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Pension Funds in Slovakia – Consequences for the Economy Peter Golias INEKO - Institute 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 (3 rd pillar) - since 1995, Overview of pension funds • Voluntary pension funds (3 rd pillar) - since 1995, popular thanks to tax relieves - approx. 1% GDP, 0. 62 mil. clients • Mandatory pension funds (2 nd pillar) - since 2005 - 9% of gross wage (biggest in Europe) - 0. 8% of GDP in 2005, 160% GDP in 2080 - 1. 4 mil. clients in 2006 (expected) Krynica, September 2005

Impact on future pensions Replacement rates (%) if entering the 2 nd pillar, working Impact on future pensions Replacement rates (%) if entering the 2 nd pillar, working period: 2005 - 2052 a – real average yearly net appreciation of assets in 2 nd pillar (%) w – average yearly real wage growth (%), Demography held constant aw -2 0 2 4 -2 47. 33 39. 88 35. 80 33. 42 0 68. 63 51. 57 42. 72 37. 83 2 115. 89 76. 03 56. 28 45. 91 4 194. 00 113. 75 75. 51 56. 28 Note: Red color shows when FF outperforms PAYG. Source: INEKO Impact is unclear - it is impossible to predict a/w 40 years from now! Krynica, September 2005

Mitigating demography risk There are predictions, that demography would get worsen in Slovakia: Source: 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 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 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 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. Public finance deficit • Sources for financing transition costs: - privatization revenues (€ 1. 75 billion) - taxes - state loans • 2 nd 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 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 5. 8 - 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 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