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Armenia prepares to privatize social security

World Bank, IMF advise against proposed pension reform

Move is considered risky

by Maria Titizian

Published: Friday March 06, 2009

Armenian pensioners. Photolure.

Yerevan - Starting in January 2010, workers in Armenia will see part of their pay go into private pension plans, under a decision adopted on November 13, 2008, by the Armenian government. Mandatory retirement contributions now go into a public pension pillar similar to the U.S. Social Security system. Workers born before 1970 can opt to remain in the existing pillar, but younger workers will not have the choice. (See sidebar for details.)

The change is understood to be a way for the government to finance the country's capital markets.

"The focus of any pension system should be the well-being of senior citizens," said the Armenian-American economist Ara Khanjian. "The purpose of a pension system shouldn't be to promote and generate the financial markets of the country."

The stated intention of the government's pension reform is to increase pension benefits and to link benefits to the amount a worker has contributed over the years. Under the current system, benefits are based on the number of years a person was employed, but not the wages earned during those years.

Armenia now has a pay-as-you-go system. The mandatory contributions workers make today fund the benefits of current retirees. The "system is based on the solidarity principle between generations," Prof. Khanjian explained. With pay-as-you-go, retirement funds are protected from financial-market risks. The government is able to link benefits to the cost of living, protecting retirees from inflation. It is able to provide benefits for as long as the retiree lives and also pay survivors' and disability benefits. And the plan has significantly lower administrative costs than private accounts.

The Armenian government's decision comes at a time when other countries – like Argentina, Italy, and Chile – are moving away from private pension funds.

International organizations weigh in

The International Monetary Fund and the World Bank, in the Joint Staff Advisory Note on the Second Poverty Reduction Strategy Paper for the Republic of Armenia, argue that Armenia should not privatize its pension system.

The note suggests that Armenia is not ready to adopt a mandatory private pension system. Such a system requires a domestic bond market, which is not yet developed in Armenia. It also requires the administrative capacity to record, manage, regulate, and supervise the private pension accounts, a capacity Armenia does not have.

In addition, the world financial markets are in crisis.

Minister of Labor and Social Affairs Arsen Hambartsumian told the Armenian Reporter that he disagreed with the position that having a developed financial market is a prerequisite for privatizing pensions. "The opposite also holds true – that the initiation of any pension reform will benefit the development of capital in the financial markets," he said.

Prof. Khanjian confirmed, "The financial markets, such as stock and bond markets in Armenia, are not developed because there aren't enough funds available to be invested in these financial markets. But when the mandatory private pension accounts are created, in a few years there will be hundreds of millions and eventually billions of dollars in these pension funds, ready to be invested in these financial markets, which will contribute to their development."

But that is not the purpose of a pension program, Prof. Khanjian said. The priority of the pension system should be the well-being of retirees, which the privatized system cannot guarantee.

Prime Minister Tigran Sarkisian and Minister of the Economy Nerses Yeritsian have long been proponents of implementing a mandatory private pension fund system in Armenia. The change was considered but not adopted when Mr. Sarkisian was chairperson of the Central Bank of Armenia (1998–2008) and Mr. Yeritsian was with the bank.

Mr. Yeritsian was not available to discuss the subject with the Armenian Reporter. Written questions submitted three weeks ago at the suggestion of the ministry's press secretary had not been answered at press time.

Theory vs. practice

In boom times, proponents of private pension funds pointed to impressive returns individuals could get if their retirement savings were invested rather than being used to pay the pensions of current retirees. At a time like this, with global financial markets in a tailspin, the argument has lost its force.

Across the globe, people who relied exclusively on private pension accounts are losing large sums of money and being forced to postpone their retirement – if they can find continued employment.

Most industrialized countries, including the United States and Canada, do not have mandatory private individual pension accounts. Many Latin American countries and some former Soviet republics do have private mandatory pension accounts invested in stock and bond markets all over the world.

"With pension funds in Latin America showing drastic losses as a result of the global financial crisis, Argentina has moved to nationalize its private pension funds, while in Chile, Colombia and Mexico there are urgent calls for reforms," Marcela Valente wrote in an article that appeared in the Global Information Network on November 28, 2008. "Many of the private sector pension plans, created mainly in the 1990s . . . followed the model adopted in 1981 by the dictatorship of Augusto Pinochet (1973–1990) in Chile. In 1993, Argentina adapted the model, without eliminating the parallel public system, which allowed workers to choose either one. But on Nov. 20, the Argentine parliament eliminated the private pension funds, which were in a state of collapse."