Stalemate in Prague

The works of Czech 20th century literary giants Franz Kafka, Good Soldier Svejk author Jaroslav Hasek and Vaclav Havel come to mind as one watches the country grapple with the question of pension reform. While the Czech Republic emerged from its kafkaesque period with the fall of the Berlin Wall and the subsequent ‘velvet revolution’, it appears to have since entered a svejkian phase as political parties deploy cunning for short-term advantage while paying lip service to a supposed greater good, with elements of havelian theatre of the absurd being thrown into the mix for good measure.
Yet it all started so well. Like all former Soviet bloc countries, in 1989 then-Czechoslovakia inherited an all-embracing and unsustainable state pension system. The January 1993 ‘velvet divorce’, when then-Czech leader Vaclav Klaus cut Slovakia adrift under its populist and authoritarian premier Vladimir Meciar, relieved Prague of the drain of supporting a Slovak economy based on a moribund Soviet-style defence sector and freed it to press ahead with reforms.
A beginning had already been made on reforming the pay-as-you-go state pension system in 1990, and parametric reforms were introduced in 1994. “We raised the retirement age by six years for men and three for women, and by eight to 13 years for some occupations,” Jiri Kral, an official at the ministry of labour and social affairs, told a recent conference in Prague.
And the government fostered the launch of a third pillar, with tax advantages for individual supplementary pension schemes and a direct state subsidy to individual accounts. Some 50% of the economically active population has signed up, and 25% also have some form of employer contribution.
But the reality is not as benign as this picture suggests. A surplus in the first pillar system resulting from the parametric changes is unsustainable. And the third pillar is beset by problems, including monthly payments that average only e13, having more than 50% of participants aged over 50, and a regulatory requirement that funds provide clients with a positive return every year leading to the adoption of conservative investment strategies that return yields that are only slightly above inflation and so not attractive for long-term savings.
So having made an early start the Czechs have since been overtaken in the pension reform stakes by the Hungarians, the Poles and, to the ill-disguised horror of the Czechs, a post-Meciar democratic Slovakia.
“There was a feeling that we could afford not to be in a hurry,” says Jiri Rusnok, a former finance minister and now executive adviser on Czech and Slovak pensions to Netherlands-based financial group ING and the current president of the Czech Association of Pension Funds. “We made reforms to the first pillar and currently it is in quite a good shape and was even in surplus last year, so the pressure to make changes has not been so high as it was in Poland or Hungary. In addition, the employment rate did not drop as severely as it did for our neighbours.”
Rusnok notes that ironically the lack of urgency was the result of the Klaus government’s failure to tackle fundamental economic reform. Although seen as the region’s Thatcher, Klaus was not as courageous as his contemporaries in neighbouring states. “His reforms looked radical but in fact were not because Klaus kept state banks in state hands and they in turn financed non-effective state-owned or state-linked private companies,” recalls Rusnok. “Although this was one of the reasons why unemployment was kept low and why there was a balanced situation in the first pillar it was the trigger for a major banking sector insolvency problem in the late 1990s and the real move towards capitalism only began in the second half of the 1990s, after the fall of Klaus’ government.”
For Rusnok another reason for the delay in pension reform is the issue of confidence. “On the one hand Czechs are like The Good Soldier Svejk and are not as patriotic towards the state as are Hungarians or Poles,” he says. “But paradoxically, on the other, they place a lot of trust in the state’s financial stability and are not so confident about private pension providers because it was the state that came to the rescue and bailed out collapsing privatisation funds and failing banks during the 1990s.”
However, official figures underline the cost of further delay to pension reform. They show that the Czech demographic situation is the second worst in Europe, with the present ratio of two working people per pensioner projected to deteriorate to 1:1 in 40 years. To maintain the current balance in 40 years the country would need to raise the retirement age to 73, to reduce the replacement rate to 20% from around 42% of a gross wage or 55% of a net wage, or double the present social insurance rate, which at 25% is already Europe’s second highest. If there were no reforms, in 40 years the public deficit would reach 200% of GDP and be growing rapidly.
According to Petr Benes, chairman and managing director of CSOB Pension Fund Stabilita, the true extent of the public finance debt far exceeds the officially stated 40% of GDP and that disclosure of the hidden implicit debt would be politically painful. “Economic need should lead to political courage,” Benes says. “But political parties cannot score any political points by disclosing the hidden debt, which is intertwined with the ageing of the population. We calculate the debt’s current value at somewhere in the region of 100% of GDP. But none of the political parties want to disclose the size and the painful agenda needed for a solution before the general election due next year.”
To be fair there are ongoing attempts to usher in reforms; the only problems being how to identify what to do and then agree how to do it. And the outlook does not look promising.
“There are three main reasons why there has not been progress on the pensions front,” says independent centre-right senator Helena Rögnerová. “First, Czech politicians, like those in other post-communist countries, prefer to pursue short-term gains, and the pensions issue does not lend itself to this. Second, all political parties have really different approaches to the issue, so it is very difficult to find any common ground. And third, somehow the time for reform has passed. People were ready for the impact of reforms in the early and even mid-1990s, but after so many years it may now be too late.”
Originally, the plan was to debate a government proposal to introduce a pension reform at the end of 2003. But it was postponed when it became clear that there was a lack of agreement among the parliamentary parties. The government – a coalition between the Social Democrats Party (CSSD) and a grouping of the centrist Christian Democrats (KDU-CSL) and the Freedom Union-Democratic Union (US-DU) – had a one-seat majority in the 200-seat lower house and then-premier Vladimir Spidla announced that political and social consensus was required for a change that would have an impact on several generations.
And it is here that the svejkian elements become evident. In the spring of 2004 cross-party agreement was reached on the establishment of an expert commission consisting of representatives from political parties and officials, backed by a working group of technocrats intended to calculate the implications of the political parties’ proposals, that would draw up a programme to be put before parliament.
“The current reform discussion is restricted to the public scheme and this is weird because there is a firm second pillar in most other European countries,” notes Markéta Vylitová, a consultant at Mercer’s Prague office. “But since the rejection of a draft law in 2001 there has not been any discussion about occupational pensions.”
“In fact there were two attempts, and I was in the middle of one as deputy labour minister with responsibility for the draft,” recalls Rusnok. “We proposed to create at least the environment for the establishment of a pure co-operative pension system on a voluntary not mandatory basis. There were doubts about the stability of an organisation that would be both a complex financial institution and governed by trade unions and employers. Another constraint came from the already existing pension funds that feared competition on costs grounds. And the trade unions and employers showed no enthusiasm for such a solution, and they did not give sufficient support for this idea.”
“There is no co-operation at all with the employers organisations due to the fact that they follow other interests than those of the trade unions,” says Jan Uhlir, president of the metalworkers’ federation (OS KOVO). “In the Czech conditions the continual financing of the state PAYG first_pillar system seems to be the best solution. The trade unions are actively involved in the reform discussions through the CMKOS confederation whose representatives participate in the various expert teams.”
But they had been there before. “The ministry of labour and social affairs has been working on this for a long time and it calculated all kinds of scenarios before this expert group started work,” recalls Vylitová. “But because they were done by a department in a ministry run by a social democratic minister, most of the proposals were simply rejected by parliament.
“The difference now is that this expert group is an external body and is not based on a ministry,” says Vylitová. “Rather its members come from various ministries – some from finance, there’s an actuary from the ministry of labour and social affairs and it’s headed by Vladimír Bezdek of the National Bank. So while there is basically no difference between the calculations being done now and those done by the ministry of labour and social affairs in the past, political parties feel that they can observe the process and so might feel more comfortable with the outcome.
“However, that only refers to the calculations,” adds Vylitová. “There’s always going to be the need to select one of the options and improve it, and that’s up to politicians. So this process just delays pension reform because we are only waiting for calculations and we know the political parties have views that are quite contrary to each other. I don’t believe the fact that an external expert group is making the calculations will bring us any further given the current political representation in parliament.”
“We are probably the last country in Europe to reform pensions as everything depends on our politics,” says Ales Vojir of the business newspaper Hospodarske Noviny. “And the main problem for pensions here is that the parties are not able to agree on how to reform the system. Their proposals are too different and they use pension reform as a weapon in their party-political disputes.”
Spidla’s CSSD, the senior coalition party, favoured a reform based on a notional defined contribution (NDC) system to apply to those born after 1966, with those born earlier retaining the benefits of the current PAYG system. Its KDU-CSL and US-DU partners favoured slightly different versions of a partial opt-out into the private sector. The main opposition party, the right-wing Civic Democrats (ODS) formerly led by Klaus, proposed a flat contribution of 20-30% of wages to private provision, rejected the NDC virtual accounts on the grounds that they will only conserve the current situation and proposed further increases to the retirement age and a tightening of conditions for early retirement. And the Communist Party (KSCM) wanted a reinforced PAYG first pillar that would obviate the need for private provision.
Spidla resigned following a disastrous showing by the CSSD in the June 2004 European election and was succeeded by his deputy, Stanislav Gross. Only 34 at the time of his appointment, Gross appeared to bring a youthful energy to the job, and signalled that he was prepared to abandon the search for a consensus and use the government’s slim majority to push through a pension reform by the 2006 general election.
But in February Gross’ credibility was dented when he appeared to be unable to explain how five years earlier he had been able to buy a luxury apartment. KDU-CSL leader Miroslav Kalousek then demanded that he step down as premier and that his wife end her links to a businesswoman who owned a property that housed a brothel. Gross refused to resign and his party proposed that he dismiss the three KDU-CSL ministers, a move that would provoke an early general election. Kalousek and his colleagues have refused to withdraw and insisted that the government can continue.
Gross’ standing was further eroded with the publication in March of How I Erred in Politics, the memoirs of Spidla’s predecessor as CSSD leader and premier and Gross’ patron Milos Zeman. His greatest mistakes, Zeman writes, were his choice of Spidla as his successor and of Gross as his protégé.
The outbursts have raised the absurdist possibility of both a prime minister whose resignation has been demanded and his deputy who demanded it standing by their positions while at the same time pretending the demand had not been made. And together with Zeman’s intervention it strongly suggests that even if the government survives until next year’s election, it will be defeated. A recent poll from the STEM agency confirmed earlier findings that shown the CSSD running third with a little over 13% support, behind ODS with 35% and the communists with 18%.
“The probability is that the next government will be led by ODS in coalition with the Christian Democrats, and that it will be in a stronger position than any administration for the past 10 years,” says Rusnok. “There is a high probability that such a government will be reform oriented but there is a chance that most of the current work by the commissions will be lost as ODS is talking about only one pillar, a basic state flat-rate Anglo Saxon type of security and the rest being voluntary. But the Christian Democrats may not favour such a radical approach. So very probably there will be some form of compromise, but it is impossible to see the shape of such a compromise.”

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