May 1, 2019

Pension reform spooks governments all over the world

Protests against pension reform in Saõ Paolo. Photo: Fabio Vieira/FotoRua/NurPhoto via Getty Images

Today, Brazilians poured into the streets to vent their anger about something that, in fairness, makes a lot of people's eyes glaze over: pension reform.

The big picture: It's the same issue that's roiled politics in Spain, France, and Argentina recently. In Nicaragua last year, it prompted a violent political crisis. And in Russia, it's the one thing Vladimir Putin is truly afraid of.

Governments do a lot of things, but few of them affect people's welfare as directly as paying for their retirement.

  • A pension is a promise: you will be provided for in your old age. When governments break that promise — as many do to avoid a debt crisis — the political consequences can be severe.
  • Many countries make overly generous promises when they set up their pension systems, underestimate how long people would live, or simply mismanage the money.
  • Often, to keep the payments flowing, governments have to divert money from other productive uses or run up huge deficits. In Brazil's case, the financial mess threatens the country's economic stability and growth.

One approach is to cut the outlays for retirees by raising the retirement age, narrowing eligibility, or reducing payouts.

  • But all of that is politically explosive. It not only hurts pensioners, but also the families who must often help shoulder the burden of supporting them.

Another approach is to raise taxes.

  • But the jump would be huge. In Europe, taxes would have to rise as much as 30% to cover future pension outlays, says the IMF. That would be political suicide.

What usually happens instead is compromise.

  • Brazilian President Jair Bolsonaro wants to save $300 billion over the next decade but will almost certainly settle for less.
  • Last year, Vladimir Putin watered down his own pension reform after it lopped double digits off his approval rating almost overnight.

It's a problem in the world's largest economy too. In the U.S., the Social Security system will have to start paying out less than originally promised in 2035 unless Congress reforms it. Many U.S. states and cities are facing pension overhauls or higher taxes to put their plans on a more sustainable footing.

The bottom line: The political compromises required to solve these problems will be painful. Pension reform cuts to the heart of what governments owe their citizens, and the difficult tradeoffs they face when those promises become unsustainable.

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