Pension Funds in Slovakia – Consequences for the Economy Peter Golias INEKO - Institute for Economic and Social Reforms Economic Forum – Krynica, Poland September 2005

Overview of pension funds Voluntary pension funds (3rd pillar) - since 1995, popular thanks to tax relieves - approx. 1% GDP, 0.62 mil. clients Mandatory pension funds (2nd pillar) - since % of gross wage (biggest in Europe) - 0.8% of GDP in 2005, 160% GDP in mil. clients in 2006 (expected) Krynica, September 2005

Impact on future pensions a\w Replacement rates (%) if entering the 2nd pillar, working period: a – real average yearly net appreciation of assets in 2nd pillar (%) w – average yearly real wage growth (%), Demography held constant Note: Red color shows when FF outperforms PAYG. Source: INEKO Krynica, September 2005 Impact is unclear - it is impossible to predict a/w 40 years from now!

Mitigating demography risk There are predictions, that demography would get worsen in Slovakia: Source: Demographic Research Centre in the SR Note: Dependency ratio equals the number of people above the retirement age divided by the number of people between 18 and retirement age.

Mitigating demography risk Supply shifts right - more pensioners are willing to sell their shares. Demand shifts left - fewer workers are willing to buy shares. Demography crisis decreases the rate of return on capital! Krynica, September 2005

Mitigating demography risk Country with negative demography expectations can avoid possible downturn in pensions (i.e. replacement rates) by exporting capital to the economy with stable or positive demography changes. Krynica, September 2005

Public finance deficit Source: Ministry of finance of the SR Note: Slovakia plans to launch “euro” since 2009 Krynica, September 2005

Public finance deficit Sources for financing transition costs: - privatization revenues (€1.75 billion) - taxes - state loans 2nd pillar should have neutral direct effect on domestic consumption Krynica, September 2005

Work incentives Half of the old-age pension contributions were diverted into private, inheritable accounts managed by private funds Contribution-benefit link got stronger: - The highest-to-lowest pension ratio rises from 1.8 to All redistribution was taken out of pensions and transferred to the welfare system Reform motivates to work legally and pay contributions!!! Krynica, September 2005

Conclusions Pension funds: Are popular in Slovakia Do not guarantee higher pensions Allow for mitigating demography risk Transfer from PAYG to mandatory funds burdens public finance, but has no effect on domestic consumption Help to improve legal work incentives Krynica, September 2005