Pension reform or ‘adult games’ of adolescent Armenia

2010-05-01 14:39:00

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, ArmInfo, 28 April 2010