TCS Daily


Saving Social Security (in Slovakia?)

By Marian Tupy & Jagadeesh Gokhale - February 3, 2006 12:00 AM

When it comes to pension reform, most of the headlines last year went to President George W. Bush's dramatic attempt to overhaul the U.S. Social Security system. Alas, reform opponents stonewalled his initiatives, preventing him from giving us all the choice of investing part of our Social Security taxes in private accounts. Although American decision-makers are refusing to deal with Social Security's massive financial shortfall, other countries are moving ahead with public pension reforms. Slovakia is a case in point.

Like the American pay-as-you-go retirement scheme, the pre-reform Slovak public pension system faced adverse demographic trends and long-term financial shortfalls. In 2003, Martin Chren, a Slovak economist, estimated there were only 132 workers per 100 pensioners in Slovakia. Projections showed that pensioners would outnumber workers by 2040, at which point each worker would have to pay for the retirement benefits of more than one elderly person.

Unlike previous governments that preferred to ignore the inevitable pension crisis, Prime Minister Mikulas Dzurinda's cabinet took the long view and decided to overhaul the entire system. The Slovak pension reform was launched on Jan. 1, 2005. Under the new system, Slovakia's 2.2 million workers received a choice: To remain fully reliant on the current pay-as-you-go system or to invest part of their public pension contributions in a personal retirement account managed by one among a number of alternative investment funds.

Total public pension contributions in Slovakia amount to just under 29 percent of wages. Now, workers can place 9 percent into their personal retirement accounts. Another 9 percent is used to finance the existing system's obligations and the balance is used to cover other types of insurance and administrative costs.

So far, roughly 1.1 million people, or 50 percent of eligible workers, have opted for personal retirement accounts, and another 300,000 to 400,000 people are expected to do so before the deadline expires on June 30. Their cumulative personal account contributions, currently worth about 8.5 billion Slovak crowns (about $275 million), are managed by eight private investment funds created for that specific purpose. Each of these pension companies manages three pension funds, tailored for "growth," "balance" and "conservative" returns. Up to 80 percent of the "growth" fund portfolios may be invested in private stocks, while "conservative" fund portfolios may contain no equities at all. Young workers can choose from all three funds, but older workers who are just 15 (or fewer) years from retirement, can only chose from the latter two fund types. The pension companies are allowed to make a majority of their investments abroad, but 30 percent of all portfolio investments must be made in Slovakia.

The relative ease with which the Slovak pension reform was implemented may be attributed to five factors. First, popular opposition to the government's reform plan was negligible. Public disenchantment with the economic catastrophe bequeathed by Dzurinda's predecessor, Vladimir Meciar, allowed the governing parties to make pension reform a part of their electoral platform — and helped elect them to power. Second, the Slovak people liked the prospect of gaining inviolable private property rights on their personal retirement accounts - safeguarding them from politicians' claws. Third, prior to launching the reform, Dzurinda initiated an extensive media campaign, explaining the reform's potential benefits to the public. Fourth, many of the reform proposals were adopted early on in Dzurinda's term in office, which meant that the new laws have had more time to set in, become more widely accepted, and, in some cases, amended.

Finally, Dzurinda eliminated the dividend tax and many tax exemptions, introduced a 19 percent flat income and corporate tax rate, and repealed many burdensome business regulations. After just 2 years of a sustained reform effort, Slovakia's business environment was ranked among the top 20 in the World Bank's "Doing Business in 2005" report. Cumulative foreign direct investment in Slovakia has risen six-fold since Dzurinda's accession to power in 1998, much of it accruing to the export-oriented manufacturing sector, especially automakers. Those reforms improved the overall business environment, thus making private saving more attractive to the populace.

The long-term success of Slovakia's pension reform will greatly depend on the willingness of that nation's political elite to keep it intact. In September, Slovakia faces one of its most important elections since gaining independence in 1993. The electorate's choice will be between re-electing the current center-right government and opting for a medley of socialist and nationalist parties. The current government is not free of problems, however; some of its members stand accused of corruption. Though he needs to do much more to fight corruption, Dzurinda's pro-market policies have ushered in a period of high economic growth and rapidly declining unemployment. In 2005, the economy grew by 5.6 percent and it is forecast to grow by 6.2 percent this year. Official estimates show that unemployment has fallen to 11 percent in 2005, down from 18 percent in 2000.

Robert Fico, Dzurinda's socialist opponent and the current leader in opinion polls, is to be congratulated for his efforts to keep the current government transparent and accountable. But he appears determined to reverse many of the Dzurinda government's pro-market and pro-business policies, including the flat tax and regulatory reforms that made Slovakia's high economic growth rate possible. Having already undertaken the reforms that the United States eventually will have to face, the Slovak people would be poorly served by a regression to their socialist past. But, on the bright side, successful economic reforms that improve people's lives are generally difficult to roll back.

Mr. Gokhale is senior fellow and Mr. Tupy is assistant director of the Project on Global Economic Liberty at the Cato Institute (www.cato.org).


1 Comment

and Chile?
It's like Fox News discovering WMDs in Iraq every day. Eventually you figure out that they don't pan out. Here we are touting a new privatization program that's going to work. But remember that the last one, in Chile, now is considered a disaster.

You say opponents "stonewalled" the Bush privatization proposal. For one thing, Bush never actually presented a proposal. That would have forced him to produce numbers, which would have allowed everyone to figure out what a sham the whole thing was. For another, people opposed the idea of privatization because they didn't want it. Disagreement is not the same as stonewalling.

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