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LOOKING OVER THE BORDER: THE PENSION REFORM IN ARMENIA
>From the ISET Economist Blog (www.iset.ge/blog)
On the first of January, Armenia will adopt an entirely new pension
system. This radical reform addresses two problems: widespread poverty
among the elderly and a lack of capital in the economy. The very
same problems also exist in Georgia, where the standard governmental
pension currently is 150 lari, and where the economy is suffering
from high capital costs due to notoriously low saving rates. So, it
is worthwhile to have a look at what is going on in our neighboring
country Armenia. Georgian decision makers may learn important lessons
from their experiences.
THE REFORM IN A NUTSHELL
In January 2014, a mandatory funded pension component is implemented
into the Armenian pension system. Everyone born after 1974
will obligatorily have to divert 10% of their gross salary to a
pension fund, while people born before 1974 can join the new system
voluntarily. The 10% of the gross salary, however, do not have to
be paid in full by the future pension beneficiaries. In fact, most
people have to pay only 5% of their salary, while the remaining 5%
are thrown in by the government. The state's contribution is capped
at 25,000 dram ($62) per month, which is 5% of 500,000 dram. Hence,
a person with a salary of more than 500,000 Armenian dram per month
will receive a subsidy of less than 5%. For example, if the monthly
salary is 600,000 dram ($1,480), the state will cover 25,000 dram ($62)
and the individual will have to make up for the additional 35,000 dram
($86).
The government does not get tired to point out the advantages the
new system yields to common Armenian residents. Unlike in the past,
and unlike in Georgia, there will be a direct connection between a
person's lifetime salary and the pension. Whether or not this is fair
is a matter of opinion; however, it smoothes the transition from work
to pension age. Moreover, the pensions are expected to increase the
living standards of elderly people considerably, and it is hoped that
in future more elderly people can afford to live independently from
their children. Currently, (adult) children often pay for their old
parents, while in advanced countries it is rather the elderly who
transfer money to the younger generation.
The state also emphasizes the safety of the accumulated capital,
which is brought about by a government guarantee to pay back all money
that was paid into the fund, compounded by the inflation factor. At
the same time, the system allows people some flexibility to invest
according to their own risk preferences. Each person can choose the
percentage of "risky investments" from the available options of 0%,
25%, or 50%. By the governmental guarantee the potential losses are
capped; hence, this scheme provides an incentive to go for riskier
assets as one would normally do.
TOUGH RESISTANCE
The new system is rejected by a significant part of the population.
Protesters are gathering every day in Yerevan, highlighting its
alleged disadvantages.
One argument put forward against the reform is that 10% of the gross
income is too large of an amount for a pension fund in a developing
country. In Armenia, the average monthly gross wage is about 150,000
dram ($370). The income tax was recently raised to 24.4% for income
below 120,000 dram ($296) and 26% above it. Thus, approximately 30%
of the gross salary of a citizen will not turn into disposable income,
a high percentage compared to neighboring Georgia. After taxes and
pension payments were made, somebody who earns the average income will
be left with just 105,000 dram ($259), hardly allowing to support a
family. Therefore, the protesters suggest that the state should not
only subsidize the accumulation of pension money, but pay the full 10%
from the government budget.
A more fundamental concern is the mistrust of many people regarding
the government's willingness and capability to keep its promises. The
collapse of the Soviet Union about 23 years ago was not only a
political crisis, but also left most of the population without a cent,
as ruble accounts held at Soviet banks were confiscated. Since the
early 90's, the Armenian government promises to refund those people
who suffered from these losses, but nothing happened. This created
a psychological barrier preventing people from trusting long-term
projects in Armenia.
The main problem, however, is the highly volatile exchange rate of the
Armenian dram (AMD) vis-Á-vis the dollar (USD). Looking at the chart,
one can hardly consider the dram to be a stable currency.
As one can see, between 2000 and 2013 the nominal exchange rate
was ranging between 300.73 and 591 dram per dollar. As much of the
consumption basket of Armenians is comprised of imported goods, locals
use to keep their deposits and cash in USD, even if there is a huge
difference in the interest rates (currently, the deposit interest rate
is 7% for dollar accounts for dram accounts it is 14.5% p.a.). In
future, people will be forced to save money for their retirement
in dram. The government guarantees the return of at least the 10%
of income plus inflation rate to each pensioner, but the exchange
rate risk remains with the pensioners.
In the debate some politicians expressed their concerns that the new
system would make it quite difficult for small and medium enterprises
to pay competitive wages. The contributions paid to the pension fund
are flowing back to the citizens when they retire, yet people are
not aware of that or they do not trust the government to safeguard of
their claims. Therefore, employees mainly care about net income, and,
so the argument goes, competing companies will be forced to reimburse
their employees for the perceived loss of income. This however, is not
a convincing argument, as all companies in Armenia are affected by this
change, so that - given the low downward elasticity of labor supply
in a market with unemployment - employers can shift the additional
burden to their employees.
In summary, one has to acknowledge that the Armenian government is
pushing a reform which is costly immediately but generates returns
just in the long run. Such reforms are notoriously unpopular with
the electorate, and hence it requires strong political will and
determination to get them through in a democracy. If things turn out
well, poverty among the elderly will be reduced. Moreover, a large
share of the accumulated money will be invested in the Armenian economy
(about 80%), improving the availability of capital. This capital is
urgently needed for fueling Armenian economic growth.
About the authors: Aram Derdzyan holds an MA degree in economics
from the International School of Economics at TSU (ISET). He is head
of the Young Researchers Organization Armenia (www.researchers.am)
which provides assistance to university graduates who want to pursue
an academic career. In addition, he is a teaching fellow of the
CERGE-EI Foundation. Also Astghik Mkhitaryan is a teaching fellow
of the CERGE-EI Foundation. She holds an MA in economics from the
International School of Economics at TSU (ISET) and a Master's degree
in Business Management from Yerevan State University.
by Aram Derdzyan and Astghik Mkhitaryan
19.12.2013
http://www.georgiatoday.ge/article_details.php?id=11772
>From the ISET Economist Blog (www.iset.ge/blog)
On the first of January, Armenia will adopt an entirely new pension
system. This radical reform addresses two problems: widespread poverty
among the elderly and a lack of capital in the economy. The very
same problems also exist in Georgia, where the standard governmental
pension currently is 150 lari, and where the economy is suffering
from high capital costs due to notoriously low saving rates. So, it
is worthwhile to have a look at what is going on in our neighboring
country Armenia. Georgian decision makers may learn important lessons
from their experiences.
THE REFORM IN A NUTSHELL
In January 2014, a mandatory funded pension component is implemented
into the Armenian pension system. Everyone born after 1974
will obligatorily have to divert 10% of their gross salary to a
pension fund, while people born before 1974 can join the new system
voluntarily. The 10% of the gross salary, however, do not have to
be paid in full by the future pension beneficiaries. In fact, most
people have to pay only 5% of their salary, while the remaining 5%
are thrown in by the government. The state's contribution is capped
at 25,000 dram ($62) per month, which is 5% of 500,000 dram. Hence,
a person with a salary of more than 500,000 Armenian dram per month
will receive a subsidy of less than 5%. For example, if the monthly
salary is 600,000 dram ($1,480), the state will cover 25,000 dram ($62)
and the individual will have to make up for the additional 35,000 dram
($86).
The government does not get tired to point out the advantages the
new system yields to common Armenian residents. Unlike in the past,
and unlike in Georgia, there will be a direct connection between a
person's lifetime salary and the pension. Whether or not this is fair
is a matter of opinion; however, it smoothes the transition from work
to pension age. Moreover, the pensions are expected to increase the
living standards of elderly people considerably, and it is hoped that
in future more elderly people can afford to live independently from
their children. Currently, (adult) children often pay for their old
parents, while in advanced countries it is rather the elderly who
transfer money to the younger generation.
The state also emphasizes the safety of the accumulated capital,
which is brought about by a government guarantee to pay back all money
that was paid into the fund, compounded by the inflation factor. At
the same time, the system allows people some flexibility to invest
according to their own risk preferences. Each person can choose the
percentage of "risky investments" from the available options of 0%,
25%, or 50%. By the governmental guarantee the potential losses are
capped; hence, this scheme provides an incentive to go for riskier
assets as one would normally do.
TOUGH RESISTANCE
The new system is rejected by a significant part of the population.
Protesters are gathering every day in Yerevan, highlighting its
alleged disadvantages.
One argument put forward against the reform is that 10% of the gross
income is too large of an amount for a pension fund in a developing
country. In Armenia, the average monthly gross wage is about 150,000
dram ($370). The income tax was recently raised to 24.4% for income
below 120,000 dram ($296) and 26% above it. Thus, approximately 30%
of the gross salary of a citizen will not turn into disposable income,
a high percentage compared to neighboring Georgia. After taxes and
pension payments were made, somebody who earns the average income will
be left with just 105,000 dram ($259), hardly allowing to support a
family. Therefore, the protesters suggest that the state should not
only subsidize the accumulation of pension money, but pay the full 10%
from the government budget.
A more fundamental concern is the mistrust of many people regarding
the government's willingness and capability to keep its promises. The
collapse of the Soviet Union about 23 years ago was not only a
political crisis, but also left most of the population without a cent,
as ruble accounts held at Soviet banks were confiscated. Since the
early 90's, the Armenian government promises to refund those people
who suffered from these losses, but nothing happened. This created
a psychological barrier preventing people from trusting long-term
projects in Armenia.
The main problem, however, is the highly volatile exchange rate of the
Armenian dram (AMD) vis-Á-vis the dollar (USD). Looking at the chart,
one can hardly consider the dram to be a stable currency.
As one can see, between 2000 and 2013 the nominal exchange rate
was ranging between 300.73 and 591 dram per dollar. As much of the
consumption basket of Armenians is comprised of imported goods, locals
use to keep their deposits and cash in USD, even if there is a huge
difference in the interest rates (currently, the deposit interest rate
is 7% for dollar accounts for dram accounts it is 14.5% p.a.). In
future, people will be forced to save money for their retirement
in dram. The government guarantees the return of at least the 10%
of income plus inflation rate to each pensioner, but the exchange
rate risk remains with the pensioners.
In the debate some politicians expressed their concerns that the new
system would make it quite difficult for small and medium enterprises
to pay competitive wages. The contributions paid to the pension fund
are flowing back to the citizens when they retire, yet people are
not aware of that or they do not trust the government to safeguard of
their claims. Therefore, employees mainly care about net income, and,
so the argument goes, competing companies will be forced to reimburse
their employees for the perceived loss of income. This however, is not
a convincing argument, as all companies in Armenia are affected by this
change, so that - given the low downward elasticity of labor supply
in a market with unemployment - employers can shift the additional
burden to their employees.
In summary, one has to acknowledge that the Armenian government is
pushing a reform which is costly immediately but generates returns
just in the long run. Such reforms are notoriously unpopular with
the electorate, and hence it requires strong political will and
determination to get them through in a democracy. If things turn out
well, poverty among the elderly will be reduced. Moreover, a large
share of the accumulated money will be invested in the Armenian economy
(about 80%), improving the availability of capital. This capital is
urgently needed for fueling Armenian economic growth.
About the authors: Aram Derdzyan holds an MA degree in economics
from the International School of Economics at TSU (ISET). He is head
of the Young Researchers Organization Armenia (www.researchers.am)
which provides assistance to university graduates who want to pursue
an academic career. In addition, he is a teaching fellow of the
CERGE-EI Foundation. Also Astghik Mkhitaryan is a teaching fellow
of the CERGE-EI Foundation. She holds an MA in economics from the
International School of Economics at TSU (ISET) and a Master's degree
in Business Management from Yerevan State University.
by Aram Derdzyan and Astghik Mkhitaryan
19.12.2013
http://www.georgiatoday.ge/article_details.php?id=11772