A rare window of opportunity for pension reform

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Aneetha Warusavitarana

The inconvenient truth about pensions is that they are costly. Governments across the world struggle with striking a balance between the dual objectives of pension adequacy and financial sustainability. Looking at Sri Lanka’s government sector pension, it is glaringly obvious that the costs associated with this scheme are exorbitant. According to the 2018 Central Bank report, the Government has incurred Rs. 194.5 billion as pension payments. This was a little over 9% of recurrent expenditure for the year, for a group of around 623,000 pensioners. Let that sink in – 9% of recurrent expenditure for less than 3% of the population. In comparison, the Samurdhi allocation for 2018 is only 2% of recurrent expenditure, and goes to around 1.4 million households.

The costs associated with pensions will only grow, as has been highlighted by the Central Bank. The Census of Public and Semi Government Sector Employees shows that 77% of our government sector employees are between 30-55 years. This means that over the next 30 years, the Government will see an additional 800,000-odd individuals moving into retirement, and in a nutshell, this is a problem which will only snowball into something larger.

Quick fixes?

The government sector pension is non-contributory – the entire burden of payment is shouldered by the Government – and given our fiscal position, this is an area where reform should be seriously considered. Reforming pensions is tricky – it is a highly sensitive topic, and if executed badly, could mean that the Government still spends a similar amount on the same group of people, but through social transfers for the impoverished elderly as opposed to through a government-funded pension. There are however, some soft reforms which would be easy to implement, and which would have a positive impact on our pension system for both pensioners and the Government.

A quick fix would be to increase retirement ages…Sri Lanka’s demographics are such that we have a rapidly ageing population, with rising levels of life expectancy. In and of itself, this isn’t a bad thing, but it means the Government and policymakers need to think about how people will spend their old age. Future generations will be able to work for longer periods of time, and it is vital that this ability is reflected in our legal systems. Increasing retirement ages has been widely adopted across OECD (Organisation for Economic Co-operation and Development) countries which also have similar demographics to Sri Lanka. From the perspective of pension payments, this will slightly ease the burden placed on the system right now. To ensure that this reform doesn’t place undue shock on employees in older age brackets, who have planned to retire in the next few years, this is a reform that can typically be introduced to younger cohorts of employees.

It is impossible to introduce sustainable reform for the elderly without looking at reforms needed throughout an individual’s life cycle. Your quality of life as an aged person is determined by the life you led in your youth. Employment, health, disposable income, financial literacy, marriage status, and a myriad of other factors affect how an individual experiences their retirement.

Opportunity for greater reform

Right now, there exists a window of opportunity for the Government to holistically address old age security. This window exists for three reasons. The first is that all government employees hired after 1 January 2015 do not fall into the current non-contributory pension scheme. They are in a kind of no man’s land where they have been promised a pension, but the details of what this pension benefit will be like has not been made clear. It is not an enviable position to be in, but in making this adjustment, the Government has created a window for pension reform. As it is clear that these employees do not fall into the current non-contributory pension, the Government can bring in a new contributory pension scheme for the government system, where both the Government and the government sector employee contributes.

It will take decades to move out of the current commitment the Government has to those in the non-contributory scheme, but at least we can be certain that decades from now, the pressure that the non-contributory scheme exerts on the national budget will be reduced.

The second reason there is a window of opportunity is because the Government has promised to introduce a national pension scheme. The name implies that this would be a scheme that goes beyond the government sector, encompassing the private sector and the informal sector. As the private sector has coverage through EPF and ETF schemes, the widely uncovered informal sector will pose a challenge to those designing this pension scheme. However, the positive of this is that the Government has made a very public commitment to wide pension reform, under which reform of the government sector will be included.

The third reason for this window of opportunity is the recently discussed labour law reforms. Sri Lanka has a multitude of labour laws, and the reform proposed is to unify these laws under one common labour law. During this process, there will also be room for amendments to be made to the more archaic aspects of our labour laws – hopefully to ensure that our laws reflect a drastically different working experience than was there a hundred years ago. There is scope for reforms such as increasing the age of retirement and making flexible/part-time work more attractive – which would be a step towards attracting more women into the workforce. With female life expectancy, more women in work means more women with agency and greater financial stability in their old age.

What does all of this mean?

Labour reform and pension reform are inextricably linked to each other. The fact that discussions for reform in both labour law and pensions are ongoing is serendipitous – now the focus of work should be to ensure that reform has financial sustainability as well as adequacy at the forefront.

Should you say no to that government pension?

Originally appeared in the Daily Mirror

By Aneetha Warusavitarana

From a purely individualistic point of view, working in government can seem as a great choice. Government jobs come with perks; allowances of all natures and a guarantee that even if you underperform, the worst that can happen to you is a transfer – you will not lose your job. 

Once you hit 55, the deal is sweetened. At the point of retirement, you are provided with a pension package that beats ones offered by OECD countries, hands down. The best part of the pension package? You don’t contribute a single rupee towards it.

Why? Because the Sri Lankan government currently runs a non-contributory pensions scheme. Simply put, the government provides a monthly pension payment from the point of retirement to the point of demise. The World Bank places this monthly payment between 83 percent – 88 percent of the employee’s final salary, to which the employee does not contribute. In contrast, the private sector is covered by two provident funds, namely the Employers Provident Fund (EPF) and the Employers Trust Fund (ETF). In the case of the EPF, employers contribute 12 percent and employees contribute 8 percent. Employers contribute 3 percent to the ETF. When looking at the public sector pension scheme from a purely welfare perspective, it is difficult to find fault – a benevolent state is providing its retired government servants with a generous pension plan.

Why should citizens be wary of such benevolence?
According to the World Bank Development Update 2019, the current cost of pension payments amounts to 1.4 percent of GDP, and it is set to increase in the coming years. This is a considerable financial obligation that the government has made – and it is clear that there is worry about how financially sustainable a scheme like this is.

The government has made it clear that reform in public sector pensions is needed, and has taken an initial step to stem the outflow. All government employees hired after the 1st of January 2016 are not included in the present pensions scheme. The government has stated that a new pension scheme will be introduced for all employees hired after this date, making it evident that they wish to phase out the existing scheme.

Apart from the unaffordability of this public sector scheme, the consequences of it are far reaching - it affects productivity in the government service and labour markets in general.

 All the wrong incentives
Complaining about government inefficiency is a fond past time for many Sri Lankans. Some would say that nothing goes as well with a strong cup of tea than a good rant about the government. 

Let’s put the cup of tea down for a minute (just a minute), and ask why the government is so inefficient? There is a general understanding that if you want efficiency, you should look towards the private sector, and not the public sector. 

But why? Surely the government could hire the same sort of people and thereby achieve similar levels of efficiency. Part of the issue lies in the perverse incentives created by a culture of status, consistent increments which are not dependent on performance, and a guaranteed retirement. 

It seems a bit cold blooded to say that guaranteeing someone a decent retirement is a bad thing – but the argument runs deeper than that. Providing employees with retirement plans is not inherently bad. However, these plans need to be structured in a way which incentivizes your employees to work productively and efficiently, while ensuring that the employee (the government in this case) is not crippled by the financial obligation. 

Right now, in the government sector, part of the problem lies in the non-contributory pension scheme. Receiving a pension; receiving a good pension that you did not contribute towards creates a sense of entitlement.

A pension is now a right and not a benefit that is worked towards. After all, people are self-interested, and require the right incentives to be productive and efficient. The public service overall does not provide these incentives, and the pension scheme is only one contributor to this problem.

Labour markets 
Pensions also affect the flexibility and mobility of a country’s labour force. The long vesting period (requiring a worker to stay in that firm or that sector for a defined period of time to be eligible to receive a pension) of the government sector’s pension scheme affects labour mobility as workers are less likely to move between jobs and sectors. While one outcome would be that skills and knowledge would not be transferred across sectors, a more economically damaging outcome would be the perverse incentive for people to join a sector simply for the pension benefit, reducing labour productivity and competition.

This can be seen in Sri Lanka where many university students only want to work in the government sector. There are routine protests against the government for their not being provided cushy government jobs, and in response the government provides 10,000 students around election time. 

How does this impact labour markets? There is a continuous surplus of unemployed graduates, waiting for government jobs – and not considering other options.

Additionally, there is a significant opportunity cost that takes place - people join the government under the assumption that this is the best job available - the option of a job in the private sector is completely disregarded, even though opportunities for job progression, creating an impact, and better wages are all a possibility. 

Prudent financial management could mean that one retires with greater stability than a government pension provides. It is only a shift in mindset that is required. 

 Solutions
Nevertheless, the budget speech 2019 stated that a national pension plan would be introduced, implying that this plan would extend beyond the public sector to include private sector and informal sector workers. However, the greatest reform need lies with the current government sector scheme. A few small reforms could be implemented to ease the financial burden that the government currently has to bear for all government employees hired before Jan 1st, 2016. 

The first would be increasing the age of retirement and changing the pension calculation to one that is based on the average wage over the best five years of employment instead of final salary. In order to make this reform more palatable, it is possible that these changes are introduced for the younger cohorts of employees and not those who will reach retirement age in the next five years. In conclusion, before acting on the promise of a national pension plan, the current one should be better managed and made 
financially sustainable.