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Russia’s pension impasse – is there a way out?

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One way Vladimir Putin has retained his popularity among Russians has been by increasing retirement pensions and other social benefits, and as a result the state pension fund is deep in the red. But as Andrey Zaostrovtsev finds, Putin is more interested in keeping voters sweet than balancing the books (photo: RIA Novosti Agency).

Andrei Zaostrovtsev
11 January 2013

At the beginning of the 21st century Russia carried out a reform of its pension system. At the time, many Russians were under the illusion that Vladimir Putin was a reformer, and this illusion was bolstered by real changes in the country’s economic system, including the replacement of a progressive income tax structure with a flat rate. And a central element of this policy was the reform of retirement pensions, which had turned during the 90s into modest, almost flat rate, payments supplemented by an incredible number of benefits in kind.

How it all began

The decision was taken to link pensions more closely with incomes and introduce both mandatory and voluntary contributions to pension savings funds, which were intended to play a more important role in the future. Benefits in kind would meanwhile be replaced by supplementary monetary payments. There was even a special term for this: ‘benefits monetisation’.

This monetisation was a failure from the start. The first large scale protest against Putin’s policies was not the nationalist rally on Manezh Square in December 2010 or the mass demonstration by angry Muscovites in December 2011 after the shamelessly rigged parliamentary election. The first demonstration took place in January 2005 and was a protest by pensioners against benefits monetisation.

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Seeing themselves as being "fooled" by the Government on many previous occasions Russian pensioners of today can be easily called one of the most active groups of society. The young protesters of Bolotnaya Square can only aspire to the same level of entusiasm and commitment. (Photo: Andrei Nekrasov)

I remember coming out of the St Petersburg University of Economics and Finance, where I taught at the time, after a day of examinations, and finding Nevsky Prospekt, the city’s main thoroughfare, completely empty. An enormous crowd of protesting pensioners had blocked it at the corner of Sadovaya Street. Even the police, who tended to underestimate numbers at anti government demonstrations, put the figure at 20,000.

Looking at what is in effect Putin’s 13th year in power, one can say with confidence that if he is more or less deaf to political protests, he is very afraid of protests triggered by Russia’s economic situation. And especially if the protesters are pensioners, most of whom are loyal supporters of either the ruling United Russia party or the Communist party, which is also a Kremlin puppet. In the end, booming oil and gas prices made it possible to monetise some benefits more generously, while leaving untouched certain key non-monetary benefits such as free or reduced price public transport and free medicines.

In retrospect, it was clear that the benefit fiasco was the first nail in the coffin of pension reform. The gas and oil revenues were still not enough to keep pensioners happy. It was also necessary to exclude a substantial age group from the pension savings scheme.

In retrospect, it was clear that the benefit fiasco was the first nail in the coffin of pension reform. The gas and oil revenues were still not enough to keep pensioners happy. It was also necessary to exclude a substantial age group from the pension savings scheme.

The problem was that at the start of pension reform in 2002, this scheme was open to men born in or after 1953, and women born in or after 1957. Naturally, part of their pension deductions were diverted into savings accounts in either a state owned bank or a privately run pension fund, to the detriment of the state pension pot. As a result, it became more difficult to fund increases in basic pensions and to finance other benefits. The problem was very easily solved: in 2005 men and women born before 1967 were excluded from the savings scheme.

These were the first ‘losers’. It is unclear what is happening to the contributions they made to pension funds for the three years 2002-2004. I am one of these ‘losers’ myself, having entrusted my savings to an independent (non-state run) pension fund as soon as the reform came into effect. Every year I receive statements telling me how my savings have grown – unfortunately rather more slowly than if I had invested them in an ordinary bank deposit account. It is also unclear how and when I can get them back. And I am one of millions of Russians in a similar (or worse) situation.

So what has happened…?

Since 2005 the pension system has supposedly been stabilized. Everyone who is part of the savings scheme and whose annual income is below a certain amount pays pension contributions equal to 22% of their salary – 16% towards the ‘insurance’ component (this is not invested, but goes directly towards paying current pensions) and 6% into a savings fund. This cumulative fund is still only at the paying-in stage; the first payouts will be in 2022, to women born in 1967, if their pensionable age hasn’t risen in the meantime. People born before 1967 have no access to the savings element, although they still have to pay the same 22% of their salary.

In 2009, a crisis year for Russia, the average pension rose by 10.9% in real terms, and 2010 (a pre-election year) saw an unbelievable record increase of 34.8%(!) In 2011 the increase fell again, to just slightly over the inflation rate, but the damage had been done.

So what happened to this apparently ‘stabilised’ system? What happened was that Vladimir Putin started increasing pensions at an impossible rate. In 2009, a crisis year for Russia, the average pension rose by 10.9% in real terms, and 2010 (a pre-election year) saw an unbelievable record increase of 34.8%(!) In 2011 the increase fell again to just slightly over the inflation rate, but the damage had been done. The Russian state’s social obligations are characterized by what economists call the ’ratchet effect’: easy to wind up, impossible to wind down again (for that you need the excuse of a major war, at the very least).

The result of this pre-election populism was a pension fund deficit, which has continued to grow. In basic terms this means that the salary deductions discussed above are no longer adequate to cover current state pension obligations. Indeed they are not just inadequate, they are woefully inadequate.

Experts at Moscow’s Higher School of Economics have calculated the financial situation in which Russia’s pension system finds itself in 2013: total contributions to the basic ‘insurance’ component (i.e. not counting the savings element) will come to 2044 billion roubles, but 4653 billion roubles will be required to meet the state pension bill. So there will be a deficit of 2044 billion roubles. In other words, the working population’s pension contributions will cover a mere 56% of the total, and the other 44% will have to be taken from other parts of the public purse.

… and what has been done about it?

Russia has one of the lowest retirement ages in the world: 60 for men, 55 for women. When Aleksey Kudrin was Finance Minister, he proposed a gradual increase in retirement age, but Putin didn’t want to hear about it – and still doesn’t. He never tires of repeating the slogan, ’There will be no rise in retirement age!’

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It is argued that the current Administration is pushing the pension reform with immediate political goals in mind. Unfortunately, this rarely works for long-term social projects like this. (Photo: Andrei Nekrasov)

Putin is no fool; he is a cunning populist. He is well aware that nearly half of Russians of pensionable age go on working until they are around 65, and collect their full pension on top of their wages or salary. And these people, still perfectly capable of work, will not forgive Putin any cuts in their benefits.

Putin’s slogan, however, is less relevant to them (it’s unlikely that their situation could change retrospectively) than to the fifty-somethings now approaching retirement age. With all Putin’s increases, the average pension is now 35% of the average wage (October 2012 figures). And who will dare deprive this significant slice of the electorate of their expected automatic increase in income of over a third?

Putin is no fool; he is a cunning populist. He is well aware that nearly half of Russians of pensionable age work until around 65, and collect their full pension on top of their wages or salary. And these people will not forgive Putin any cuts in their benefits.

The same goes for proposals to restrict the right to receive both a salary and a pension at the same time. Such a measure would probably only apply to a very limited and uninfluential group such as university lecturers, research fellows at Academy of Science institutes and so on, but certainly not to the bulk of working people.

After long debate it was decided that from 2014 obligatory contributions to pension savings schemes will be cut from 6% to 2%. People will still be able to pay the extra 4% voluntarily, but if they choose not to, the money will go into the state pension fund, and as compensation they will receive a higher basic pension when they reach retirement age (at least, that is what is they are being promised).

The experts at the School of Economics tell us that that this measure will make an insignificant dent in the pension fund deficit (which will fall from 3.0-3.1% of GNP to 2.4-2.5%). Meanwhile we will more or less lose any savings-based pension system; people in Russia don’t generally make long-term financial plans and won’t save for a pension voluntarily.

To understand Putin’s decision, we need to bear in mind that it was taken not out of concern for his country’s economic welfare, but for short term political ends. These same ends will be the same in 2018, when Putin will stand for a second six year term as president. His administration evidently believes that the extra money diverted from the savings funds will at least allow them to maintain current pension levels for a while.

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