Photo: Matthew Mirabelli

The topic of pensions has been featuring on the local agenda for decades. Stakeholders voice their opinions on what needs to done, but unfortunately these often focus on a narrow perspective which interests their own lobby group.

Politicians, meanwhile, treat the topic with extreme caution because any decision is likely to endanger popularity. To make things worse, financial literacy in Malta is still rudimental, so misconceptions are widespread. These factors explain the strong bias towards the status quo.

Going forward, in order to take the right decisions, there is need for a back-to-basics approach to pension reform.

The role of pensions is primarily to enable consumption smoothing, which basically means that people are able to enjoy a stable lifestyle throughout their young age and their old age. Under the current system, workers and employers pay taxes in the form of social security contributions, with the presumption that the government will honour a promise to offer income in old age. This can happen as long as the government manages to maintain a sustainable financial position through prudent tax and expenditure behaviour.

The role of pensions is primarily to enable consumption smoothing

The first dilemma which emerges is whether the government’s promise will actually translate into a pension which is adequate. People who evaluate adequacy purely by looking at the amount of income will, however, be making the mistake of not considering the other side of the story, namely expenditure. As long as the healthcare system in Malta remains free, adequacy can to a large extent be guaranteed even if in nominal terms the pension remains rather low.

The initial raison d’être for the existence of pensions is to protect for a subsistence level of consumption, and not as a top-up income to finance luxury travel or grand weddings.

Another important issue which is often neglected is the large stock of housing wealth. Most people who retire are home owners. The fixation that people want to keep property for bequest purposes must be challenged. Housing wealth is part of one’s lifetime savings which are particularly adequate to finance consumption during the retirement phase. In this respect, it is curious to observe that notwithstanding the large financial sector in Malta, the extent to which banks package financial products to convert an illiquid asset into a liquid asset is still very low. The banking sector in Malta should play a more active role in this respect.

At the same time, the average stock of household deposits is quite substantial, which means that a segment of the Maltese population definitely has no problem to meet lifestyle expectations during retirement, in the sense that their freely determined savings are adequate to meet reasonable consumption patterns during old age.

The real problem lies within a specific segment of society: the low-income, low-saving population. Given the lack of public statistics on income distribution in Malta, it is hard to quantify this problem with certainty. These are the people who are at risk of falling into poverty in old age, and necessitate a strong welfare system.

The way forward depends on the school of thought one ascribes to. The ‘liberal economist’ would advise upgrading skills to increase one’s earning potential. The ‘interventionist’ would try to encourage savings by offering fiscal incentives and explain the importance of saving for a rainy day. The ‘command economist’ would introduce mandatory savings through higher social security contributions.

The pressing issue is whether any reforms should be targeted exclusively towards the low-income, low-saving population segment rather than to the whole population. This is ultimately a political decision.

What priority should the pension reform be given? By their nature, pensions are a long- term issue. The priority should be resolving the current short-term challenges, namely ensuring that the public finances’ trajectory is on a path to balance over the economic cycle, while the public debt ratio falls.

Ultimately, stronger economic fundamentals lead to economic growth which in itself is the most relevant factor which sustains the welfare state. Between being alarmist and complacent, the likelihood is that the country’s situation lies somewhere in the middle.

Nonetheless, regular discussions on pension reform should be encouraged. Better be bombarded with reports and projections rather than be unaware of a latent time bomb!