Dr. Banyár József

1. The different European handling of the explicit and implicit state debt as the barrier of the pension reforms Dr. Banyár József

2. The PAYG-type pension systems are in crisis - all around the World This crisis come from mainly: disadvantageous demographic trends These demographic trends don’t affect the funded pension systems (until these systems are not particularly prevalent Worldwide) → a possible solution for this problem, the (partial) funding of the pension system

3. Funding of the pension systems The essence of the funding: paying back (or – at least – printing out) the state debt. To this, the following have to be true: Where: a: ratio of the state debt in GDP r: the real growth rate of the GDP i: the real interest rate of the state debt s: the prime (i.e.: without interest payments) balance of the state budget in GDP (negative in case of deficit).

4. The necessary time for paying back the state debt In years, if the starting value is 80% of the GDP

5. The necessary time for paying back the state debt In years, if the starting value is 300% of the GDP

6. Consequently: the funding is a time-consuming process → in the foreseeable future only partial funding is a realistic aim An example for this was: the (World Bank suggested) Hungarian reform in 1998 (After a voluntary entering campaign) there was mandatory for the new entrants into the job market to pay ¼ of their contribution onto an individual account and also, their pensions decreased the ¾ of the original – the remaining part of it would came from an annuity bought out of the individual account.

7. The meaning of the Hungarian reform - background In case of growing population the implicit state debt of the pension system is also growing: more new debt is originating than expire In other worlds: in this case the contribution is bigger, than the benefit → there is no need for government intervention (budget supplement) In case of declining population the situation is different:

8. Background – implicit state debt in case of declining population

9. The meaning of the Hungarian reform I.e.: because of the demographic trends, after the retirement of that generation (baby-boom echo), which wouldn’t have reproduced itself, the implicit state debt willstart to expire en masse → The benefits will surpass the contributions → The deficit of the pension system will have to be supplemented by the state → High state budget deficit … then!

10. The meaning of the Hungarian reform The Hungarian reform intended smoothing this lately high deficit … by its gradual anticipation The Hungarian reform thus supposed, that: • this anticipated deficit will be „worked out” now → • the Government follows a disciplined, low-deficit budget policy. And in general: debt-cutting. What really happened was totally different! → the Hungarian reform become fragile!

11. The problems of the Hungarian reform There was chosen a needlessly expensive solution („casses” instead of the Swedish „blind account” model) Wrong prioritization: there should be worked out the short term state debt first, instead of the long-term implicit one There wasn’t worked out any state debt at all - instead of it: growing indebtedness – furthermore: started to convert the long-term implicit state debt into short term explicit one Albeit that problems above: the policy of partial funding itself was a good policy, should have been continue.

12. The advantages and disadvantages of the reversal of the Hungarian reform The reversal of the Hungarian reform had short term advantages and long term disadvantages. • Advantages: • smaller current deficit (because ceasing anticipating the deficit later) • a one-shot reduction of the explicit state debt • Disadvantages: • the anticipation/smoothing of the lately big deficit ended • the increase of the implicit state debt was higher, than the decrease of the explicit one

13. The role of EU in the reversal of the Hungarian reform The outcome above was politically rational – because of the EU rules on deficit and state debt. The Hungarian government’s (in the company of other governments) first attempt was trying to loosen the deficit-rules. Only after the failure of this they ended the funding reform. To loosen the deficit-rules would have been a wrong way, but it doesn’t mean that the EU rules are good.

14. The EU rules for state debt • The Stability and Growth Pact (SGP) sets a maximum for two values in GDP : • the annual deficit can be max. 3% • the all – explicit – state debt can be max. 60% • The meaning of these rules: • To prevent the excessive indebtedness of the member states • To slow down the move towards indebtedness The advantage of these rules: their simplicity.

15. The problems of SGP • Setting a maximum for the deficit – it isn’t a problem! • The imperfection of the rules: • They cover only the smaller part of the all state debt: the explicit one, • They don’t take into account the sustainability of the debt, namely • structure of the expiration, • interest rate • origin

16. The problems of SGP • The problems came from these imperfections: • False to think, that similar debt-rate of two countries shows similar problems. E.g. Japan’s 200% state debt with 0,5% interest rate in local currency, with long term expiration in the hands of loyal citizens causes almost any problems – contrary to the (e.g.) Hungarian one where all the parameters above are the opposite.Formally - according to SGP - Japan’s situation is more acute.

17. The problems of SGP • Further problems: • It makes rational to increase the all state debt, if this decreases the explicit one → • It is a serious obstacle of the opposite move: to decrease the all state debt if it cause an increase in the explicit state debt → it is an obstacle of the funding reforms!

18. The proposed reform of SG • Have to do: • To extend it to all (explicit and implicit) state debt → have to reveal the implicit state debt • → to set a new, higher ceiling for the all (explicit + implicit) state debt • Have to take into consideration also the expiration structure (the majority of the implicit state debt is very long term one)

19. Objections The implicit state debt is hard to estimate „soft” debt, because it can be decreased by discretionary measures Contra-objections: Hard to estimate only if the rules of the pension system are ambiguous. But to make these rules unambiguous is important and so, this reform would encourage it. The more unambiguous the rules, the less soft the implicit state debt.

20. Thank you for your attention!