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The market for social security

The Market for Social Insecurity
A shady pension reform entices economic elites
and clouds the future of Sweden‘s elderly
An efficient national pension system that has helped to make Swedish old folks among themost economically secure in the world has now been replaced by a costly, elaborate construc-tion which is almost certain to make the retirement years of future generations less secure.
The pension reform that wentinto effect in 2001 has been pre-sented as a necessary response tothe “welfare paradox“ that con-fronts virtually all developedcountries. The paradox is that asteadily shrinking work force,working fewer hours, must sup-port a steadily expanding popu-lation of retirees.
widespread and frequently exag-gerated alarm over the solvencyof national pension schemes. TheSocial Security system of theUnited States, for example, has inrecent years come under intensifying attack “Pensions: Time to Grow Up“, in The Econo- from those who claim, mainly on the basis of mist, 16-22 February 2002). Approval by such dubious assumptions, that it is on the verge interests should signal a warning to those who are devoted to the traditional Swedish model of general welfare and social solidarity.
fore attracted considerable attention abroad, It turns out that there are, indeed, several since it is said to provide a solution to the reasons to be concerned about the likely ef- threat of fiscal insolvency posed by the wel- fects of the recent reform on the well-being fare paradox and other factors. Ironically, the of Sweden‘s senior citizens. Among other enthusiasm appears to be greatest among in- things, the new system will almost certainly terests which in the past have frequently result in reduced pensions for a large major- heaped scorn on Sweden for its general-wel- ity of citizens, and promote social injustice fare system. These include the enemies of by yielding varying retirement incomes for Social Security in the United States, and the individuals in similar circumstances. It also international business press (see for example, power from society as a whole to special in-terests, and stimulates the flow of capital out SECURE RETIREMENT
pared with its abandoned predecessor.
The old system
The old pension system, which went into ef- fect in 1960, consisted of two components: auniversal basic pension (“FP“) to anyone who had resided in Sweden for a total of at least worked and the amount of earned income.
Both components were keyed to the Stand- ard Income Unit (SIU)*, and were automati- cally adjusted for changes in the Consumer tired at age 65 with at least 30 years of eligible work experience received pensions averag- ing 60-65 percent of pre-retirement earnings.
(Most people also had a collectively negoti- Note: Terms such as “decent. . . relationship.
ated supplement, adding roughly ten percent.) . . viable. . . fair. . . easy”, etc., are relative,and can only be understood in compari- This was among the highest pension levels in the world, and greatly improved the stand-ard of living among the Swedish elderly.
valuable during economic downturns. These you-go basis, with tax revenues from the cur- funds grew in real terms from 1960 to the mid- rent work force contributing to the pensions 1990s, when the revised pension system was of the retired. Substantial buffer funds were agreed upon, amounting at that time to some established to minimize the effects of varia- 700 billion kronor. This contradicts the fre- tions in contributions, investment returns and quently made assertion that the old system benefits. The funds were invested primarily steadily to the equivalent of ca. four years‘ the old system. It was easy for most citizens total pension benefits. The size of the buffer to understand, future pension benefits were funds was reviewed every fifth year. In addi- predictable, and the purchasing power of the tion to their function in the pension system, elderly was maintained. It was also compara- they provided a source of investment capital tively simple and inexpensive to operate: The for the entire economy that was especially cost of administration was only about 0.5percent of total benefits.
Given these advantages and the relatively *Standard Income Unit (SIU) is an accounting comfortable pensions it provided, the old sys- device used in the calculation of social benefits, tem enjoyed wide acceptance among the gen- income levels, tax tables, etc. Roughly 85 percentof the labour force have incomes less than 7.5 eral public. But due to such factors as the SIUs. The value of an SIU in 2002 is set at SEK welfare paradox noted above, concern began 37,900 (roughly US$3,800 at the end of May 2002).
to mount during the 1980s that benefits would eventually outstrip revenues. Critics pointed to a The new system is based on lifetime earnings and number of perceived shortcomings, including the is financed by a levy of 18.5 percent on wages.
Sixteen percent is allocated to a “pay-as-you-go pension“ and 2.5 percent is placed in a “premiumreserve pension“ which is required to be invested • Benefits were not linked to real economic According to its authors, the reform has re- • The system was financially “unstable“ sulted in a stable system which automatically adjusts to changing demographic trends. Theyalso claim that the system is linked to national • The relationship between the individual‘s economic performance, particularly with regard contributions and benefits was not strong to the 2.5 percent of earned income that is required to be invested in mutual funds. Future pension- ers are confronted with a choice of nearly 700 funds offered by some seventy financial institu- parliament by a margin of just one vote.
tions including banks, insurance companies andmutual-fund operators. Up to five funds may be Of course, there were conflicting views about the selected at any given time, and cost-free trans- urgency and the relative importance of these de- fers are permitted on a daily basis. The pension ficiencies. But there was general agreement that credits of those who do not make any active something would have to be done in order to pre- choice are placed in a state-operated fund estab- lished specifically for that purpose.
ments to the existing system, and pension experts Serious problems
Exactly what all this means for the pensions of • indexing benefits to real economic growth the future is a mystery to which no one appears to have a satisfactory answer. But it is already • raising the normal retirement age.
apparent that the new system is burdened with a • providing for a reduction in benefit levels For one thing, it is vastly more complex and difficult to understand than its predecessor. It isalso much more costly to administer: A special Modifications of this sort were entirely feasible.
national agency had to be established just to han- But that option was ignored in favour of the very dle the traffic in mutual funds. One indication of different thing which is now being cited by fiscal the system‘s complexity is that its introduction conservatives as the very model of a modern pen- was delayed by several years due to difficulties in developing an adequate computer system.
Whether that problem has been solved remains The new system
to be seen, but large sums of tax money have al-ready been expended for that purpose.
The primary goal of the pension reform is to One thing that no computer system will ever achieve automatic, long-term financial stability.
be able to do is to predict future retirement ben- The self-evident social goal of a pension system, efits. Although the amounts of contributions are i.e. to maintain the living standards of the elderly, clearly defined, the benefits to be paid are not.
is no longer self-evident. That is a secondary con- This is due especially to fluctuations in the value cern of the new system, which will almost cer- of the mutual funds in which citizens are required tainly result in reduced living standards for the to invest. Those who choose more wisely or more majority of pensioners. Certain subgroups, such luckily will receive higher pensions than those as young people who are late in entering the la- whose choices are not so fortunate— even if their bour market and middle-aged women, are likely to be especially disappointed upon retirement.
Thus far, the vast majority of those involved have been losers. Since the funds are tied to the *It is very doubtful whether any national pension sys-tem can be “funded“. See page 4.
Funded“ vs. “Unfunded“ Programmes
In his prize-winning essay, “Paygo Funding and Intergenerational Equity”, Prof. RobertL. Brown makes a strong case for the pay-as-you-go principle in financing nationalpension systems. He argues that a fully-funded pension scheme is no more financiallysecure than a paygo scheme. Both depend on the ability of the economy to create andtransfer wealth. For a pension system, the funding mechanism is irrelevant.
In his essay, Brown quotes from The Economics “To understand the equivalence, it is im- of the Welfare State by Nicholas Barr: “The portant to remember that a government bond schemes are inherently ‘safer’ than paygo is an make a payment in the future. A government example of the fallacy of composition*. For in- promise to make a payment, to pay off a bond dividuals, the economic function of a pension is not fundamentally different from a govern- scheme is to transfer consumption over time.
ment promise to make a payment for social But, ruling out the case where current output is stored in holes in people’s gardens, this is not possible for society as a whole; the con- bonds and promises you future payments to sumption of pensioners as a group is produced retire the bonds, then it is not doing anything essentially different from requiring you to pay “From an aggregate viewpoint, the economic taxes and promising you a future transfer pay- function of pension schemes is to divide total production between workers and pensioners,i.e. to reduce the consumption of workers so Sources
that sufficient output remains for pensioners.
Once this point is understood it becomes clear Robert L. Brown, Professor of Statistics and Ac- tuarial Science at the University of Waterloo both simply ways of dividing output between in Canada, has been president of both the Ca- workers and pensioners, should not fare very nadian Institute of Actuaries and the Society differently in the face of demographic change.” of Actuaries. In 1994, he won the third SCOR International Actuarial Prize for his essay, the essay, “Can the Latin American Experience “Paygo Funding and Intergenera-tional Eq- Teach Us Something about Privatised Pensions uity”, which was published under the same with Individual Accounts?”, published in early title in the Transactions of the Society of Actuar- ies, Vol. 47, 1995. It is also available on the SOA “In economic terms, there is no fundamen- web site at: tal difference between a tax transfer pay-as- you-go social security scheme and a bondtransfer, pay-as-you-go social security scheme.
The Economics of the Welfare State by Nicholas In a bond-transfer scheme, the bond issue pos- Barr was published by Stanford University its an illusion of asset-creation. But, the sole purpose of the bonds is to engineer a transferpayment to the retirees. In a practical sense, Dr. Tapen Sinha is Professor of Risk Manage- benefits of the current retirees come from the ment & Insurance at Instituto Technologico Autonomo de Mexico, Mexico City, and also aprofessor at the School of Business, Univer-sity of Nottingham, England. The essay cited *The fallacy of composition is to assume that, if above was presented at a Society of Actuaries something is true for an individual, it must also betrue for an aggregate of individuals. For instance: conference, and can be found on the SOA web If I stand on my seat in the theatre I will get a better view; but if everybody does the same, nobody will stock market, the recent crash has resulted in widespread losses, some much greater than others.
“Between 1920-1929, the value of stocks in the Once again, people are learning the hard way that United States increased by over 400 percent. Then the stock market can go down as well as up.
came the great crash of 1929, followed by a mod- est recovery until 1936. But from that year until assurance that the stock market will rise again 1949, stock values declined. True, the level in 1949 and, with it, the value of market-related funds.
was twice that of 1920; but that doubling of value What they have not done is to offer any solace to happened to be exactly the same amount as the those who have exercised the poor judgement to U.S. Gross Domestic Product (GDP) increased reach retirement age at a time when the value of their pension funds has declined. They will have “The stock market climbed again during the to live with the financial consequences of that un- period from 1950-1960. Then followed fifteen fortunate timing for the rest of their lives.
years of slow decline. In 1979, the value of the Even if a positive result could be guaranteed stock market was twice that of 1950-- which was, (an impossibility, as noted) the question remains again, the same amount that GDP had increased as to how many Swedes really want to devote time and effort to figuring out which of nearly 700 mutual funds to invest in. The largest single climbed straight toward heaven for what seemed category (86% in 2002) consists of those who likely to be all eternity. A sobering decline has choose not to make any choice; their credits are since occurred and, if history repeats itself, it is invested by default in the state-operated fund, more probable that the stock market will fail to which has been one of the less dreadful performers return to its previous heights than that it will ex- perience a new long-term upswing.” (Translated In general, the system is based on faith in the from Swedish text of Sten Ljunggren, “Veckans dia- stock market‘s ability to generate higher invest- gram 10” in Etc. magazine at: ment returns than the economy as a whole. It is a The logic of the new pension system also ig- faith that appears to be highly exaggerated, as nores the most fundamental rule for playing the indicated by the following summary of the stock market: Never invest more than you can COMPARISON: OLD VS. NEW PENSION SYSTEM
afford to lose. For the vast majority of future pen- velopment of the Swedish economy, to which the entire pension system is supposed to be linked.
It should also be noted that not even the For a large majority of citizens, the net result “guaranteed portion“ of the new pension is guar- will almost certainly be a lower pension than anteed. It may decline in value, since the formula would have been the case if the old system had with which it is calculated is partially based on simply been adjusted. In addition, there is a seri- the performance of the mutual-fund portion.
ous problem of social justice: Individuals whohave worked equally long and hard will receive Transfer of power
widely varying pensions, depending on the luckof the mutual-fund draw.
In effect, what the new system does is to transfer All of this has been justified by the quest for a large portion of economic power from society automatic financial stability. But the fact is that as a whole to special interests, including banks, all financial systems require adjustments over insurance companies, mutual funds and other fi- time. The goal of automatic long-term stability is exceedingly elusive— the pension-planning Further, and in contrast to the old system, equivalent of a perpetual-motion machine. The there has been a large transfer of capital out of unlikelihood of ever achieving that goal makes Sweden as pension funds invest in foreign stocks.
the subordination of the system‘s social function This hardly contributes to the stability and de- THE LATE, GREAT INSTITUTION OF THE PUBLIC INQUIRY
A fundamental feature of the Swedish general- Åkesson, who submitted several proposals in welfare society during its formative period was the mid-1950s, which were then discussed with the use of thorough public inquiries. whose customary thoroughness. This was followed history dates back to pre-parliamentary days.
by a political commission, led by government Every reform and all proposed legislation was official Per Eckerberg, which presented its rec- grounded in a lengthy public inquiry, often The Eckerberg commission‘s most signifi- The first stage was often a study of practi- cant contribution was to raise the pension ceil- cal matters, followed by a non-partisan par- ing, which had the effect of greatly expanding liamentary review, and sometimes concluding the range of eligible workers. This led to strong with a political commission whose task was public support for the ATP system— support to prepare the implementation of the proposed that was much broader than suggested by the narrow margin of victory in the referendum that preceded adoption of ATP in 1960.
solicit comments and suggestions from gov- ernment agencies with the relevant expertise, shifted in a neo-liberal direction during the political parties and all organizations with an 1980s, the institution of public inquiries was interest in the proposal. The purpose was to bypassed. Examples of major decisions that ensure that all relevant issues were analysed were rushed through without the traditional and discussed from every possible angle prior process of careful review and consideration are to final decision. In this way, technical and the currency deregulation of the mid-1980s and practical matters were thoroughly illuminated the tax reform of 1990-91. The Social Demo- in the political arena, and members of parlia- cratic government‘s revolutionary decision to ment could become well-informed about im- apply for membership in the European Union portant matters on which they were to decide.
was presented as a footnote to a budget pro- posal in 1989. The recent pension reform is yet of this procedure. The first public inquiry into pension reform was commissioned by the gov- These and other far-reaching changes have ernment in 1935. It was a one-man inquiry by the chief insurance inspector at the time, O.A.
In short, the deficiencies of the new national pen- Brave new democracy
sion system are so profound that the questionarises as to why it was ever adopted. The answer That is what democracy looks like in the brave is probably to be found in the secretive, undemo- new world of Sweden, for a fundamental issue cratic process by which it was constructed and that will directly affect the lives of every citizen who reaches retirement age in the decades ahead.
It is a style of democracy and an approach to As with all fundamental issues in Sweden, the pension reform that corresponds quite well with controlling power over pension reform was held similar trends in other countries. The Social by the Social Democratic Party (SDP) which has Security system of the United States, in many dominated national politics for more than sixty ways similar to the abandoned Swedish system, years. Since the assassination of Olof Palme in has long been under attack by reactionary forces 1986, the SDP has undergone a transformation that have never forgiven Franklin D. Roosevelt from a grassroots movement serving the interests for introducing such an element of “socialism“ of lower- and middle-income groups, to an in- creasingly autocratic apparatus dominated by a political elite (see “The Price of Everything“ at Security system‘s impending collapse have been a standard feature of U.S. politics for decades, and That transformation is more or less complete, experiments in other countries are often cited as and the pension reform reflects the autocratic better alternatives. The market-oriented pension methods that the SDP leadership has now estab- system of dictator Pinochet‘s Chile was frequently served up as a suitable model— until it sank in This can be seen clearly in the fate of the “con- the wake of the market crisis that afflicted the sultation process“ that preceded the adoption of the new pension system. In accordance with SDP tradition, the party faithful were invited to study Sweden‘s recently abandoned ATP system since and debate alternative proposals for pension re- its inception in 1960. The difference is that the U.S.
form. An overwhelming majority of the 15,000 Social Security system has, thus far, survived the active members who participated in this process propaganda assault by powerful special interests.
recommended that the old ATP system be re- Now, it is the Swedish model of pension re- tained, adjusted and further developed.
form that is being touted as the best bet for the That was not the right answer. So the SDP leadership chose to misinterpret it and, instead, future. Some countries of Western Europe and to conduct closed-door negotiations with repre- the former Soviet bloc have been so effectively sentatives of four other political parties. The pro- indoctrinated that they have modelled their own posal that emerged from this secretive and hasty pension reforms on the new Swedish model.
process— lacking any significant input of available These include Latvia, Poland, Russia, Croatia and expertise— was submitted for a review that was Mongolia— societies that differ in many signifi- scandalously brief by Swedish standards: The cant respects from each other and from Sweden.
members of parliament and other interested par- But they do have one thing in common: The ties were granted a mere six weeks to study and new Swedish pension system is very likely to comment upon an extremely complex technical have very unpleasant consequences for all of document of some 1000 pages‘ length.
them, and especially for their most financially barked on a public relations campaign to soothe the mounting anxiety and outrage of the partyfaithful with an account of the proposed new sys-tem that was either remarkably misinformed or Jan Hagberg, chief actuary at a large Swedish insurer, is also Chairman of the Swedish Actuarial Society and In the ensuing bewilderment and confusion, a member of the International Actuarial Association. the SDP and its centre-right collaborators were Ellis Wohlner, Senior Vice President International of able to ram the reform through the parliament another major Swedish insurer, is a member of the with a large majority. It is doubtful that more than Swedish Actuarial Society, the Society of Actuaries, a handful of the MPs who gave their consent had the American Academy of Actuaries and the Interna- any real idea of what they were voting for.



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