Goldman Clarifies The Confusion Regarding The Recent Challenge Over Accounting Rules For European Pensions
A few days ago, we posted a piece which sought to describe EURUSD weakness, equating it to the news of an attempt to change European pension accounting rules (which would have an impact on the all too critical deficit calculation). Oddly enough, any public mention of this development was quickly buried, as most public media venues promptly removed all mentions of this story. Luckily, in validation of our collective sanity, none other than Goldman's European Strategist Erik Nielsen takes on this issue and bring much needed light to the latest accounting fudging exercise, that could have a serious impact for European deficits, and pension systems, down the line.
As I mentioned in my weekend note on Sunday, nine (mostly Central European) EU members have written to the European Commission to challenge the way government payments into the public part of the pension system are incorporated in the calculations of public deficit and debt numbers as they apply under the Stability and Growth Pact. A Commission spokesman said today that the commission is “analyzing the arguments put forward [and] answers will be drafted over the next few days.”
The issue at stake is several years old (and was rejected by the Commission in the past), but it has been revived by Hungary (and Poland) in reaction to the present disagreement on the speed of fiscal consolidation in Hungary. It is purely an accounting issue, and has no impact on cash flows, but – as I argued years ago when it was first being debated – the Central Europeans have a fair point which should be taken into account. However, the timing now is unfortunate because it risks muddling the greater issue of the needed fiscal consolidation in Hungary.
Here is the issue: While most Western European countries’ pension systems are “pay-as-you-go” (PAYG), most Central Europeans used the reform momentum of transition in the 1990s to implement “fully funded” or “defined contribution” pension systems, with the PAYG system providing only a minimal level of support. Such changes need to be gradual and phased in over many years as younger people start paying into pension funds (while receiving tax benefits in return), while older – but still working - people (who wouldn’t have time to build up enough savings in a pension system before retirement) need help to build the nest of capital, and the already retired remain in the old PAYG system. During the transition, there’ll be additional stress on public finances as (1) the young receive tax benefits to make money available for their payments to pensions, (2) the middle group of older employees needs help with payments into their pension plans because their “contributions” in earlier life (part of their past tax payments) are essentially gone, and (3) the PAYG requires state support as it loses contributions (they now go to the pension funds) while still paying out pensions to the retired. In all, however, these additional payments for the governments can be thought of as an investment in the future as later pension claims will decline.
The numbers are significant during these years of transition. This year alone, the Polish government will support the public pension system to the tune of about 1.1% of GDP (in addition to supporting the private funds), while the Hungarian government will be paying up to 1.4% of GDP. If the Commission were to agree to exclude these payments from their calculations of the deficit for the SGP presentations, then Poland’s 2010 budget deficit would be about 5.2% of GDP (instead of 6.3% on our forecast; 6.9% of GDP on the government’s own forecast), and Hungary’s deficit would be 2.8% of GDP (instead of our estimate of 4.2% of GDP; 3.8% on the government’s estimate.)
Happy to elaborate.
In other words, America is not the only nation that is facing a crunch in pension funding. Yet while our own Social Security system is certainly going to be bankrupt within 2 decades at the latest, few such analyses have been performed for Europe. And with the outcome unlikely to be much different, European nations that are doing all they can to fudge the accounting of their budget deficits to make their economies seem stronger, are happy to take the trade off of pension insolvency in the future in exchange for perceived strength currently (and who blames them - the US is doing this precise bait and switch every single day). Hopefully this issue will bring some much needed analysis to the issue of the European pension system to discover just how largely underfunded pensions are not only on this side of the Atlantic but across as well. And with Europe's population getting ever older (and with a far lower natural growth rate), it appears demographics are about to raise their ugly head once again, this time in a completely different aspect of the economy.