Pensions and Capital Markets: Engines for Ukraine’s Economy
An aging population not only affects families that must care for their elderly parents and grandparents, it is a burden on an entire economy. This year, pension expenditures in Ukraine reached 18 percent of Gross National Product, which translates into one of the largest pension burdens in the world. Over the next 10-15 years, costs in Ukraine are expected to soar. Unchecked, they will sap future productivity gains and soon will be tapping into critical budget expenditures for health, education, and infrastructure.
Ukraine, like most countries, pays current pensioners with contributions from current workers (known as a “pay-as-you-go system”). This works well when the number of workers exceeds the number of retirees. Currently, the contributions of 100 workers support 90 pensioners. By 2020, this ratio will change to 100 workers per 104 pensioners; by 2050, 100 workers will be needed to support 140 pensioners.
If the average pension remains at half the average wage, as it is under the current benefit formula, in 25 years, workers will have to pay 70 percent of their wages to support pensioners. No workers in any country would agree to that. A better solution would be to have workers save additional money for their retirement in a separate mandatory accumulation system. In this system, each worker contributes a percentage of his/her wages to an accumulation account. The contributions are invested, the returns added to the account balance, and the entire new balance reinvested. At retirement, the entire account balance becomes available as a supplemental to the pension received through a pay-as-you-go system.
It may sound simple, but it is not. The biggest problem would be what to do with the large amount of money that would be generated. Even if limited to half the work force (those under age 45), contributions from 8 million workers would soon generate the largest single pool of capital in Ukraine. Five years after implementation, the new accounts would be generating $4 billion per year. In a country with poorly organized capital markets, these precious savings could be squandered. The inflation rate also plays a critical role. Workers can only finance their own pensions if the contributions saved earn more than the rate of inflation. Otherwise, little is added to their nest egg for retirement. The system would work if Ukrainian companies put the new pension savings to good use by supporting productivity and new jobs.
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This is the aim of USAID’s Capital Markets Project – turning workers’ savings into secure investments in Ukrainian productivity and new job opportunities. In addition to dealing with Ukraine’s pension system, the project also works on developing a capital market infrastructure; on developing stock exchanges, depositories for clearing and settling transactions; and, regulatory oversight and legislation to protect investments. It also involves educating workers on new pension and savings opportunities and helping today’s pensioners who also need information and education.
Over its first three years, the project has assisted more than 3,500 pensioners a month through its Ministry of Labor and Social Policy free hotline on pension reform issues. Four qualified pension specialists answer questions on the new pension system's parameters. Each operator responds to approximately 80 calls a day from all over Ukraine.
Raising awareness among potential pensioners is also a high priority. In 2003, a new law was enacted that created voluntary non-state pension funds to allow current workers and/or their employers to develop additional retirement funds. Although any Ukrainian can join, participation in such funds is still low (only 2 percent of those eligible). To raise awareness and explain the mechanisms of this retirement option, the project has developed two PSAs and a brochure on non-state pension funds issues.
The bottom line objective of the USAID project is to create vibrant and effective markets for stocks and corporate bonds. This will ensure that savings can go where they are most needed for investment when they are needed most. In turn, this will do more than increase productivity and create jobs. It will help sustain the economic growth essential for delivering pensions that are adequate, affordable and reliably financed.
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