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placement from tax-funded pay-as-you-go systems. The post-communist states need to place greater reliance on prefunding of pension obligations (with private management of reserves) to (1) smooth out contribution rates as the "baby boomers" retire, and (2) deepen capital markets, and thus enhance growth, through the development of a contractual savings industry. The main difficulty in applying these recommendations in transition economies is that prefinancing in a mature pay-as-you-go system implies that the members of one generation must bear an additional burden—saving for their own retirement while simultaneously paying for that of their parents.4 This is affordable only if the current transfers can be gradually reduced through a major reform.

In the typical post-communist system, governments can reduce future entitlements by the following means:

  • Raising the effective retirement age (eliminating early retirement and raising the normal retirement age)

  • Changing the formula to lower the average benefit

  • Reducing indexation provisions (to, for example, the lower of wage or price increases)

Prefunding can be achieved in the public system only by building up a reserve fund. The World Bank (1994) recommends that these reserves be allocated to individual accounts (the Latin American approach), as this reduces the "taxation" element of the public pension system, thereby reducing labor market distortions. It also improves the management of the reserves. Funding can also begin through the development of optional, privately managed programs (private pension systems).

Few governments in Eastern Europe have tackled this entire agenda. All of the Baltic countries, Albania, Georgia, and the Czech Republic have tackled major parts of it, with some success. Of these, only Latvia and Georgia have adopted radical pension reforms. While Lithuania, the Czech Republic, and Estonia have been able to avoid the kinds of pension cost explosions faced by Poland, Bulgaria, and Slovenia, even the former three countries are experiencing steady growth in expenditures, as they have simply not reformed entitlements sufficiently. Estonia was able to implement a steady increase in retirement age, but left in place all the exemptions from the Soviet period, even adding a few. Lithuania and the Czech Republic courageously eliminated almost all early retirement, but chose generous formulas as they attempted to return to the status quo ex ante. Lithuania and Estonia have also

4  

Strictly speaking, the savings of the working generation is not a "burden" since the money saved will come back to them later. Saving represents postponed consumption, however, which has a cost. Were the members of this generation able to obtain from future generations the equivalent on a per capita basis to what they are transferring, they would be better off than under a reformed approach that includes more funding and less reliance on current transfers. However, this is an unrealistic scenario.



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