Changing the system: the necessity of Russian pension reforms.

Over the past decade Russia's economy has been buoyed by renewal and newfound prosperity. Since the financial meltdown of 1998, the country has achieved positive economic progress. Driven by higher oil prices, Russian exports totaled US$317 billion, and annual GDP growth reached a significant 6.8 percent. The percentage of population below subsistence level dropped from 29 percent in 2000 to 17.6 percent in 2004 and continues to decline.

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However, while economic indicators provide reason for optimism among Russia's citizens, the poor financial state of the national pension system poses a threat to the standards of living of current and future Russian retirees. Without the right kind of reform, these retirees will find themselves with a lower standard of living and increased poverty. Most current retirees live on a basic fixed-income pension provided by the state--the monthly pension is roughly 2,726 rubles (US$103) per month. Even though particular groups such as World War II veterans receive an extra 550 rubles (US$21), fixed-income payments from the government for retirees are not sufficient to sustain a comfortable standard of living. As Rimma Markova, a pensioner and the head of the Pensioners Party in Russia told Lateline, "They've kicked us in the teeth and the most vulnerable people remain neglected. The current pension is 20 percent of the average salary, it's just enough to stop us dying of hunger." Others echo a similar sentiment: Tonya Fominyh, a 79-year-old pensioner, told the Guardian, "now our pensions means nothing [sic]." In addition, the small base pension rate is only periodically indexed to the price level. Given that inflation has been above 10 percent over the last five years, the purchasing power of these pension payments is being constantly eroded. Russia's population--in particular, its proportion of workers to pensioners--is also shrinking: the UN Population Division projects that the country's citizenry will fall from around 140 million people to around 108 million by 2050. This population dynamic poses additional challenges for Russia's pay-as-you-go pension system in the long term.

While the system has undergone gradual reform since 2001, continuing these efforts is necessary. In order for the government to ensure adequate living standards for its retired population, the Russian pension system requires initiatives that address the following challenges: the aging dynamic of Russia's population, the need for the pension system to provide adequate retirement income, and the proper role of the government in encouraging this reform.

Demographics

As with other countries around the world--including the United States--Russia's current pension system is pay-as-you-go: a portion of current taxation levied by the government on businesses is used to pay the benefits of current retirees. As long as the working population and wages have a positive growth rate, current workers can expect their future retirement benefits to be larger than the total tax they paid to social security as workers.

However, the population of Russia currently is shrinking. In 1992, the rate of natural decrease was 219,800 persons. The rate of natural decrease in the population since then has increased markedly and now hovers around 800,000 per year. As a result, the proportion of the population over the working age is now 20.4 percent, and the population under the working age has fallen as recently as 2005 to around 16.8 percent. Given that retirement benefits under Russia's pay-as-you-go pension system come solely from government taxation of then-current workers' wages, this presents a problem for the solvency of the Pension Fund of Russia (PFR), the government organization responsible for distributing payments.

Fundamental pension reform is probably the most economically and politically effective way of maintaining the solvency of the Pension Fund. Demographically focused methods seem either unpopular or difficult to implement in the near future. For example, President Vladimir Putin recently proposed a pro-natalist program in his Annual Address to the Federal Assembly of the Russian Federation, arguing that "the programme to encourage childbirth should include a whole series of administrative, financial, and social support measures for young families." This seems both difficult to implement and ineffective at increasing solvency in the near future. Encouraging immigration, which would allow the working population to increase, is not politically feasible: a recent Economist survey demonstrates that workers in Russia feel threatened by the presence of foreign workers such as western Europeans and Africans, and, if given the choice, would rather they not live and work in Russia. Therefore, the most promising solution in the short-term seems to be reforming the national pension system. The process of pension reform began shortly after Putin took office in 2001. Under the direction of Prime Minister Mikhail Kasyanov and with the help of Minister of Health and Social Development Mikhail Zurabov, a number of reforms were passed from 2001 to 2004, progressively instituting piecemeal reforms to the pension system.

The current pension system is based on federal laws passed during this three-year period and is a "three-pillar" system--each "pillar" refers to a separate source of retirement incomes for retirees. The first pillar is comprised of the basic pension from the Russian government, which as recently as April 2007 was 2,726 Rb (around US$103) per month. This in essence is the pay-as-you-go portion of retirement income. The second pillar is referred to as the insured portion. Eight percent of a worker's wages are withheld by the employer, and moved directly to the PFR. Upon retirement, a certain return is assessed on one's lifetime contributions to this fund, and payments are made to the individual accordingly. The third pillar, which was implemented in 2004 for all workers born after 1966, is the accumulative portion. This is in essence the fully funded portion of Russian social security. Six percent of wages are withheld by the employer and paid to the Pension Fund. From there however, these "savings" can be moved by the employee to one of around 55 licensed private pension management corporations in Russia; in essence, workers' contributions are being moved to individual pension accounts. In all cases, the withholding of these wages is performed under the auspices of the unified social tax system, which is in this sense equivalent to the social security tax that Americans pay.

The system's general strategy, which aims to provide a mix of government provision and private savings, has two key benefits. Firstly, it increases the likelihood that the Pension Fund of Russia will remain financially solvent by encouraging citizens to supplement their government-provided retirement income with private savings. This restrains the growth of government benefits being issued without necessarily decreasing attainable living standards. Secondly, mandated savings provides Russia's economy with a much larger pool of capital. These extra pools of savings could spur economic growth.

The troubles with the current system and solutions

While this type of reform is a step in the right direction, there are still problems. The main challenge the government will face when rectifying these problems is the political pressure against changing the federal entitlement program. Six percent of wages as a contribution to an investment account may not be sufficient for retirement savings. The administrative costs for the government, given the commissions that pension companies require for funding, may make the program prohibitively expensive. The contributions of the investment portion of the fund should be augmented to make the accumulative portion of the pensions a more feasible way of financing retirement pensions. This need not come from an increased percentage of wages withheld on the part of the worker. One possible course of action would be a matching grant system. For example, the government could enact a policy in which for every one percent of wages contributed to the accumulative portion of the account, the Russian government could promise to contribute a proportional amount such as 0.5 percent. Such a plan would augment the retirement savings of a Russian worker without increasing the six percent requirement. The funds for such a policy could come from Russia's "Stabilization Fund," which was established in 2004, to collect revenues from Russian oil and natural gas exports. The size of such a fund--currently, it is almost US$76.6 billion--makes such a matching grant policy financially feasible.

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