Russia's Pension Reform Invites Financial Stability

August 27, 2003

A brief article from The Economist, "Privatization Looms: Pensions in Russia Start Saving," hints that gradually moving Russia's pension funds to private accounts might solve more than just retirement benefit cuts. Individual savings will inevitably reduce the burden of the crippled pay-as-you-go system and, in addition, may systematically stabilize Russia's financial markets, encouraging further economic growth.

The article states: "In a country where male life expectancy is less than the retirement age, and the hardy survivors, after an increase on August 1st, get an average pension of just 1,901 roubles ($63) a month, it ought not to be a great challenge to keep the state pension system going. But Russia's rulers, like others who have promised workers some sort of a living in old age, always assumed that the taxes paid by the workers' children would cover the pledge. The snag is that there aren't enough taxpayers."

Russia's worker-to-beneficiary ratio is far worse than in the United States, Europe, and elsewhere. According to the article: "A dozen years ago there were 2.28 workers for every pensioner; last year there were only 1.74. This 'coverage ratio', low to start with, has fallen faster than almost anywhere else in the world. Within 20 years, says the government, it could be one-to-one.

"Russia's solution…is similar to those elsewhere: switch from a pay-as-you-go (PAYGO) system, where today's workers pay today's pensions, to funded schemes, where they invest for their own futures. … From August 1st asset-management firms are applying for the right to invest the state pension fund's money. Only those with enough experience and assets will be able to do this. By early September an approved list of firms will be ready, and from the start of next year workers will be able to choose one to manage their investments. In theory this is good not just for them, but for the economy, because pension money will pour into capital markets. This should be handy, because bank lending is weak and the markets are driven by a handful of big strategic investors.

"As elsewhere, the PAYGO system will keep running for several decades to support existing pensioners. Until then, each worker's pension contributions will be split between the old and new systems, with the new getting a gradually rising share. … To start with, only 7 percent of a worker's contributions will be invested in his own pension, rising to 22 percent by 2006."

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