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Defined Contribution Pensions, But Not Really

Defined Contribution Pensions, But Not Really Economy Near Us (XXXI)

From a theoretical (and philosophical) point of view, the (defined contribution) pension in a pay-as-you-go system is an impersonal, non-coexistent, inter-generational, and mandatory quid pro quo. The referee which must assure that the quid pro quo is respected is the state (we have here a nice example of a hard core of public interest which would be desirable to be extended to others, i.e. national interests). As it is inter-generationally applied, such a “social contract” faces some accidents, some of which are objective, others not quite. For example, a current generation “i”, is paying social contributions during its active life to the generation „i-1” – I will do not complicate the discussion by taking into account that, in fact, there is an overlapping of generations both as paying social contributions and as benefiting from defined-contribution pensions (this would be useful if done for the public finance decision). In turn, the current generation “i” (which is the future “i+1” retired generation) will benefit for its pensions from the social contributions paid by generation “i+1”, and so on. This mechanism seems to provide a roughly fairness, because the pensions are calculated based on the effective social contributions paid during the active (that is, economically productive) life. Rawls, as pure contractarian, would say it should be designed and implemented in the legislative stage of making the social contract, not in the original position. Below, I ask myself whether such fairness is really effective and, if not, how we should to proceed. The discussion is inherently coupled to the debates regarding the increasing of the pensions in Romania. I will do not discuss the (judicial) fact that a normative act which was already been constitutionally enacted by the legislative authority leaves, I think, an extremely narrow room, if any, for doubts regarding its implementation, but, instead, I will deal with only some very simple economic and social questions (more exactly, of social justice).

In fact, the problem can be reduced to the pension point (a monetary value assigned for every point accumulated by the retired, for the period of active life, during which the social contributions have been paid).

Some problematic issues can be held here:

(a) from the perspective of the purchasing power of the monetary unit, the economic conditions are different between the stage of paying social contributions and the one of getting pensions – for example, inflation can occur meanwhile

solution in force: indexing the pension point with the average inflation (if deflation occurs, the pension point is not adjusted at all);

discussion: the solution is correct and fair, because the current recipients of pensions are not to blame for the deterioration of the purchasing power of the monetary unit;

proposal: to maintain the solution concerned (maybe using not an annual average of inflation, but a multiannual one – for example, over the last three consecutive years, in order to eliminate the temporary and reversible inflationary phenomena which, once included in the pension point, cannot be at all removed in the case when, for example, the causal phenomenon evolves inversely).

(b) from the perspective of economic conditions of work (including the economic productivity) and the social conditions of life (including the increased standard of living), the two mentioned periods differ, as well, from each other

solution in force: indexing the pension point with 50% from the annual increasing rate of the average real gross wage (if the average real gross wage decreases, the point pension is not adjusted at all);

discussion: the solution is economically correct, but socially unfair; my arguments are the following:

> the solution is economically correct, because if the nominal increase of the average gross wage had been used, the impact of inflation would have been introduced twice;

> the solution is socially unfair, because the average gross wage is not the best proxy for the standard of living in the current year, as follows:

- the average gross wage accounts (as source of social contributions) for the next generation of retirees (for the current active employees’ pensions), that is, for future, not for the current standard of living;

- the current retirees did not contribute at all to the increase of the current annual average gross wage, so the contributory character of the final value of the pension point is lost or, at least, mitigated enough; in fact, it must be mentioned that there is a governmental program (supported by an adopted law in the matter) of gradually reducing, until zero, the coefficient with which the pension point is adjusted based on the annual average gross wage increase;

proposal: holding that the current retirees have the right to benefit from the current standard of living, because of the very social contract which promised this synergistic effect of social cooperation I think the most appropriate variable which justifiably could adjust the pension point is the increase of the real total productivity of employees. The pension point adjusting with the inflation does not do anything else other than conserve the standard of living at the time when the pension amount has been established. Some additional remarks are called for:

> why is the real value of total productivity increasing? Again, to not double the effect of inflation adjustments;

> why the total productivity? Because the resources for increasing the demand (which is one of the impacts of increasing pensions) must be ensured so that it does not deteriorate the purchasing power of these pensions; such an assurance is best provided by the total productivity;

> why the productivity instead the average gross wage? Because, despite the economic (neo-classical) theory, it is not sure that the employers pay the gross wage exactly to the level of the marginal physical productivity of labor, so two alternative effects could arise here: 1) such pay is lower than the marginal physical productivity of labor, so the pensions adjustment is unfairly below the level aimed at the current standard of life; b) such pay is higher than the marginal physical productivity of labor, so the pensions adjustment is above the level aimed for the current standard of living, which is equally unfair and, additionally, could trigger some inflation by generating an excess of demand over the supply;

> since I (with one of my Ph.D. students) have already proposed to governmental decision makers that the minimal wage must be linked/anchored to the average productivity of employees in the economy, a good proxy to adjust the pension point, independently from the adjustment with inflation, could be the minimum wage, as average of the last three consecutive years;

> quantitatively, I think that the increased in the average productivity of the employees must be shared like this: 0.8 to employees, 0.2 to employers (as return both of technical investments and of managerial performance which are presumed to have brought a contribution, as well, to increase the average productivity of employees). Regarding the coefficient of adjusting the pension point based on the average productivity of employee, I think 50% from the part acquired by employees could be a good and justified coefficient.

It clearly results, I hope, that the defined-contribution pensions in a pay-as-you-go system are not fully contributory, but that the difference between the pure contributory amount and the (politically – Nota bene: here, the term politically rather addresses issues of social justice than of politics as such) due amount must be carefully grounded in order to conserve its social dimension and not be captured by the narrow and thin economic argument of the cost-benefit analysis. 

Photo by Andrea Piacquadio from Pexels

 
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OEconomica No. 1, 2016