Poland Doesn't Need to Fix Unbroken Pension System

Since 1989, Poland has stood out among the former communist countries as the most successful reformer with the highest cumulative economic growth. It sailed through the global crisis and was the only European Union nation that didn't experience a recession in 2009.

Given that record, it is puzzling that the center-right government of Prime Minister Donald Tusk has proposed a reversal of its excellent pension reforms of 1999 as a way to reduce the budget deficit. A measure is being debated in the Polish parliament this week, and the lower house could vote on it Friday, December 6, with the senate to follow next week. Approval would be a tragedy.

Caring for the elderly is a sacred duty of every society. The crucial question is how to balance responsibility toward them with obligations to the working-age population.

In the early 1990s, the World Bank came up with a sensible three-pillar model. First, everybody should receive a minimum pension, financed out of current state revenue. A second layer of compulsory private savings should be handled by private pension fund managers. The third pillar would be voluntary private pension funds that are open to all. Many countries, such as Sweden and most in central and eastern Europe, introduced the three-pillar model in the late 1990s. Poland did so in 1999 with a broad political consensus.

The changes also eliminated implicit public debt for pensions, because future additional pensions were financed with savings rather than current revenue. This increased national savings, which are vital for economic growth and investment. The emergence of large private pension funds also helped develop the capital market. The Warsaw stock exchange has more listed companies than the Moscow stock market.

Major Strains

As revenue decreased with the financial crisis of 2008–09, public pension funds experienced major fiscal strains. Most of the central European countries temporarily cut contributions to their second pillars for fiscal reasons, though most have since raised the contributions again. There have been complaints about high fees, which need to be monitored and checked through regulation and competition.

Hungary set a dangerous example. In 2011, Prime Minister Viktor Orban nationalized the private funds and instituted compulsory private pension savings, claiming they were really public. He simply wanted to reduce Hungary's public debt without cutting public expenditures or raising taxes. Because the Hungarian government retains the pension obligations, the public pension debt didn't disappear: It was transformed into implicit public pension debt. Considering Orban's undermining of other key institutions, his deplorable reform reversal wasn't surprising.

This precedent made it all the more surprising when Poland's democratic center-right government suddenly suggested a similar measure in late June. The government has one objective: to reduce the explicit public debt and render it implicit.

Poland has a constitutional amendment that requires the government to pursue mandatory cuts under a so-called sequestration when the public debt exceeds 55 percent of GDP. Debt is currently 57 percent of GDP, according to Eurostat estimates, but the Polish government is using a different measurement to avoid having to implement the budget sequestration, and it plans to increase the debt with a budget deficit of 4.6 percent of GDP in 2014, adding to the public debt.

Reversing Reforms

To afford excessive expenditures, the government intends to nationalize slightly more than half of the Polish pension funds, essentially those containing government bonds. This nationalization of 7 percent of GDP would reduce the explicit public debt to 50 percent of GDP. The focus on government bonds is probably intended to make nationalization easier technically, but it makes no economic sense. This tactic would severely damage the Polish government bond market. Usually governments promote their bonds to increase demand and reduce the government's interest cost.

Moreover, a pension fund typically has similar proportions of bonds and stocks. To maintain such a balance, Polish pension funds would seek foreign government bonds, because private corporate bonds are usually considered too risky. A shift toward foreign debt would introduce an undesirable currency risk in pension funds.

The government's reform reversal would swiftly reduce pension savings and, therefore, the demand for Polish stocks. The valuation of the Warsaw stock market would undoubtedly be constrained, which would reduce the initial public offerings that have provided many Polish companies with ample equity capital.

The government proposal faces blistering criticism led by the father of the reforms, Leszek Balcerowicz. Facing falling popularity, Tusk allowed Finance Minister Jacek Rostowski, the author of the proposal, to resign on November 20. Yet Tusk still insists on moving forward with this damaging reversal.

Strangely, the European Union and the International Monetary Fund have been silent, even though this deterioration of Poland's economic system should be of concern to Europe and beyond.

The Polish government's inability to manage the country's public finances cannot be repaired or disguised by undoing reforms that work.