Central Bank governor discusses pensions challenge

Several international studies have shown that the replacement of pay-as-you-go pension regimes by funded systems provide more incentives for private saving and reduce the scope for tax evasion by linking contributions paid into the system directly to the benefits received, Central Bank Governor Michael C. Bonello has observed.

"This contributes to increased investment and augments the productive base, thereby facilitating the financing of social security expenditure commitments."

Mr Bonello made his comments at the opening of two international workshops on pension reform held in Malta by the World Bank Institute.

Mr Bonello said policies aimed at meeting the challenges of population aging must aim at producing an increase in productive capacity and output, and stimulating saving and investment, thereby alleviating pressures on inflation, fiscal resources and the external account.

Indeed, these outcomes were desirable independently of population ageing, but were rendered even more urgent by the onset of the phenomenon. It was the way in which this strategy was to be implemented that was often subject to contention.

Opinions tended to diverge because it was not always appreciated that any course of action chosen, including a passive stance, involved sacrifices.

"An increase in resources devoted to pensions must imply higher taxation, a reduction in funds allocated to other equally worthy causes, or burdens on society as a whole in terms of higher inflation and interest rates.

"On the other hand, reforms that should engender a win-win situation in the long run could perhaps impose sacrifices on a number of individuals in the short term. It is, therefore, important to promote an informed debate which takes account of the costs and benefits involved in any course of action, with a view to reaching agreement on viable solutions."

Mr Bonello recalled that the 1990s saw many governments implementing pension reform initiatives, generally based on the three-pillar approach advocated by the World Bank. Under this approach, individuals may have up to three different sources of revenue during retirement, namely a basic state pension, the balance accumulated in a mandatory pension account and voluntary saving arrangements.

"A number of international studies show that the replacement of pay-as-you-go pension regimes by funded systems provides more incentives for private saving, and reduces the scope for tax evasion by linking contributions paid into the system directly to the benefits received. This contributes to increased investment and augments the productive base, thereby facilitating the financing of social security expenditure commitments.

"Apart from specific reforms in the social security system itself, an improvement in the fiscal position would have an overall positive macroeconomic effect, compensating in part for the addition in aggregate demand brought about by ageing. The lower absorption of resources by the state could also lead to a higher average level of productivity and to an improvement in the country's balance of payments. Productive capacity would also be enhanced if the state creates fiscal and other incentives for individuals to provide for their own needs after retirement, leading to an increase in the household saving rate and, consequently, also to a faster accumulation of capital."

Fiscal consolidation would, however, only solve part of the problems created by population ageing, Mr Bonello said.

The negative supply shock caused by this phenomenon also had to be countered by a positive shock. Supply-side reforms aimed at increasing the availability and the efficient use of economic resources were, therefore, essential.

"The efficiency of markets can be improved by implementing a vigorous competition policy and reducing public sector involvement in the economy.

"Productive capacity would also be improved through such policies as market liberalisation, greater investment in infrastructure and education, and a market-driven industrial policy. Structural rigidities in the labour market must be eliminated in order to decrease their disincentive effects in terms of the labour supply and the work ethic. A labour market policy intended to increase skills, and consequently the employability of individuals, is also desirable.

"This grey cloud on the horizon, therefore, appears to have a silver lining in the form of appropriate policy responses that would effectively enhance the welfare of populations," Mr Bonello said.