Željko Garača: Without the 2nd Pension Pillar, Public Debt Would Be Half as Much, and Pensions Higher

The historic sporting success of our national football team, no matter how great and exciting, is not on par with two current events that evoke bitterness in me and cannot be washed away. The announcement of pension system reform, or the reactions to it, and the voting on the Agrokor settlement are the results of two strategic decisions, unfortunately, in my opinion, wrong ones, the first in the distant past and the second in the recent past, which are being presented as great successes that solve key societal problems. I consider this a success of wrong processes.

The Agrokor settlement has definitely prevented the correction of one strategic mistake. Among a series of controversial elements, I would single out one that is absurd. We are being shown that the delivery of thirty thousand hectares of the most fertile and valuable state land to foreign capital is actually in the national interest. Even those who shed blood for that land do not protest. Recently, we were almost on the brink of armed conflict with a neighboring and yet friendly country over a few hundred hectares of almost worthless sea bay.

Hysteria Around Pension Changes

There may be hope for the pension system, which is why I will focus more on the so-called pension reform. The almost hysterical reactions to the announced outlines of changes that the ‘expert public’ and, by default, part of the opposition, supported by the main media, glorify the second pension pillar are such that I am surprised by my position of defending a minister. I do not support the entirety of the proposal due to some controversial, perhaps unconstitutional elements, but I believe it was heading in the right direction, towards reducing the detrimental effect of the second pension pillar on the national economy and society, until politics overnight made the first compromise and announced the strengthening of the second pillar to appease opponents, interest groups, and coalition partners, even part of the opposition.

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The introduction of the second pillar is not our idea. This project was discreetly imposed by the World Bank as part of the neoliberal doctrine, and it was enthusiastically accepted by a large part of the expert public who saw their own promotion or mere survival in the academic world in aligning with the ‘mainstream’. Those who warned of many problems and harmful consequences were at best marginalized. However, the main problem is that the theoretical assumptions necessary for such a project to succeed were neglected, and they did not exist.

A surplus of the state pension fund is a necessary assumption, and a surplus of the state budget is also desirable. We had two large deficits, and the realistic prospects for success were minimal. The optimism at the introduction of the second pillar can be somewhat understood due to the then enthusiasm for the market and the postulates of neoclassical economics, but today, after the collapse of those postulates in the previous economic crisis, it is hard to understand those who still insist on it because the numbers are devastating.

How the State Renounced Its Money

Countries that were economically behind us, and today we envy because they have overtaken us, did not embark on such a project or abandoned it very quickly. In Croatia, however, this reform has taken on a pathological form. The state is currently renouncing a significant amount of money, around six billion kuna a year, to reduce its future obligations by about six billion kuna a year, while it will still have to pay that six billion a year in the future, that is, return the borrowed money to the pension funds. Without that money in the present, the state cannot function, so it borrows it from those to whom it has entrusted its management at costs it cannot bear. This is an incestuous relationship in which the state is dealing with itself and is paying dearly for it. However, the interest on such borrowed money is only part of the unnecessary cost to the state.

It can be assumed that the interest on total public and private debt is more than it would be if we had not incurred excessive macroeconomic imbalances and excessive public debt due to contributions to the second pillar. I roughly estimate that the state has so far, along with unnecessary debt greater than 69 billion kuna, which is the net payment to pension funds, paid more than 50 billion kuna in unnecessary interest due to more expensive borrowing, which continues. Of course, to pay that interest, the state had to borrow. Roughly, if the second pension pillar had not been introduced, public debt would be half as much, the economy stronger, and GDP and pensions higher. The problem of pensions has not been solved; rather, it has become even greater.

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Furthermore, the thesis about the intention to nationalize the second pension pillar and that the state will take citizens’ savings is being imposed. Setting aside whether this would be a good or bad move, it is simply not the subject of the current proposal. Otherwise, it is a very strained thesis that it is indeed about citizens’ property. They cannot dispose of it, cannot decide who manages it, with what risks, responsibilities, and costs. Furthermore, the interpretation that money from the second pension pillar is transferred to the first also seems questionable to me.

Upon retirement, citizens in any case leave the pension fund and transfer money to some private pension insurance company (currently only one) and conclude a contract for the payment of part of the pension according to one of the possible models. In addition to the fact that this money will immediately be reduced by the commission of the insurance company, the insured have nothing more to do with the transferred money except the right to receive the agreed pension. What is the problem with transferring that money instead of to a private insurance company to the HZMO? The only answer that comes to mind is the unrealized profit of financial institutions.

Shocking Amount of Profit

How much is that potential profit? Even rough estimates are shocking. Let’s take, for example, an insured person with an average salary who has been paying into the second pension pillar for twenty years by law, and who will retire in a few years at 65 years old with forty years of work experience and decides on a guaranteed pension payment for twenty years. Let’s assume that the amount in his pension fund account that is being transferred will be around 150,000 kuna.

The total amount that will be paid to him for the agreed period is around 160,000 kuna. This means that the total return on capitalized savings for twenty years is around six percent, which does not even cover the loss of value of the pension due to minimal inflation of 0.3 percent per year.

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On the other hand, annual returns in pension funds are around six percent. The pension insurance company, through the owning banks, will certainly invest that money, and there is no reason to believe that the return will be lower than that of pension funds, with the difference that all that return of around 50,000 kuna per average insured person remains with the banks. If we multiply that by, say, a million future retirees in the next thirty years, just for a sense of scale, we arrive at a staggering amount of 50 billion kuna.

Advocating Wrong Policy

The thesis that the pension system of generational solidarity is unsustainable is also wrong. On the contrary, it is the only financially sustainable one, of course, if it is not sabotaged. The second question is how much pension it can provide, whether it will be sufficient for mere survival, and we can agree that in that sense it is unsustainable. If the economy is in such a state that it cannot provide pensions of generational solidarity, it is unrealistic to expect that the second pillar will be able to do so. However, the pension system is not to blame for that. The responsible party is the economy, and above all, the state with its economic policy.

If we do not strengthen the economy, the second pension pillar will not help us. In the end, the state will still have to take responsibility for paying pensions. There is simply no money in the second pillar. It has been invested, borrowed, not to say already spent, at least as far as the state is concerned. For pension funds to be able to pay out the savings of the insured in the future, someone from their debtors must return part of the borrowed money. The state, as the largest debtor of pension funds, cannot return that money unless it borrows more or raises taxes. I do not know which is worse.

I would not want it to be thought that I advocate the current state. It needs to be urgently changed, and radically, if it is not already too late. I want, above all, to warn against the casual advocacy of wrong economic policy without a broader discussion among experts because it is divided.

Author: Dr. Željko Garača