Pension Reform in Bulgaria—Increasing Youth Unemployment

April 27, 2015 3:00 PM

Like many countries in Eastern Europe and the developed world generally, Bulgaria faces the challenge of unfunded liabilities in its pension system. Reforming the system has been debated in Bulgaria over the past decade. Recent proposals for reform, including the introduction of higher social security taxes in lieu of raising the mandatory retirement age, and reducing early retirement schemes for the army and police, do more harm than good. The tax increase, if adopted, will increase youth unemployment, for example.

In our book The Great Rebirth, coedited by Anders Åslund and me, several Eastern European reformers provide accounts of successful pension reforms in their countries. The needed reforms are simple: increase the mandatory retirement age, typically to 65 years of age for both men and women; and reduce early retirement schemes for the army and police and in certain sectors like mining. Some countries have gone further. Last year, for example, Poland adopted legislation to increase the minimum retirement age to 67 years. The Czech Republic has adopted a plan to increase the retirement age step-by-step to 69 by 2040.

Pension reforms in Eastern Europe are being undertaken for two reasons: to reduce the deficit in the social security system and to increase labor participation, especially among women. Faced with unfavorable demographics, countries in the region need more workers to keep the labor force from dwindling. Labor participation is now nearly ten percentage points lower than that in Western Europe: 65 percent versus 74 percent, respectively.

Bulgaria's labor demographics are second-worst in Eastern Europe after Latvia's. The average effective retirement age is 56, and tens of thousands of young people leave each year in search of better work opportunities in Western Europe, mainly in Germany, Spain, and the United Kingdom. In 2014 alone, 30,000 people emigrated from Bulgaria, according to the Bulgarian Statistical Office. Household surveys paint an even darker picture, putting this number at three times the official statistics. Clearly, there is a lot of urgency to stem the outflow.

And indeed, two rounds of reforms were successfully undertaken in recent years. First, in 2001, the government of Prime Minister Ivan Kostov raised the mandatory retirement age to 63 for men (from 60) and 60 for women (from 55). The reform also eliminated several early pension schemes in the manufacturing and extractive sectors. Second, in 2011, the government of Prime Minister Boyko Borisov, in which I was deputy prime minister and minister of finance, raised the retirement age to 65 for men and 63 for women and significantly reduced early retirement benefits in the army. We failed to reform early retirement in the police because of fierce opposition from the Ministry of the Interior.

In late 2013, however, the second round of reforms was reversed. In 2015, the reforms were put on ice again. Instead, the government has backed away from touching the early retirement schemes and has proposed raising social security taxes by 4.5 percentage points. This proposal may reduce the deficit in the social security fund, but it will increase unemployment among the young. Higher social security taxes make the hiring of new workers more expensive. Employers shy away from hiring young people, since they lack experience and take time to learn the job. Governments try to address this issue by offering subsidies to firms that hire less experienced workers. The costs of this active labor market policy are borne by the national budget. Thus you reduce one source of deficit spending and increase another. The problem remains.

What to do? Simply take the reforms started in 2011 further. This is what the latest European Commission's report suggests as well.