Drawing The Right Lessons From The Greek Pension Crisis

The Financial Times has a useful background article on the debate about pension reforms in Greece, one of the main sticking points in the current showdown, which makes a number of important points. Some comments and amplifications are in order.

The article refers to groups of workers that, at least until the crisis, enjoyed very high replacement rates on entering retirement, and could do so at comparatively early age. As is typical of benefit systems in southern European countries more generally, the Greek pension system has always been highly discriminatory between different categories of workers. This means, among other things, that the very high replacement rates for some workers, which (rightly) arouse the ire of politicians and voters in creditor countries, are matched by low rates, indeed no coverage at all, for other categories of workers.

The creditors are insisting that Greece adopt “a ‘zero deficit’ system that would end budget subsidies for the pension system”. It is worth noting that a ban on the state budget subsidising the pension insurance system, if it were applied in Germany, would almost immediately bankrupt the system. Very substantial sums are pumped into the German pension insurance system by the federal government every year. And, in principle at least, there is no reason why this should not be the case. The provision of some pension entitlements can be seen as a task for society as a whole, and thus financed out of general taxation, rather than just by those paying pension contributions. (Of course this may not be behind the subsidies in Greece, but the point is that the “institutions” want a blanket ban on this practice, which I consider wrong as a matter of principle.)

The article provides another example of why sovereign debt default is not a magic bullet, but rather has unintended and unpleasant consequences. As I warned long ago, a bad haircut is not a pretty sight. In the minds of many well-meaning people, imposing a haircut on Greek sovereign debt punishes undeserving “speculators” and foreign bankers. In fact the prime victims of the Greek haircut were domestic banks (which had to be recapitalised using borrowed money) and the Greek pension system: according to the article the pension funds lost €25bn as a result of the 2012 haircut. It is absolutely standard practice for staid financial institutions like insurance companies, local banks and pension funds, rather than City sharks and Wall Street vultures, to be the prime holders of boring domestic sovereign bonds.

As with many other issues, many commentators get the crisis causality the wrong way around. In this case that means: the lousy Greek pension system is (partly) responsible for the country’s economic plight. But as the FT article rightly notes, the sustainability issues of the Greek pension system, while partially due to institutional failings, have not least been caused by the austerity policies imposed on the country by the same institutions now vociferously calling for pension reform. Alongside the haircut losses, the rise in unemployment has drastically reduced revenues: unemployed workers no longer make pension insurance contributions. Not mentioned in the article is the related point that severe nominal wage cuts have also reduced the contribution base and dried up revenues (It is true that the wage issue is more complicated given the need for competitive rebalancing. All the more important to limit wage cuts in the crisis countries and rebalance via faster nominal wage growth in surplus countries. See here, p. 97ff.).

Lastly, it is worth pointing out that a somewhat similar story can be told about labour market reforms. In an earlier SE post I provided some evidence that, contrary to perceptions in creditor countries, Greece has pursued very substantial labour market reforms since the crisis broke. Both the pension system and labour market institutions in Greece are certainly far from optimal, to put it mildly. There is scope for reform here, as there is in other countries. But the evidence and common sense tells us that it is the design failures of the euro area and macroeconomic mismanagement of the crassest sort that has resulted in such misery in Greece and elsewhere and that the priority must be to address these issues.