In part one of this two-part story, IMR analyst Ezekiel Pfeifer examined how the Russian pension system managed to build up annual deficits of more than $50 billion. In part two, he attempts to answer the eternal Russian question in relation to this massive problem: What is to be done?

 

The working-age population in the country is expected to fall by as much as 10 million people over the next 15 years because of the demographic “crater” caused by the upheaval of the 1990s. Photo: © Dimaberkut | Dreamstime.com.

 

Curing the Zombie

The Kremlin knows that these annual $54 billion shortfalls represent an existential crisis for the regime. But not everyone in the government agrees, at least publicly, about how to bring the zombie pension system back from the dead—that is, how to cure it of its chronic need for budget funds.

The most widely touted solution, one that a consensus of experts agrees on, is raising the retirement age. Currently set at 55 for women and 60 for men—with thousands of people, such as those who worked at so-called “harmful and dangerous” enterprises, able to receive a pension even earlier—the retirement age is low by international standards. Virtually all 34 OECD countries have a normal retirement age of at least 65; for almost half those nations, it is 67 or older. And Russians’ life expectancy has been on the rise, having reached 76 for women and 65 for men. Putin, after years of ignoring the idea of raising the retirement age, broached the issue during his annual call-in show in April, hinting that such a move could be on the horizon. The current draft budget for 2016-2018 would gradually raise the retirement age by increasing it six months every year until it reached 63 for both men and women. The Labor Ministry also recently wrote a bill under which state workers would start receiving special pension benefits only at age 65.

Why wasn’t this all done sooner? For one thing, it was easy for the government not to do it—with energy revenues steadily being pumped into the budget, the Kremlin didn’t have to worry about the problem. Life expectancy for men was also so low—only 59 from 2000 to 2005—that it didn’t make as much sense. But delaying the debate has made things worse. As social researcher Yury Gorlin recently argued, the long-running taboo surrounding the subject has turned public opinion about it even more negative. Kudrin believes the government should do a better job informing people about the consequences of doing nothing. “Society needs to understand that without this measure, it will be impossible to provide a normal pension for future retirees. If we don’t do this, taxes will have to be raised,” he said in April.

No one has suggested raising the pension tax yet, but another measure is being seriously considered that would lower pension payouts. The 2016-2018 draft budget proposes indexing pensions at a rate lower than the predicted rate of inflation—meaning they would go up by 5.5 percent instead of 7 percent in 2016, by 4.5 percent instead of 6.3 percent in 2017, and by 4 percent instead of 5.1 percent in 2018. Keep in mind, annualized inflation is currently at a sky-high 15.6 percent, and while it is expected to drop next year to 6-8 percent, that would still deal a painful blow to pensioners’ real wages. This process has already begun: in July, the value of the average pension dropped 3.9 percent compared to a year ago, due to inflation. Pensioners by law cannot technically be below the poverty line, but their incomes put them very close. In the first quarter of 2015, the average monthly pension nationwide was about 12,000 rubles ($200), while the cost of an average “market basket” of essential food items for a single person was just under 10,000 rubles.

This problem is exacerbated by the fact that, unlike in many Western countries, in Russia the vast majority of retirees live almost exclusively on their state pensions. In a 2013 survey, 93 percent of retired Russians said they lived off their pensions, even though a majority of Russians believe a state pension is not enough to get by. (Compare that to retired Americans, for whom Social Security benefits make up just 38 percent of their income.) Contrary to popular belief, elderly Russians do not receive much financial support from their children or other relatives, either— only 8 percent of pensioners said they received additional income from family.

 

Taking Baby Steps

The government has already taken a few progressive baby steps toward putting the pension system back on its feet. New rules came into effect in 2015 that will gradually increase the minimum number of years a person has to pay into the system—meaning to have a job where his or her employer pays the pension tax, as opposed to receiving a salary under the table—from five to 15. This is a positive incentive for people, both to work longer and to work for a company that actually pays its taxes—especially considering that around 40 percent of working Russians say their employers do not pay the pension tax in full. The system is also now based on credits that people collect over their careers based on their salary, how long they worked, and when they started receiving their pensions. This is similar to the way the U.S. Social Security system functions—the longer you work and the more you earn, the bigger your retirement payouts will be. Russians are apparently perfectly fine with these changes: more than 65 percent believe that the minimum number of working years should actually be 20 or more, and 69 percent think the amount of one’s pension should depend on how many years you were employed.

It is possible that no matter what solution the government devises, it will be inadequate, at least for now. Pensioners will get poorer and the federal budget will continue to face annual deficits due to onerous pension coststhis is the most likely scenario for the coming years.

But these reforms alone are not going to fix the system. The population is aging too quickly—and Russia is not alone in facing this massive challenge. In Japan, over 25 percent of people are now 65 or older, the highest-ever share for the country, and the population is shrinking due to low birth rates. As a result, its pension system is now paying out more than it takes in, despite the fact that the government has built up a trust fund worth more than $1 trillion. Germany is also in dire straits demographically—its population is expected to shrink by 20 percent over the next half-century. The U.S. Social Security system, after years of running a surplus, began paying more than it collects in taxes in 2010, due to the baby boom generation beginning to retire. All these countries are studying possible solutions to the pension problem. Japan is seeking to invest its trust fund more aggressively, to compensate for increasing payouts; Germany plans to raise its retirement age from 65 to 67 by next decade; and the U.S. is pondering various options before its trust fund runs out, which is currently expected to happen in 2034.

Russia’s situation is uniquely terrible in the short-term, however. The working-age population in the country is expected to fall by as much as 10 million people over the next 15 years because of the demographic “crater” caused by the upheaval of the 1990s. “Currently coming into the labor market is the tragically small generation of the 90s—there has never been such a low birth rate as in that decade,” said sociologist Tatyana Malyeva in April. “And not just in our history, but in the history of the world. What’s more, this crater will last a long time.”

As a result, it is possible that no matter what solution the government devises, it will be inadequate, at least for now. Pensioners will get poorer and the federal budget will continue to face annual deficits due to onerous pension costs—this is the most likely scenario for the coming years. The state’s constant tinkering with the system also creates intense uncertainty for taxpayers. “From an employee/employer perspective, the constant state of pension reform change (i.e., in 1996, 1998, 2001, 2002, 2005, 2010, 2011, 2013 and 2014) makes long-term retirement planning a challenge, to put it diplomatically,” financial planning firm Towers Watson wrote in March.

 

Dim Prognosis

Perhaps the best action younger Russians can take is to follow the example of Western populations and start building their own safety net. Apparently they already expect to do so: only 66 percent of working-age Russians say they expect to live off their pensions, while 32 percent think they will be supported by their own earnings. The government could promote this transition by encouraging the use of private retirement accounts and the taking of responsibility for one’s savings. Of course, because the Kremlin has to fill such an enormous budget gap in the pension system, it has done the opposite by freezing the accumulative system, which allowed people to decide how to manage part of their state retirement funds.

In late April, Prime Minister Dmitry Medvedev announced that the government would not get rid of the accumulative system permanently—but it has already been downgraded: another one of the changes that took effect this year made the accumulative system optional, whereas it used to be mandatory. This means that while all working people automatically collected savings payments in their accumulative accounts from 2002-2013, they will now have to tell the government if they want that 6 percent of the pension tax to keep going into their own ledgers or to go into the pay-as-you-go system. Theoretically, if government pension payments rise faster than the accumulative accounts, it could be better to halt one’s participation in the accumulative system. But it’s impossible to know. “It’s very difficult for people to account for all these factors in evaluating their pension deposits,” Kudrin said in November 2013 after the changes were passed. “It’s hard for them to evaluate what will happen with the accumulative portion. Not even a professional finance expert could make that kind of historical decision. And yet we’re forcing people to choose: go with the accumulative system, or stay in the distributive system.” If a person does nothing by the end of 2015 (or possibly 2017), then by default payments will stop going to that person’s accumulative account and will start entering the pay-as-you-go system instead.

In 2012, the International Monetary Fund published a working paper about reforming the Russian pension system. In the paper, the authors warned that by 2050, the government was on track to spend a whopping 16 percent of GDP on pensions, almost twice the current level. But looking that far into the future is a futile exercise in Russia. Thirty years ago, no one knew with any certainty that the Soviet Union would cease to exist just six years later. It is equally difficult to know what the coming decade holds for modern-day Russia. When it comes to the country’s pension system, the relevant timeline is shorter than 10 years, however, let alone 30. If the government does not act to make the system less of a millstone on the federal budget, it could quite simply bankrupt the country.

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