Wednesday, April 28 2010 13:21

Pension reform or 'adult games' of adolescent Armenia

ArmInfo. Interview with Edward Sandoyan, Professor, Doctor of Science (Economics)

Mr. Sandoyan, lack of “long” money in Armenia's economy is considered a factor hindering development of our economy. It is connected also with the pension reform. What will pension reform give to Armenia? Is it relevant today?

Before answering your question, I'd like to mention that any non-systemic decision in economy is doomed to failure. Speaking of pension reform, we, first of all, mean a necessity to change over from the current pension provision system to the accumulative pension system. The factors connected with this idea are quite clear. They generally stimulate creation of the so-called “long” money in the economy i.e. certain cash flows are deposited and then turned into investment assets, invested in certain securities, thereby bolstering the capital market. We connect the mortgage market, long-term credit resources market, including long-term borrowings by the government in the domestic market, directly with long money. All this is very important. We cannot do without all this and solution to this task is important for development of the finance market.

On the other hand, we can never ensure population welfare without settling the major task i.e. ensuring at least minimal living standards for the people of pension age. This problem can be settled either through introduction of the accumulative pension system, or on the principle of solidarity of generations i.e. pension security via social taxes, the so-called pension payments. Various countries use these systems differently depending on the model of economy regulation. Modern models of market economy imply existence of accumulative pension insurance, first of all through establishment of corporate pension funds. There are many examples of successful decisions in the sphere of social reform, for instance, the experience of Chili and a number of European countries. First and foremost, it is necessary to realize that settlement of the pension insurance problem, specifically, establishment of pension insurance institutes without accompanying decisions in other sectors, including tax regulations and social sector management, is a road to nowhere.

The supporters of the pension reform say it should have been carried out yet 15 years ago, whereas the foes of the reform say that it is untimely and may deteriorate the living conditions of vulnerable sections of the population. What is your stand on this problem?

If we started establishing financial system mediation institutions, and generally pension reforms 15 years ago, we would have quite a mature financial market today and rather mature system of pension age insurance as well as rather effective system of social institutions. The example of Kazakhstan is more comprehensible for us. Pension reform was launched in that country 10-12 years ago and there are already quite developed institutions of financial mediation there despite some significant mistakes.

Whereas Armenia, it is delaying reforms not only in the social security sector, but also in the other sectors of economic regulation. Today's system of pension provision is not market-based absolutely. It meets the Soviet system of centralized planning and distribution of national income. Generally, we are far behind in development of “market economy” and I think that on this way we have been moving sideways for a long time already.

How to approach settlement of such problems?

To ensure merited future to the present generation - the future pensioners, we should start founding reliable sources of financing that will make it possible for us to increase the average pension to 40%-60% (in mid-term outlook) and 80% (in foreseeable future) of salary. We have no such sources, and, first of all, incomes of the population or budgetary opportunities. Besides, an average pensioner is not a self-sufficient person for he is short of the funds necessary for normal life or at least for the real minimum consumer basket. But a pensioner is also a consumer that demands goods and services and stimulates economic growth. The more solvent are the people of pension age the more important they are for economic growth in the country. Almost 20% of our population is pensioners and the people will live longer as the living standards in the country grow. This means that the number of pensioners will increase as well. There is another important problem. The state of pensioners makes young people lose confidence in their future as the government pension system is not efficient. We can and must change over to the accumulative pension insurance system and the sooner, the better. There is no alternative to that. Nevertheless, we will not solve fundamental problems of our economy by pension reform only. For instance, we have no resources to redistribute to the pension system to get a tangible effect on financial market development and social provision of future pensioners. The accumulative system is good if we have what to accumulate.

Well, but calculations show that in certain period of time total assets of pension funds will tangibly increase and may become the capital market accelerator giving a good incentive to the process.

Certainly, we will solve more tasks if start the reform as soon as possible, but to make huge steps forward and settle all the social problems, we must introduce effective mechanisms of fundamental restructuring of the national income distribution system, the structure and scales of population spending. We should modernize the whole complex rather than just pension insurance. I mean fiscal policy, taxation, budgetary policy, monetary and financial market regulation and other types of economic regulation.

Let’s imagine the following scenario of development: the government significantly increases the minimal payment for labor stipulated by the law thereby provoking countrywide increase of populating incomes, for instance 1.5-2 times. Simultaneously, the profit tax is abolished (the profit invested in capitalization i.e. the profit left at the disposal of corporation), a singe income tax is set for all types of incomes of privates, including dividends (when distributing profits among owners). In addition, a system of general declaration of incomes and property of the population is introduced with relevant institutions of tax monitoring and control. An institution of standard spending (for instance, spending on education, medical services, mortgage payments etc.) is introduced. The VAT is reduced significantly (to 15%, for instance) and a number of compulsory insurance lines are introduced, in particular, medical, pension, property insurance, motor vehicle liability insurance (OSAGO), as well as general third party liability insurance, life insurance and others. Hence, the state budget will no longer have to fund the healthcare system, for instance. These are huge funds that are spent inefficiently now. The government will direct these funds in the same sector indirectly thanks to the significant increase of incomes of state and private employees. Targeted financing of medical services via medical insurance funds will come to replace direct budgetary provisions.

It is also necessary to develop legislative requirements to the state and corporate employers regarding certain co-financing of the pension insurance through monthly provisions to pension accounts of their employees at the corporate pension funds. Rising the salary of our citizens we will fundamentally change the structure of their expenses, giving them an opportunity to be more creditworthy and more “targeted” consumers of goods and services. Distribution of the same funds via the state budget is a not targeted, inefficient and corrupt mechanism. In audition, it is necessary to significantly increase the property tax, which will result in redistribution of national income through population income leveling and reduction of polarization thanks to flow of funds from the rich in favor to the poor sections of the population. In particular, a high rate of property tax and its exemption for the privates having, for instance, up to 50 sq/m of housing and other property, will form significant incomes for local budgets, which will make it possible solving housing and communal problems within the shortest time period.

I repeat that it is very important that the fiscal policy is based on the system of general declaration of incomes and property of individuals, which makes the revenue service much more efficient. Institutions of revenue agents and litigation between the revenue service and taxpayers originate, which brings the probability of concealment of income by taxpayers almost to naught. Abolition of profit tax settles conceptually theoretical tasks – a serious problem of double taxation and economy capitalization, since profit distribution will be taxable and capitalization (reinvesting in own capital) will prove in a preferential regime. Considering the element of pension insurance in this package, we will get a big effect on economy and on development of investment component and on social security of the population.

All this is difficult to achieve and requires time and fundamental reform of the existing systems, and new economy building. Is it possible now in conditions of global economic crisis?

Our crisis is not connected with the global one. I have repeatedly said that our crisis began with the first day of our independence. In principle, our crisis started yet in the Soviet period of time. We destroyed then existing economic system without building a new one. In fact, we have something “new” (I call our system "neofeudal") bearing no relation to “market economy.” We are accumulating big foreign debts, we experience rise of prices, our state budget is overloaded and we are left behind the world innovative development. This will continue forever unless we settle the major task of complex modernization of economy, and not of separate sectors and institutions. We must create an original market economy. We have no system, developed, effective economy because neither the level nor even the format of our economic regulation system meets the market categories.

I think that our government cannot settle these problems independently. It needs mobilization of the intellectual potential of the Armenian public and Diaspora.

Who must do that, the Government?

Yes, of course. I can tell you a good joke. What the country does to form, for instance, a national chess team to participate in the Olympic Games or world championship? It selects the best professional chess players. It is trite and natural, isn’t it? And how we form the government? The government is formed on the basis political parties though we have no developed culture and traditions of party building; we have still immature civil society and no long-standing democratic traditions. So, let's select the chess team of Armenia on the same principle: two representatives of the Republican Party, by one representative of the Prosperous Armenia Party and Orinats Yerkir and one reserve player from ARFD. It is silly, isn’t it? What do you think, whether the national chess team is more important and prior for the nation and the state than the government activity? It turns out that we are squandering our national resources and neglecting the future of our nation and country. Figuratively speaking, we are playing adult games at the age of 19, copying the forms of "western government systems" without studying their content. We need professional Government, professional Parliament. In the meantime, many government members and parliamentarians are not making laws as stipulated by the Constitution, they are making business.

We must search for professionals in various spheres worldwide, offer them high salary, ensure for them proper social conditions and concentrate the best forces in Armenia. Source of financing will be found as well. We must not save budget funds for such purposes and we can raise also foreign funds. We must just work on this and search for professionals. Diaspora must appreciate Armenia not for patriotic reasons only. Making business for Armenians from Diaspora must be easier in Armenia rather than in any other country. Unfortunately, highly monopolized economy in Armenia limits the possibilities of foreign investors, also from Diaspora. We ought to create the best business environment in Armenia, the best investment climate; otherwise we will lose to history again.

Why didn’t we do that yet 10-15 years ago?

We didn’t that for the same reasons as now. They are two: lack of adequate knowledge and experience and influence of destructive factors. I have already told about the first reason. Nevertheless, I'd like to say that unlike many other nations, we have enough human resources to search for and implement the best solutions in the sphere of institutional development of the country. We just need to revise the approaches to attraction of people to development and implementation of institutional resources. As regards the second group of reasons, I’d like to outline, first of all, the high monopolization and oligarchic nature of our economy. The other problems result from the first two. After all, the interests of oligarchs have never met the nation’s ones.

We must demonopolize the market through introduction of institutions of effective anti-monopoly regulation and effective fiscal system also though progressive taxation of surplus profits of importers “earned” after “above-level” revaluation of the Armenian dram or misappropriation of the monopoly position in the market etc.

The pension reform is a very important task and we need such reform, but we will not get from it what we expect, for the pension system reform will settle very few of the package of tasks we have to settle.

Don’t you think that the pension reform will be the first step on the way to settlement of that package of tasks?

No, all these tasks should be settled simultaneously, as a whole; otherwise we will not see any tangible result. The banking system is a bright example of the aforementioned. Although the Armenian banking system regulation and supervision is one of the best among transitional and developing countries, it is still inadequately small even for our economy. We can speak of a full-fledged banking system only when the aggregate provision of crediting reaches 100% to GDP, instead of the present 23% considering the significant decline of GDP in 2009 (in 2008 this indicator was much lower). We are far behind the transitional countries by this indicator. Having the most efficient system of banking regulation in the CIS and even comparing to some countries of new Europe, such as Latvia, Bulgaria, Russia, we have not achieved an adequate result because the banking system cannot settle all the problems of the financial system alone.

We need a serious revolutionary modernization of economy starting with modernization of the net material income distribution system, strengthening of private property institutions and competition, the institutions of contract enforcement, property protection, the rights of higher labor forces, the rights and freedoms of our citizens. It is very important to create compulsory insurance institutions otherwise the insurance market will not develop.

Considering day-to-day reality in the insurance market and possibilities of separate players, what can we expect after awhile? Will we have an efficient system of insurance regulation?

With our today's incomes it is impossible. This task must be settled in a package with other tasks. The expected introduction of compulsory motor vehicle liability insurance without settling accompanying regulative tasks, for instance, securing competition in the insurance market, will turn into something dangerous because all these cash flows will occur in the hands of one, two oligarchs. In addition, we cannot wait until our insurance companies accumulate the necessary reserves in 50-100 years. We must allow leading foreign companies to our insurance market. Armenia is a country with small economy. Therefore no big capitals will be in the insurance sector. Sooner or later we will have to make our market open for foreign insurance society. This issue needs a competent approach. We need systems of cooperative regulation and supervision meeting the memorandums with mega-regulators of relevant countries, institutions of cooperative regulation and detailed selection of leading insurance companies from “reliable” countries with high rating assigned by professional rating agencies and with audit resolutions by authoritative audit companies etc.

But foreign companies will “eat up” our market with all its players…

There were such concerns also when foreign banks entered our market. Over 70% (official data) or actually over 90% of the capital in the Armenian banking system is under management of foreigners (subsidiaries of big foreign banks and financial organizations or the banks owed by foreign citizens). They have already “eaten up” our banking market and it is good. But to upgrade the quality of these institutions, it is necessary to revise our attitude to them. If we allow foreign banks to operate in Armenia not only with the status of branch organizations, but also as affiliates, not separating capital and with a universal license for banking operations, the economy of Armenia will get a source of financing for the largest credit projects in the real and other sectors.

But we are restricting access of these cash resources to our economy through normative regulation that provides a bank subsidiary (for instance HSBC-Armenia, VTB-Armenia or Areximbank-GPB Group) operating in Armenia with the right to lend no more than 20% of its regulative capital and not of the parent bank. In fact, we have already allowed foreigners to our banking market but still limit their opportunities to fund our borrowers.

We must fundamentally modernize the system of economic regulation. We cannot but be a really market country. We have no alternative.

By Elita Babayan

RUB	4.73	-0.02
USD	382.65	-0.07
EUR	442.76	-1.39
GBP	502.42	-1.81
CAD	273.11	-1.10
JPY	24.83	-0.03
CNY	53.79	-0.02
CHF	477.00	-1.40

News

Pension reform or 'adult games' of adolescent Armenia