The Pension Crisis
Lack of reforms is diverting scarce resources away from human and economic development.
Photo Credit - Dawn
Pakistan’s economy is facing a new monster: mounting pension costs. Over the last few years, while all eyes have been focused on the growing debt burden, including circular debt, pensions have emerged as a line item that is constraining both the federal and provincial governments’ finances.
The World Bank highlighted this issue in a February 2020 report titled Pakistan - Assessment of Civil Service Pensions:
These costs grew since 2012 from about 4.5% of provincial fiscal revenues in Sindh and 6.7% in Punjab to about 12% of provincial revenues in 2019. Actuarial projections in this report suggest that these costs, along with growing salary costs will continue to grow substantially in the coming years crowding out other scarce public expenditures.
And it isn’t only the World Bank that has sounded the alarm. Hassan Khawar wrote the following in a recently-published column in The Express Tribune:
Federal pension payments have been growing at 18% a year, while provincial pension liabilities have been growing even faster. Such abnormal growth is taking a toll on the development budget — the voters’ share. All other budget heads, whether salaries, defence, debt or markup payments, are quite inflexible. It’s the development budget that is likely to get squashed as pension payments balloon further.
Pensions in Punjab have been growing at 24% per annum, outpacing 13% growth in revenue receipts by a wide margin. In K-P, the pension payments have grown by a whopping 7.8 times in nominal terms over the last 10 years. Moreover, presently K-P has 166,000 pensioners but an employee strength of 530,000. This means that in the next 30 years, the number of pensioners is likely to grow approximately four times.
Ali Khizar has written two must-read columns on this issue, which can be found here and here. One of the most important issues Ali raised is the following:
Ten years ago, the combined pension expenditure of federal (including military) and four provinces was Rs164 billion. Today, it is Rs988 billion. Pension liabilities have grown by 6 times, while the consolidated tax revenues are up by a mere 2.7 times. As percentage of taxes, pension expense grew from 9 percent to 21 percent in the last decade.
I invited Ali Khizar on a special episode of Pakistonomy to discuss this issue. You can watch the 15-minute discussion below:
One of the key things that stood out to me in this discussion and while reading Ali’s articles was how increases in pension payments have created perverse incentives:
The fact that a government official retries today would take more money home than what he was drawing as last salary is shocking. This implies that he has an incentive to take early retirement. He can spend his retired time in leisure or work in the private sector. It is beneficial for him to take an early retirement. Data is validating this assertion. In 2006-10, the early retirement to total retirees in Punjab was 22 percent. This increased to 26 percent by 2011-15; and in 2019, the toll stood at a whopping 63 percent.
In short, the structure of pensions is such that government employees are choosing to retire early and deciding to take in pension payments + have a side hustle!
Why should you care about this crisis?
My own analysis for why folks should care about this crisis is as follows:
With both federal and provincial tax revenues lagging due to a slowing economy, it is essential that scarce resources be used for human and economic development.
A growing annual pension burden redirects resources away from this spending, eroding long-term economic competitiveness and productivity.
Additionally, because governments cannot cut pension spending - this would be immoral and unethical - they must borrow increasing sums of money. This increases the government’s debt burden which must be paid back with interest by taxpayers.
The government’s growing borrowing needs crowds out the private sector, reducing private business’ ability to borrow for their businesses.
Additionally, running large fiscal deficits leads to higher inflation, which increases interest rates, leads to currency depreciation, and an erosion of households’ purchasing power.
All of this creates a vicious cycle that increases debt and inflation while lowering growth and household welfare.
Pensions reforms can convert a vicious cycle into a virtuous cycle.
Reforms can help convert unfunded pension liabilities into fully-funded pension funds, with contributions coming in from both government employees and the government.
In addition to reducing the annual pension burden on the exchequer, these reforms would:
Deepen Pakistan’s capital markets by creating large pension fund holdings that have inflows coming in every single month.
These holdings can be invested in long-term investments, some of which can include financial instruments that fund low-income housing and important public infrastructure projects.
By professionally managing these funds, government employees’ contributions can be invested in a way that beats inflation, yielding a net positive return for future retirees.
Additionally, professionally managed public pension funds could be used to buy stakes in state-owned enterprises (SOEs) that are being privatized, ensuring that millions of public servants have a stake in ensuring execution of SOE reforms to make these businesses into profitable and viable enterprises.
Here is what Hassan Khawar wrote about the benefits of these reforms:
If somehow, all these pensions could be transitioned to a contributory scheme, it could very well save the government at least Rs500 billion a year, assuming 50% contribution by employees.
All of this goes to show that pension reforms are not only good for both the federal and provincial budgets, they are good for the overall economy. Dealing with this crisis is a no-brainer and given that Prime Minister Imran Khan has expressed a desire to deal with this issue, one hopes that his economic advisers move quickly to defuse this ticking time bomb.
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