The planned changes to the pension system will make the economy more volatile
The government’s planned changes to the pension system may lead to a temporary spurt in growth in the Estonian economy if a lot of people leave the second pillar. This temporary burst would be followed by slower growth in the economy or even by a recession that would hurt the living standards of people in Estonia. Estonian exporting companies would become less competitive over the years, as the faster growth stemming from increased consumption would later slow again, but labour costs would remain higher than they had been previously.
Ending the mandatory funded pension would increase the risk of poverty in retirement, as people could spend in a very short time all the savings they have built up towards their pensions throughout their lives.
“There is certainly some space for repairs to the second pension pillar, so that people could get the maximum possible income from their savings when they retire”, said Governor of Eesti Pank Madis Müller. “However, the impact analysis of the planned changes shows that the plan as it is announced will probably not benefit Estonian pensioners over the long term. Allowing pension savings to be spent over a short time may give the economy an additional boost through increased consumption, but this would be followed by growth slowing to the same extent. The issue is that saving for a pension will not be compulsory, and the mandatory funded pension will be ended. The long-term problem with this is the increased risk of poverty in retirement and additional pressure to increase the tax burden”.
Five billion euros will have been saved up in pension funds by 2021. Recent surveys show that some of those who have joined the second pillar would remove their money from it to spend straight away. Consumption will be boosted further if the state decides that the amounts that have previously gone into individual pension savings accounts will be used instead to increase pensions. Overall, making pension savings voluntary will temporarily increase consumption and growth in the economy.
The growth in the economy that would come from this increased consumption would then be followed by a decline in the economy or at least by very slow growth
If consumption increases sharply after the payouts are made in 2021, then prices, wages and imports can be expected to increase as well. Later on, once people have spent the money they have withdrawn from the second pillar, consumption will decline and the jobs created in the meantime will disappear again. The temporary increase in consumption will push prices and wages to rise. When the economy later cools though, prices and labour costs will not fall back as fast, meaning that Estonian companies will become less competitive over the longer term.
A rapid sell-off of pension funds could reduce the return from those funds
Although the lion’s share of pension fund investments are made abroad, funds have in recent years invested increasing amounts in Estonia too, which has helped local companies to develop. It may be assumed that pension funds will be less able after the changes to make less liquid investments that bring smaller returns to the funds than expected. A rapid sell-off of assets would see both those leaving the funds and those remaining in them lose money.
Recommendations to the government
- Before making fundamental changes to the pension system, it is important to explain clearly what the results expected from the new system are and to get the widest possible agreement on them. The comprehensive picture should make clear the relative size of the pension that the state will provide in the future, the amount that people are expected to contribute themselves, and the cost of the pension system.
- We do not recommend making it voluntary to save for pensions, as the consequence could be that old-age pensions will be smaller in future. This step would also increase the pressure to raise taxes in the future.
- Given the desire to make the second pension pillar more voluntary, we recommend the following:
- if people start to spend their pension savings immediately, it will make growth in the economy more volatile. To balance this, it would be wise for the government to avoid spending additional tax revenues and for it to lengthen the minimum period for withdrawing pension savings;
- if the second pillar is to be made voluntary, it would be worth considering ways of encouraging people to save for their retirement through a funded pension;
- ways should be sought to protect those shareholders who have put their money into the second pillar pension funds that have invested most in the Estonian economy and have the least liquid assets.
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