity and quality of pillars in the pension scheme are of no importance. As long as there are only 2,000 loaves of bread to be divided between people, the kind of the pension scheme actually has an influence only on the bargaining power of certain groups (old versus young) and within a group. Basically, it is a game which does not bring profits.

The only solution to improve the situation is to bake more than 2,000 loaves of bread. We can do it in different ways:

– increase the number of bakers – e.g. by raising the retirement age,

– increase the efficiency of the economy – by getting rid of needless barriers and burdens,

– increase accumulated capital – by more economical life before retirement and by investing in real economy.

In this case, we may think that OFE and the 3rd pillar can be really helpful – additional savings can mean additional investments. They can, but do not necessarily have to – since the main absorber of savings is our state, which is always hungry for funds, most of which it does not invest but consumes. That is why, without the reform of public finances and reducing state’s consumption, there are no chances of increasing retirement payments in the future, because our savings are intentionally consumed. Investors, lured by high return, finance this consumption, but one day they will wake up and read that the state is no longer able to fulfil its liabilities. And this will be the end of these savings.

That is why, the key to improving the situation, apart from unpopular reforms extending work time, and deregulation, is to reform public finances. OFE itself will not give us noticeably higher retirement payments and this is not the main reason to protect it. The main reason to protect OFE should be the fact that money outflow from the budget will make politicians undertake reforms faster. That is the key to higher retirement payments, not encouragement to save money in the 3rd pillar.

Here comes another conclusion: “Changes suggested by the government will decrease the deficit of the Social Insurance Fund (FUS) and improve the situation of public finances.” – this is not an advantage of suggested solutions, but their main fault!

“From the perspective of intergenerational burdens, the pension reform from 1999 financed by taxes was beneficial for future generations (they will be paying lower taxes), but at the same time, it was unfavourable to the present generations (they pay premiums for their retirement payments and pay taxes, which finance benefits for the present pensioners). Financing the costs of the reform by the debt allows to transfer some costs to future generations.”

This is only one half of the truth. First of all, we have a great reason to make the solution beneficial for future generations – after all it doesn’t mean that future generations will be doing great and we are additionally helping them. Future generations will be doing terribly – when I retire (which is not very probable) less than one working person will be paying premiums for one pensioner. Now the situation is four times better. That is why, knowing the terrible situation of future generations and seeing how comfortable our situation is, we are trying to help them a bit by accumulating capital. As the professors notice, most of this effort is blighted because of the fact that savings are not invested in real economy, but are consumed by the budget.

“In the light of these outcomes, financing the reform by privatisation would be rational if there were ways to guarantee such a means of financing.”

It would be, and of course is, rational – the question is why there are no “ways to guarantee such a means of financing”. It is politically impossible, because there would be no posts to be filled by fellow deputies, and there would be no money to buy support at conventions. Why do we need these public firms? What kind of strategic lines of business are we talking about? Because it seems that strategic lines of business are the ones which either bring losses (Polish State Railways (PKP), the Polish public postal service (Poczta Polska), LOT Polish Airlines, mines) or the ones where you can have an influence on big money (Polish oil refiner PKN Orlen, KGHM Polish Copper). Personally, I cannot see any reason why digging in the ground, flying by plane, going by railway engine etc. were to be extremely strategic. Why not use these measures and set capital free from being wasted, for the sake of national development?

“Any arguments used in the contemporary dispute which suggest that the existence of OFE guarantees higher retirement payments than ZUS, do not have any substantive basis, just like advertisements suggesting “pensions on the Caribbean” thanks to OFE.

It is not nice playing to the crowd, especially on the part of professors. Somehow I cannot see any advertisements of “pensions on the Caribbean” in the contemporary dispute. When it comes to the first part – I agree. Planning 30 years in advance is not really credible. But we ask for honesty to the contrary and confirmation of the statement that “any arguments used in the contemporary dispute which suggest that the inexistence of OFE guarantees higher retirement payments than ZUS do not have any substantive basis” – because such arguments have also appeared.

“From the economic point of view, the whole premium which goes to public pension scheme (today 19.52%) has always been a kind of a tax.”

Frankly speaking, I cannot see any economic point of view which would justify this. From economic point of view, one can easily imagine a completely different situation, and situation in Poland depends on legal conditions. Undoubtedly, there was such an intention, but our legislative geniuses cannot draw up a simple act in the right way, so – undeniably – also in this case there are many doubts. Surely, it will be the Constitutional Tribunal, not a Committee, that will settle the details. This is a simple attempt to “smuggle” a legal opinion under the guise of an economic one. Professors, please keep the line.

“The safety of state’s liabilities, both in ZUS and OFE, depends on the general state of public finances, that is why their good condition in a long period of time is especially important.”

This is the so-called half-truth. I mean, the contemporary situation looks like that. But it is enough to introduce simple legal solutions – e.g. in the form of investment limit for OFE in Poland, especially when it comes to investments in treasury securities – to make pension from OFE not dependent on the general state of public finances. In other words, there is a kind of fault of the OFE system – quite easy to be fixed.

“Funds gathered both in OFE and ZUS have collaterals. OFE has gathered financial assets, and ZUS has future premiums from working people. The introduction of a rule that indexation of funds gathered in the 1st pillar cannot be lower than inflation, and the indexation of newly created subaccounts with nominal GDP make it more difficult to balance future premiums and future liabilities in ZUS.”

Here we have a simple example of a contradiction, already in the 1st and 3rd sentences. In the first one, they claim that ZUS has collateral. In the third sentence, they admit that this collateral is incomplete, also because of the fact that the reform was ruined (indexation and inheritance of premiums). According to present calculations, the difference between retirement payments and proceeds from new premiums reaches 100% GDP. It means that there is some kind of collateral in ZUS, but this collateral is very incomplete, which has been mentioned by the professors but only indistinctly. Whereas the collateral in OFE concerns the whole value of gathered assets – the difference is huge.

“The transfer of a part of the premium to OFE means making the decision that state’s obligation towards a pensioner in the scope of this part depends on real profits which are generated by the investment of the money in the economy. The money can, in the case of right investment, generate higher profit than the one which is calculated on the basis of the indexation of funds on accounts and subaccounts in ZUS. But this kind of investment is also connected with the risk of loss. According to logic, the transfer of money to OFE should be a voluntary decision of these citizens who want to take such a risk and hope for higher profits.”

Let us refer to economic empiricism – within a long period of time, share market always generated better paybacks than bonds (already in the case of an 8-year investment horizon), taking into account all breakdowns, together with the latest financial crisis. Of course, there is some risk. But the professors quietly assume that this is definitely not true. A few countries have recently learned that this is not the case. Also in Poland, we dealt with such a case when the liabilities of ZUS were not fulfilled – it came to quota valorisation. If I were to have a choice, then I would like it to be extended also onto the funds in ZUS, which I think are much more at risk than funds in OFE (in the stock part). Unfortunately, there are no risk-free assets and leaving these risks unsaid will not change it.

“The freedom of choice will concern only a minor part of the whole premium; it means that a relatively minor part of the future retirement payments will be at such a risk. But at the same time, it is worth highlighting that the scope of future retirement payments’ dependence on capital part (for the ones who will choose OFE) will be exactly the same as at the moment of the introduction of the system.”

Of course, under the condition that ZUS fully fulfils its liabilities, which is not really probable. I guess it would be much better to diversify the risk, and fix one of the faults of the 2nd pillar, namely, make it invest such a significant amount of funds in treasury bonds.

“Every insured person should receive the information about their future retirement payment not separately from ZUS and OFE, but as a joint summing-up resulting from three factors – the 1st pillar of ZUS, ZUS subaccount, and OFE.”

Gentlemen, what is the justification for such a solution? Why do you blur the information?

I prefer to know who works for my retirement payment and how efficiently they do it. Or maybe it is all about having someone to blame in case of low outcomes? It is the first time I have heard serious economists agitating to give people less information.

“Within the scope of the pension reform, the state committed itself to filling the budget of ZUS with the amount of money which will be invested by OFE. That is why it is incurring a debt by selling bonds on the market. It does not make much sense for OFE to buy the same bonds (it would be costly for a state – OFE as a go-between in a vicious circle, and from a pensioner’s point of view nothing changes) because it does not bring pensioners hope of additional profits from investing their money in the economy.”

Bravo, gentlemen! What is the only right conclusion? OFE should stop buying government securities and start investing in real economy. This will enable it to develop better and maybe in the future we will be able to bake 2,500 loaves of bread instead of 2,000, won’t we?

I guess we will not, because the professors keep dwelling on the influence of the remission of bonds and the transfer of liabilities to ZUS. So, it is not about bigger investments in the economy, but about money for the budget! Instead of freeing money frozen in bonds, we will simply keep them irretrievably as liabilities of ZUS. The only non-accounting effect mentioned by the professors is the reduction of state’s borrowing needs and the costs of debt servicing. I would really like to see the calculations – especially check if they include the costs of the servicing of the liabilities transferred to ZUS together with valorisation. I would not be sure of the outcome of such evaluations.

Later on, the professors notice clear-headedly:

“It is also worth adding that by introducing the reform in the form from 1999 and continuing it within the next years, many mistakes were made e.g. high charges transferred to the firms managing OFE, the lack of solutions forcing OFE to be more effective and the introduction of additional pension privileges, which increased the deficit of ZUS. All the mistakes mentioned above contributed to the great increase in the cost of the system functioning with highly unsatisfactory outcomes from a pensioner’s point of view.”

Bravo – that is right. But why did the Council realise it only today? As far as I remember, it was talked about when the premium transferred to OFE was decreased to benefit ZUS and these reservations were expressed even by Minister Boni – a member of the government, after all. As far as I understand, this paragraph is the element of Council’s and government’s self-criticism – because we cannot bear a grudge against anybody else for the state of affairs.

Lastly, the media are to blame for everything:

“Publications often quoted in the foreign press which negatively judge suggested changes do not present any convincing economic arguments confirming these accusations.”

But, convincing to whom? The Council? Thank you for the information, we will try to wait and see ourselves.

It has to be admitted that the Council’s statement is a significant step ahead in the debate. After the statements of such experts as Mrs Leokadia Oręziak, which were full of obvious substantial mistakes, we have the answer which misleads us by numerous unclear points, concealments and suggestions. Let us put it frankly – there came a bill for warm water in

the tap, very high bill indeed, and the reason for it is the fact that the whole basement is flooded. Tenants are not eager to undertake redecoration, so for the peace of mind we reach for money box and pretend that everything is ok. But soon another bill will come and there will be no money left in the money box. But it will be a problem of the next building administrator. Mr Tusk – it is high time you undertook redecoration. It will be painful to pull out a tooth, but if you leave it, it will be much more painful in some years.

Translation: Anita Stradomska