Sustainable Convergence and Pension Reform in Central and Eastern Europe

Abstract

Discussions on pension reforms in Europe usually start with the now commonsense observation that adverse demographic developments put the financial viability of publicly run pay-as-you-go (PAYG) systems under increased fiscal strain, even threatening their long-run sustainability. In particular, increasing life expectancy, falling fertility rates and rising dependency ratios add up to rather bleak future projections. Furthermore, labour market distortions caused by rising social security contributions are cited as another rationale for reform. While we do not dispute these reasons for reform, we contend that there is a third dimension to this issue which seems to have been forgotten in the discussion so far: the impact of aging on economic growth and the effects pension reforms have on domestic savings and capital markets. In particular, to what extent the conversion of a PAYG scheme (or parts of it) into a fully funded system affects private savings, and thus investment and therefore growth, is an issue that deserves more than casual attention. While discussed to some extent with regard to developing countries, we claim that this aspect is also of great importance in the European context, especially with respect to the recent accession of the considerably poorer Central and Eastern European countries (CEEC). Indeed, for the CEEC the reform challenges are even more daunting than for the mature economies of Western Europe. The reason is that they not only have to reform their social security systems against the backdrop of an aging society, but also need to organize an economic catch-up process. This calls for policy measures that help increase savings and investments. At the same time however, the populace yearns for fast increases in current consumption that matches Western European levels, which makes this endeavour politically even more delicate.