A view from Central Europe and the Baltics
Saving for old age is important in countries where longevity is increasing. Countries in Central Europe and the Baltics emerged from the economic transition of the 1990s recognizing that they needed to encourage their workforce to retire later and save more in order to be comfortable in old age. To this end, they modified their pay as you go pension systems which collects taxes from workers to pay retirees (the "first pillar") to create an additional or "second pillar" of individual pension accounts funded by taxes. As these second pillar pension accounts were the private property of individual workers, they were expected to encourage saving. Over time as these savings grew, it would be possible to reduce the pensions paid by the government from the first pillar without reducing the standard of living for pensioners who would be able to rely on complementary pensions from their private saving in the second pillar. Typically, a share of payroll tax receipts was redirected to finance individual pension saving accounts. This resulted in revenue shortfalls in pay as you go you pension schemes, and most governments raised additional debt to meet their obligations which was in turn held by the companies who were managing the pension savings on behalf of employees. However, since the economies were growing rapidly, fiscal deficits were generally kept manageable, easing concerns about additional debt.
Following the global financial crisis of 2008, growth slowed sharply in Central Europe and the Baltics. Heavily integrated with Western capital markets, the financial crisis led to a huge contraction in both credit and demand. As growth rates tumbled, the second pillar became a casualty - with many countries using the tax revenues that were funding second pillar accounts to shore up deteriorating public finances.
Estonia was the first, announcing a temporary suspension of contributions to the second pillar for two years in 2009. Latvia and Lithuania followed by reducing contributions to the second pillar, with the understanding that this decision would be revisited as public finances permitted. The larger economies experienced financing difficulties later but then followed suit. Romania announced a postponement in its scheduled increase in contributions to the second pillar in 2010, followed by reductions to second pillar contributions in Poland and Slovakia in 2012.
With economic growth now resuming, the response from these countries has varied. Following the end of the temporary suspension, Estonia is attempting to make good on the "lost" contributions - not only restoring contribution rates to former levels but also encouraging higher contributions in 2014-17. But it is the only country to do so. While Romania has resumed increasing its contribution rates, Latvia and Lithuania are partially restoring their second pillar contributions. Poland will not restore contribution rates, as it intends to have a smaller second pillar which is divested of government bonds, and neither will Slovakia.
So, to answer the question posed in the title of this blog: second pillars have not proven to be robust in the face of the economic downturn - with the possible exception of Estonia.
In large part, the difficulty appears to lie in the decision to finance the transition costs of introducing a second pillar through issuing government debt. This strategy runs into difficulties when the economy slows down and public debt begins to mount. In all cases, reducing the allocation from tax receipts to second pillar accounts allowed countries to bring deficits under control to meet EU or national requirements. The downturn also threw into relief the relatively high fees charged by companies who manage second pillar accounts, which relate to design features that can be improved upon. Finally, there also appears to have been an issue of "ownership" of second pillar accounts by the public at large - the only country where the second pillar has come out of the economic crisis relatively unscathed is Estonia, where participants are encouraged to make a personal top-up of additional contributions. Many of them do - making them far more invested in the system than in other countries.
With countries having mostly chosen to have smaller second pillars, the question remains as to how they are planning to address the challenges that second pillars were designed to help with – namely, the need for more retirement saving to compensate for lower but more affordable public pensions. These challenges are made more acute by the rapid aging of the population as shown by my colleagues Anita Schwarz and Omar Arias. Countries can either choose to restore their second pillars following Estonia’s example. This will involve expenditure reductions elsewhere to keep deficits under control. Or they can explore alternative ways of encouraging retirement saving while still keeping public spending in check. Either way, more retirement saving is likely an important part of the solution, which means that countries need to think hard about what policy and institutional design choices can best make this happen.