Book Review: H. Sadhak,Pension Reform in India: The Unfinished Agenda

One of the first lessons in macroeconomics is the income versus consumption (and saving) paradigm. While an individual is a consumer from birth until death, he/she is a producer and earner for only her productive years which are typically not more than 40 years on average. Hence, an individual does not consume all that she earns but saves up some for post-retirement needs. This is the simple philosophy underlining old-age security and pension policies across the world. If each individual saved up for her future needs in a disciplined manner, where is the problem? Complications arise from uncertainty. Future is uncertain—how much an individual might require is uncertain, not because she does not know her requirement for food, health and lifestyle but because she is not sure of how much money she will need in order to fulfil those real needs. Uncertainty over future interest rates and inflation rates makes it difficult for an individual to plan out her saving–consumption pattern with any modicum of certainty.

The above issue has been known for long and each country has been tackling it in its own way for years. So why is it coming up now with renewed interest? The world is growing old, that is why. It is a known fact that practically every economy is aging—proportion of population over 60 years of age (old) and over 80 years of age (oldest of the old) is increasing. Sociological changes have led to fewer births, advancement in medicine has led to longevity and fewer deaths thereby, changing the demographic profile of societies and economies over the last half-century. Potential support ratios are reducing while dependency ratios are increasing in practically every economy. India is still an exception—we have a relatively younger population though demographic shift is the same as in other economies. An important question is how much of this young population is productive and how productive.

Besides providing for post-retirement needs, aspects of social security and social support include health care, care for the poor, unemployment doles, etc. Pension and social security policies arise from the sociological philosophy adopted by the state and its people. Then it has economic and financial ramifications. The sociological issues address questions such as: Whose responsibility is the elderly population of the state? The government or the collective society or is it individual and family responsibility? Are they a public or private responsibility? What about destitute, widows and unskilled workers without social security cover? The economic ramifications of answers to these questions are felt on the agent who carries this responsibility and burden. How much money is required, where will this money come from and how will it be distributed across people and over time?

With the state taking responsibility for creating systems for overall well-being, every nation has created funds that accumulate savings from various parties—the individual, her employer and probably the state—that is (hopefully) put into productive use and accumulates into a reasonable sum in future to enable a decent annuity for the individual, post-retirement. Most such pension policies are benchmarked to ensure such annuities cover inflation and/or grow at the rate of average income growth at least. Issues arise when accumulations fall short of such targets and the state has to pitch in with current taxpayers’ money to bridge this gap. This inevitably can lead to a deficit spiral unless savings are deployed in high return opportunities and pay for themselves.

Dr Sadhak has tried to put together a comprehensive guide on pension policymaking and reforms by studying pension policy, structure and administration across countries. Most pension structures comprise two ‘pillars’—a mandatory pillar largely provided for by the state and contribution by employee and employer and a voluntary pillar for supplementing income provided by the former. The sums saved through the mandatory pillar are typically invested in safer bets such as government bonds and debt instruments—a low risk, low return option while the latter money can be invested in riskier bets (read equities) depending on the risk profile of the investor. Most pension policies started with universal pension that was built on the basic philosophy of equality and a PAYG (pay as you go) defined benefit (DB) system. This system over time has put immense pressure on the state and its treasury—current income of the state, rather than returns from past invested savings, is being used to pay pension.

Many countries have hence, started moving pension responsibility partly to the private arena—let the individual be at least partly responsible for his post-retirement income. This helps encourage more active savings through defined contributions (DC) as against the former system of guaranteed pension that did not incentivize savings. It also forces employees to take conscious decisions about risk-return trade-offs as such sums are invested in funds with different risk profiles managed by professional investment managers, with nil or minimum guaranteed returns. However, this is not a perfect panacea to all problems. What about investors who are not financially savvy or even financially literate? What about the poor who are barely literate? Who makes decisions for them and takes on their responsibility? There is no doubt that burden on the exchequer and the burden of social security primarily on the state has to reduce over time for any society to reach any sustainable solution. A trade-off between human and societal imperatives, on the one hand, and economic imperatives, on the other, is what pension reforms are all about.

Dr Sadhak has provided a detailed account of how basic pension structures are formed and why they are attracting attention across nations and how they are being reformed in different countries. Countries differ in terms of economic development, size, philosophy around governance and role of the state, historical context and of course, demographic shift. It is a no-brainer that pension reforms have to be tailor made for each. However, certain basic assumptions and truths do not change. The author has done deep research in the area to come up with near-comprehensive coverage of the subject.

Section 1 sets the backdrop against which pension reforms in India are discussed—what do pension systems look like and how these reforms are evolving in selected emerging market countries. Pension reforms can be primarily undertaken through parametric reforms and/or structural reforms. The section discusses what these reforms include and how much of an impact they can create. Hence, helping to answer the question as to what kind of reforms different nations can adopt.

Section 2 starts with setting the Indian context, the prevailing social security and pension system leading up to the challenges that have now taken proportions of urgency. With pension expenditure of the central and state governments growing faster than tax revenues and the GDP, pension expenditure has progressively been eating into a higher proportion of annual tax revenues. The New Pension Scheme (NPS) was envisaged to supplement the existing system comprising EPF, PPF, EPS, insurance schemes including health insurance besides sector-specific pension schemes. It was with a view to move the structure from the erstwhile DB system to partly DC. It came into effect in 2004 but has not seen the kind of success that was expected. It is plagued by low enrolment and few professional fund managers. Dr Sadhak tries to analyze what went wrong and why the system has failed to attract stakeholders on all fronts.

Section 3 goes deeper into the issues to study the regulation and administration of pension funds, pension products, risk management, investment avenues, governance and most importantly the state of the capital market in the country. Lack of a deep and liquid debt market for long-term debt instruments is a major limitation for pension reforms, which by definition, are safe deposits for the future. An effective pension system needs to be able to have wide reach and be professionally managed, while keeping costs low in order to maximize returns for investors. The author concludes the need for efforts to create awareness around pension planning and the NPS specifically while at the same time, efforts are required on the structure, governance and administration of the NPS to make it inclusive, self-sustaining and cost effective.

The book is a good compilation for researchers, policymakers and administrators in the pension reforms and policymaking space, especially in the emerging markets. However, the book is quite voluminous and the writing can be a bit dry for most readers, making it a little difficult to keep up focus and reading tempo. Editing could have been better—too many grammatical errors and lack of attention to punctuation make reading an effort at many places. Having said that, this is probably one of the few pieces of work providing so much information and background on India’s and other emerging markets’ pension policies and structure in one place.