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A Holistic Approach To Sustainable Pension Reforms In Malta – Aaron Grech

2 Aug 2019 12:00 | Anonymous
The Accountant – Sustainability. Summer 2019
The sustainability of state pension systems has been at the centre of policy debates across the world since at least the 1980s. This followed the sharp slowdown of economic growth in the 1970s, combined with the realisation that life expectancies had been seriously underestimated. International institutions such as the World Bank argued that, to be sustainable, spending on public pensions should not rise exponentially while pressing for reforms that reduced generosity and led to more reliance on private saving. Furthermore, policymakers looked at ways of adjusting their system to reflect demographic changes, such as by raising the pension age.

In contrast with systems across the EU, the Maltese pension system remained relatively unchanged through the 1990s and early 2000s. This lack of reform attracted the attention of international institutions; for instance, in 2003 the IMF “encouraged the authorities to move forward without further delays with a sufficiently ambitious pension reform that would ensure the financial viability of the system”. Although the delay has arguably made the task trickier, it also meant that reforms adopted a more holistic approach than that which was current before the mid-2000s. In fact, pension reforms in Malta have been inspired by the EU’s open method of coordination of social protection and inclusion policies. Under this framework the objective of reforms is “providing adequate and sustainable pensions”.
Placing adequacy and sustainability on an equal footing may at first appear to weaken reforms, however, there is ample evidence to show that interpreting sustainability as lower future spending on pensions is self-defeating. Many European countries that had adopted radical World Bank inspired pension changes in the 1990s and early 2000s ended up reversing considerable parts of their reforms. A prime example of policy reversal is the UK, where the removal of wage indexation of the basic state pension in the 1980s was reversed in the 2010s, and contracting out of state pensions was recently replaced by auto-enrolment in workplace pensions. A holistic approach to assess pension sustainability could help limit this cycle of reforms and increase trust in pensions.
Developing reforms with too strong a focus on long-term spending projections can be problematic, particularly in the context of a small and fast-evolving economy like Malta. The EU’s Ageing report issued in 2009 had projected that pension spending would rise consistently from 9.1% to 13.4% of GDP between 2015 and 2060. Projections issued a decade later, using the same methodology, show that in 2015 spending was 8% of GDP, and that it will fall to around 7% of GDP in  2030 before rising to 10.5% of GDP by 2060. This significant downward revision occurred despite there being no further increases in pension age, an increased generosity of pensions and further improvements in life expectancy. This apparent paradox disappears when one recalls Nicholas Barr’s statement on “the centrality of output to the macroeconomic viability of pensions”. While in 2009, Malta’s long term GDP growth was assumed to fall to 1% by 2060, the latest projections envisage it closer to 2%. A much higher level of GDP inevitably reduces the burden of pension spending.
One of the key reasons underpinning the higher path of GDP growth is that we now expect the labour force to be considerably larger than was projected a decade ago. A significant factor behind this is the increased inflow of foreign workers. However, focusing just on this factor ignores the substantial contribution of the improvement in employment rates of Maltese citizens. Back in 2009, the participation rate was assumed to rise from 59% to 64.5% by 2060. In reality, the latter rate was already achieved by 2013, and by 2018 the employment rate had exceeded 74%. This reflects three developments; namely changes (like tax credits and free childcare) which have led the female participation rate to increase by half, measures that have extended working lives (such as increased benefits for those who forgo early exit) and reforms that have made work pay (including the tapering of benefits and the introduction of in-work benefits). This fully justifies the adoption in the latest pension reform of the principle that an adequate and sustainable pension system has to be sustained by a strong active employment policy.
A frequent criticism made to Maltese policymakers is that the pension age in Malta remains too low compared to life  expectancy. Once again the reliance on a single indicator can be deceptive. The pension age in Germany in 2018 was 65 years and seven months, considerably higher than the 63 years in force in Malta. Yet, Eurostat estimates that on average men worked 40.9 years in Malta, as against 40.7 years in Germany. Having a high pension age is no guarantee that individuals will actually be working till that age. Only an active employment policy, together with broad cultural change in favour of active ageing, can help achieve that. The IMF estimates that the ongoing pension reform will reduce the burden of Malta’s national debt by 30% of GDP in the long run.
The main lesson to draw from recent reforms is the need to have a gradual and well-studied approach that places the pension system within a wider context. In Malta, the system now undergoes a five-yearly strategic review which looks at both adequacy and sustainability. It is a process that has helped generate significant changes; including the introduction of tax incentives for voluntary personal and occupational pensions, rules on home equity release, the improvement of minimum and survivors pensions, the introduction of contribution credits for those who continue their studies or care for their children, and higher pensions for those with a full contribution history who work past the age of 61. 2020 will see yet another review which will continue to further strengthen the Maltese pension system.

Dr Aaron Grech is the Central Bank of Malta’s Chief Economist and is a member of the Pensions Strategy Group.

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