Jobs in MENA: How transforming pension systems can boost inclusion, equity, and prosperity

Pension systems globally have faced challenges in fulfilling their commitment to providing adequate financial security for individuals in their old age. In developing countries, pension coverage is often low, and benefits frequently fall below the poverty line. The design of the pensions systems, among other factors, tend to exacerbate informality, with only a fraction of formal workers receiving pensions. The low coverage and the little redistribution leads low wage workers to end up subsidizing high wage workers. The way contributions finance pensions contribute to the informality dilemma by creating a disparity between employer payments and worker benefits, perpetuating a cycle of low pensions, high informality, and discouragement of formal employment. For instance, in some MENA countries, if the worker does not accumulate enough years, he/she will forfeit the contributions from the employer. Governments, facing fiscal and debt sustainability pressures, struggle to enhance coverage and benefits. Bridging this gap between pension promises and realities is an urgent challenge requiring immediate attention.

There are current challenges in the way that contributory pension systems operate. First, there is limited coverage: In the MENA region, poor design of pension systems led to high informality rates (60% to over 90% of the working-age population) hindering pension system coverage. Second, pensions are insufficient, failing to provide a basic, decent living for the elderly and pushing many pensioners into poverty. Third, contributory pension systems in the MENA region face sustainability challenges. Parametric reforms encounter political resistance (e.g., raising the retirement age or contributions or reducing benefits). Efforts to expand coverage and increase benefits are hindered by a limited overall tax base because of extensive tax exemptions, inefficient tax administration, and low revenue collection revenue. This fosters government overborrowing and indebtedness. 

Fragmented pension systems also hinder labor market mobility and incentivize early retirement, impacting economic contributions, which then leads to informality of employment in the region. 

But governments in MENA can make reforms to fix the situation with certain policy options that enhance pension systems and address poverty among pensioners. Introducing a basic or social pension that guarantees a minimum decent living for all eligible individuals stems from the principle that general taxation should fund against risks common to all citizens (e.g., the Mexican model). This will increase the system’s generosity and extend coverage to those currently left behind.

Secondly, governments can replace contributory systems with social pensions: and grandfather in existing contributors, transferring remaining assets to state ownership, and introducing a fixed monthly transfer for new entrants upon their retirement. To ensure fiscal sustainability, direct taxes can allocate funds to support the proposed social pension. States need to: (a) introduce or slightly raise income (or other direct) taxes and place extra revenues into a special fund to be used for social pensions; (b) transfer all planned state contributions for new entrants to the fund to be used after 40 years of the implementation of the new social pension; and (c) improve management and performance of the current systems.

Another policy option is to introduce IRAs with tax incentives to encourage supplementary savings for consumption smoothing upon retirement. Voluntary pensions provide benefits for special groups, are easier to administer, improve long-term economic outcomes through greater efficiency, provide low risk for workers than relying on government and they ensure more fair ways to provide benefits. Other measures that can help are reducing subsidies, expanding the tax base, and “taxing of bads” (tobacco, carbonated drinks, fossil fuels, etc.) and removing tax expenditures to finance social pensions.

The benefits of adopting such policies for a better system mean:

1. Universal coverage, which ensures fairness and equity, leaving no one behind.
2. Increased benefit generosity, fairness, trust that can underpin a renewed social contract
3. Longer working ages (no incentives for early retirement) and greater labor mobility (particularly, between private and public sectors).
4. Improved tax base and fiscal and debt sustainability, as smart design of the social pension will avert the ballooning fiscal stresses that will emanate from the unsustainable contributory systems.
5. Increased Competitiveness due to a reduction of labor costs (deductions for pensions) which may attract new competitive advantages, and
6. Greater incentives towards formal employment.

There are still challenges to this proposed system: The size of informality in most developing countries imposes the adoption of a pragmatic expansion of noncontributory or social pensions, but the expected growth of the elderly population will require careful management for programs to be sustainable. 

This proposal aims to satisfy broad coverage, decent generosity, and fiscal sustainability and therefore would reduce poverty, minimize disincentives to formalize. But it must also: 

1. Ensure social pensions, combined with private savings incentives, adequately smooth consumption at retirement.
2. Implement direct taxation to ensure the proposed social pension’s fiscal sustainability.
3. Minimize incentives for grandfathered individuals to reduce contributions and labor market participation.

The proposed reforms aim to usher in a future where decent pensions are a reality for all, addressing not only the performance of pension systems but also contributing to a more equitable, efficient, and revenue-productive tax system. By implementing these changes, governments, particularly in MENA high-income countries, can bridge the gap between pension promises and performance, ensuring a just and sustainable future for all in their old age.

Source: blogs.worldbank.org