Commentary

Poland Moves Toward Pension Freedom

By Andrew G. Biggs
This article appeared on Cato.org on July 15. 1999.
Ten years ago Poland was still a communist country mired in poverty and persecution. Adding insult to injury, Poland’s people and practices were the subject of mockery and derision—of “Polish jokes.”

Yet the Poles may well have the last laugh. As America’s Social Security system slides closer to insolvency, Poland has instituted far-reaching reforms that should make American workers and retirees envious. Unless American politicians summon the courage to reform a program that clearly is not working, America’s workers may retire only to find that the joke is on them. Poland’s government-run pension system faced many of the same problems our Social Security system faces: The pay-as-you-go system relied on present workers to support present beneficiaries. And the system was going to be swamped by a demographic wave of retirees with smaller numbers of workers to support them. As a result, Poland’s payroll tax had risen to over 48 percent of wages. The Polish system—and the economy—faced a crisis.

The World Bank identified pension reform as Poland’s most pressing economic priority, and the International Monetary Fund termed Poland’s “erroneous and malfunctioning old age system… the biggest problem for the state of Polish finance.” Despite political pressures against reform from retirees—who make up close to 50 percent of Poland’s eligible voters—the government in Warsaw summoned the courage to act.

Poland adopted a variation of Chile’s successfully implemented pension system: Workers may divert a portion of their payroll taxes to personal retirement accounts. Beginning this year, 9 percent of a worker’s wages are invested in the market by the worker’s choice of private investment managers. Some fund managers are Polish/Western joint ventures; others have been set up by industry, the Catholic Church, and labor unions such as Solidarity. Fund managers are subject to government supervision for safety and soundness while consumer protections ensure that workers are aware of fees and commissions when they choose management firms. Should a manager go bankrupt, workers’ accounts are guaranteed by the government.

Polish workers can now tie their retirement savings to the higher rates of return obtainable in the market. In fact, though Poland’s 1997 per capita gross domestic product was only $7,500—barely one-quarter of that of the United States—if Polish workers receive average rates of return they could well end up with larger retirement incomes than many American workers will receive from a foundering Social Security system.

And unlike the old Polish program—and Social Security—the new system affords each worker a property right in her pension. No one can take it away from her.

The benefits of current retirees and workers too old to change to the new system have been guaranteed. And the Poles financed the transition to the new system in the best way possible—not by raising taxes, but by selling off inefficient government-owned assets.

Plus, the estimated $3 billion flowing into these accounts in the first year alone will increase national savings, modernizing Polish capital markets and spurring economic growth for years to come.

In short, Poland faced an economic and political predicament every bit as challenging as the one Americans face with Social Security. But the Poles possessed one asset American politicians conspicuously lack: the courage to act.

It is rich irony that a former member of the Warsaw Pact and one time adversary of the West trusts its citizens to invest their retirement savings with financial giants such as Citibank, Aetna, Crédit Lyonnais and Allianz, while the U.S. government traps workers in a system promising only higher taxes and lower benefits. Poles may once have been the object of jokes, but when it comes to retirement security, it is they who may end up with the last laugh.

Andrew Biggs is a Social Security analyst with the Cato Institute.