Policy Reform and the Development of Democracy in Eastern Europe

Chris Hasselmann

• Publisher: Routledge
• Year: 2017
• eBook ISBN:
  9781351151627
• Topic: Política y relaciones internacionales
• Subtopic: Política

Integrating the international pressures emanating from the Washington Consensus with an analysis of domestic interest representation, this book explores the political consequences of privatization and the progress of democracy in Eastern Europe. Chris Hasselmann investigates whether the issue of pension reform offers a natural controlled experiment with which to explore both issues throughout the region and the former Soviet Union. The volume will prove of value to those with an interest in public policy and governance issues, the politics of Eastern Europe and political theory more generally.

Chapter 1
Introduction

During the summer and fall of 1989, an extraordinary series of events rapidly unfolded in Eastern Europe that ultimately culminated in the eventual collapse and disappearance of the communist regimes that had been encamped there since their installation by the Soviet army following World War II. In the years that followed, each nation began the process of economic and political reform, a simultaneity that separates Eastern Europe from other Communist regimes such as China and Vietnam, which, while also undergoing market-based reforms, are attempting to hold onto their political control. By the late 1990s, a vast array of new institutions had been drawn up covering almost every facet of social, economic and political life. Aiding in this creation were an army of international consultants and financial experts from both academia and organizations like the World Bank, the International Monetary Fund (IMF), and the European Union (EU). While these international actors helped structure the transition, the period was also one of democratization and the supposed advent of real domestic interest representation. How have these two political forces, one international one domestic, interacted? More importantly, what does this interaction tell us about the status of the transition to democracy itself?

A Pension Crisis and the Need for Reform

This research addresses these questions in the context of efforts to reform the communist-era pension systems in Poland, Hungary and the Czech Republic. The choice of pension reform as a vehicle of inquiry is two-fold. First, the issue provides an ideal environment in which to comparatively study the question of the interaction between domestic and international politics. In order to properly examine such a relationship, one of the elements must be held constant. In this case, the policy pressure applied by the international community was the same across the board; what varies is 1) a nation’s responsiveness to that pressure, and 2) the ability of domestic actors to influence the legislative process. As a result, we have a natural, controlled experiment across multiple countries. Moreover, because it is the international aspect that is constant, it is possible to comparatively evaluate the process of democracy and interest representation across the region.

Apart from methodological advantages, lies the salience of pension reform itself, one driven by two factors that combined to place the issue on the agenda of every country in the region. The first has to do with the nature of the communist labor market, and the solutions that were devised to the employment crisis that resulted from the transition to a market economy in the early 1990s. Throughout the communist-era, the incentive for managers of state-owned enterprises (SOEs) had been to employ as many workers as possible; essentially, they learned to hoard labor like they hoarded everything else. When subsidies were cut-off as part of the market and price liberalization process, firms had to bring their employment levels closer in-line with the actual requirements of producing at or near profit maximization. This entailed a massive scaling back of their labor force, and one often chosen means to this end was to offer early retirement to anyone willing to take it. As a result, most countries in Eastern Europe experienced a dramatic increase in the size of their pensionable aged populations as early retirement and generous applications of disability pensions became seen as “more humane” ways of dealing with an employment crisis in a region where people had grown accustomed to job security that “was more stable than the Japanese promise of lifetime employment” (Laszlo Bruszt 2001, personal communication).¹

The second factor forcing states to address the issue of pension reform was the manner in which these systems were financed. Using a Pay-As-You-Go (PAYG) arrangement, current workers and employers provided for current retirees through jointly financed payroll contributions.² Such a system is premised on an “intergenerational covenant [whereby the current] generation of workers pay for the pensions of the generation before, with the assurance that they [will] be provided for by the generation to follow” (Noonan 1998, 2). This kind of system works extremely well where the ratio of workers to pensioners is relatively high, and as such was the standard model for communist systems everywhere as all available workers were claimed to be employed. What forced politicians to undertake reforms was the sudden collapse of this ratio in the early 1990s. As unemployment and early retirement grew, those paying into the system, and thereby supporting the current retirees, began to shrink at an ever-increasing rate. To make matters worse, gloomy demographic forecasts showed a rapidly aging population, a fact that only added to the growing sense of crisis. In short, some type of reform was inevitable as bankruptcy and insolvency suddenly loomed large on the immediate horizon. A visual assessment of the impending doom faced by Poland, Hungary and the Czech Republic is provided in Figure 1.1; (the numerical data for each country is provided in Appendix 3).

One way in which to evaluate the viability of a PAYG pension system is through the System Dependency Ratio, which relates the number of pensioners to the number of contributors (expressed as a decimal in Figure 1.1).³ Using Hungary as an example, we see that by 1995 it took the effort and payroll contributions of nearly four workers to support three pensioners (ratio: 0.748); by comparison, in 1950, almost eight retirees could be supported by the contributions of a single worker (ratio: 0.129). Figure 1.1 also clearly shows the effect of using early retirement and disability pensions to solve the employment crisis as the ratio jumped by more than 62% between 1990 and 1995! The impending demographic danger can also be seen in that the ratio is expected to reach 1:1 by 2035, all of which contributed to the projection of a pension system deficit totaling 6% of GDP by 2050 (Palacios and Rocha 1997, 12–14). While the time horizon varies, the trend is the same in all three countries. In the absence of reform, all countries would, by the middle of this century, face massive pension deficits and overwhelming dependency ratios. In short, as early as the mid-1990s, they were facing the limits of financing pensions through inter-generational means.

The World Bank to the Rescue?

The international community was quick to offer a solution to this growing problem.⁴ The basic idea was to supplement, if not replace, inter-generational financing with mandatory, fully funded individual pension accounts that would be managed not by the state, but by private financial corporations. The basis for this particular set of policy prescriptions originated from the experience of several Latin American countries a decade before.⁵ In 1981, Chile became the first country in the world to

Figure 1.1 The System Dependency Ratio in Poland, Hungary and the Czech Republic, 1950–2030
The System Dependency Ratio relates the number of pensioners to the number of contributors, expressed here as a decimal. The figure reveals how widely the burden of providing for current retirees is spread among current workers. For example, in 1950, the cost of providing for 3 pensioners could be spread among 12 Czech workers (0.240), while in Hungary a single worker could provide for eight retirees (0.124). However, driven by an aging population, growing unemployment, the use of early-retirement, and generous applications of disability pensions (particularly in Hungary), these ratio began to grow substantially during the 1990s. In all cases, it is estimated that the ratio will reach 1:1 by 2050.

Sources:

Poland – Statistical Yearbook of the Republic of Poland, various years.

Hungary – Hungarian Statistical Yearbook, various years

Czech Republic
1950–2000: Czechoslovak (Czech) Statistical Yearbook, various years
2005–2030: Kral 2001, Lasagabaster et al 2002, own calculations.

fully privatize its pension system by shifting from a public PAYG arrangement to a system of mandatory, but privately managed pension funds that were fully funded by the individual. The only remaining role for the state, beyond supervision of the funds’ investment practices, was the provision of a limited number of tax-financed pensions for those who had never contributed or had failed to do so for at least 20 years.⁶ In essence, the Chilean government removed itself from the provision of pensions leaving individuals to look after themselves through the marketplace. By the early 1990s, both the Chilean system and its Argentine variant had become models of the “new pension orthodoxy” and countries around the world were advised by neo-liberal institutions in Washington and Europe to follow their lead (Müller 1999, 26). In making its case, the World Bank argued that adopting a Chilean-style system “would signal the government’s intention to transfer responsibility to individuals for their own well-being ... and establish a constituency for macroeconomic stability, financial sector reform, and enterprise privatization” (World Bank 1994, 286). To further spread this message, the World Bank began sponsoring a number of conferences and seminars throughout Central and Eastern Europe; it also funded the work of numerous scholars and government working groups looking at ways to implement the Latin American experience in the region. Although the individual details of their respective reforms varied, by the end of the 1990s, seven countries in the region, including Poland and Hungary, had adopted a mixed pillar model that included partial privatization.⁷ The Czech Republic, however, refused and chose instead to reform its existing PAYG system.

Among those adopting the new pension orthodoxy, however, the level of adherence varies considerably. The most orthodox adoptee was Kazakhstan, a state with strong, authoritarian political institutions and control. Using these tools, “reformers in Kazakhstan set out to implement a Chilean-style pension reform, and were highly successful in pushing through their initial proposal. The Kazakh reform eliminates, over time, the current PAYG system and replaces it with a minimum pension guarantee and a mandatory, funded, second pillar” (Orenstein 2000, 29). However, most other countries in the region do not have the kind of political control seen in Pinochet’s Chile and or present day Kazakhstan. In these countries, reforms have to pass through a developing democratic process, complete with multiple veto players, organized interest groups, and a multi-party system. Just how much of an effect a democratic process can have can be seen in Hungary, where the initial proposal put forth by the Finance Minister (Lajos Bakros) called for a 100% Chilean-style system. When the final package emerged several years later, it bore no resemblance to Bakros’s initial proposal. While this surprised no one given the radical departure Bakros proposed, how do we explain the selection of the eventual reform package? Which factors account for the “paradigm choice in the area of old-age security?” (Müller 1999, 53).

In accounting for this policy choice, previous studies have focused on the influence international indebtedness and system deficits gave the Washington Consensus; a view best seen in the work of Müller (1999) and Müller, Ryll and Wagener (1999).⁸ Müller makes the argument “that structural factors – notably the financial situation of the existing public retirement schemes and the degree of external debt – largely determine which actors take part in the process of pension reform, as well as their relative strength” (Müller 1999, 5). She goes on to argue that in order “for radical reform to become feasible, those actors inclined towards pension privatization – the Ministry of Finance and the World Bank – must have stakes and leverage in the local reform process, thereby outweighing the Ministry of Labor” and other actors more inclined to support adjustments to the established programs (Müller 1999, 52). Using a comparative analysis of the East European experience, these arguments are well supported. In Poland and Hungary, where the central budget stood to be immediately and significantly affected by the impending deficits of the pension system, the Ministry of Finance became a vocal and forceful advocate for the implementation of mandatory, private pension accounts. However, in the Czech Republic, where the pension system promised solvency for at least the next five years, the Ministry of Finance remained noticeably absent and no such reform took place. The experience of these three countries also points a finger squarely at the leverage large external debts gave the World Bank in influencing the reform process. Although the international community did not dictate policy anywhere, heavily indebted Poland and Hungary were forced to consider the Bank’s arguments and advice to a degree that the relatively debt free Czech Republic was not.

However, these factors alone cannot explain the choice of a particular reform alternative nor the politics behind its passage. Even in Hungary, where this argument should be at its strongest given an overwhelming debt ratio and a pension system facing the financial abyss, there are serious shortcomings. Most damaging is the inability to explain why the reformed and partially privatized system is really still a PAYG system in disguise. As described in more detail in Chapter 4, despite the creation of mandatory private accounts, the contributions contained within them are still used to provide benefits to current retirees in the PAYG pillar. Because an unexpectedly large number of people voluntary opted to join the new system rather than continue in a purely PAYG system, the government was faced with a higher than anticipated deficit in the public pillar as individuals began diverting a portion of their payroll contributions to their own private accounts.⁹ To make ends meet, the government requires these private funds to invest almost exclusively in government bonds, raising revenue, which it then uses to provide benefits to current retirees covered under the public pillar. While there is some policy flexibility within the new pension orthodoxy, this was not what the World Bank had in mind as the end result is a PAYG system in disguise: the burden of paying off bond holders (i.e., the next generation of retirees) will fall on the next generation of Hungarian taxpayers. This is precisely the kind of inter-generational financing the World Bank was arguing against, particularly in light of a falling fertility rate and a rapidly aging society.

Such shortcomings are not limited to the Hungarian case. In both Poland and the Czech Republic, a reference to a lack of indebtedness and international leverage leaves a number of questions unanswered. For example, how or why were Czech opposition groups able to include a new, tax-financed, universal flat-rate pillar over the objection of Prime Minister Vaćlav Klaus? In Poland, how was it that the reforms began under a left-of-center government and were continued and finally brought to fruition under a subsequent, right-of-center government? Moreover, how did over 30% of the labor force manage to exclude itself from the reforms in favor of a different paradigm altogether? In short, focusing on the role of structural factors and the influence of the Washington Consensus underestimates the significance of domestic politics. Although the debt situation and the dangers to the central budget clearly account for the origin of the Ministry of Finance’s preferences, and help account for the responsiveness to international pressure, alone they cannot fully address the politics of interest representation or the choice a particular policy alternative. Ultimately, it is the ability of domestic actors to influence the legislative process and have their voices heard that accounts for the unique reform packages that emerged in each country. As Gourevitch argues

The international system, be it an economic or politico-military form, is underdetermining. The environment may exert strong pulls but short of actual occupation, some leeway in the response to that environment remains. .... Frequently more than one way to be successful exists. .... Some variance in response to the external environment is possible. The explanation of choice among the possibilities therefore requires some examination of domestic politics (Gourevitch 1978, 900).

While the current literature makes it clear that international pressure shaped the options available, I argue it does not provide an adequate explanation for the policy choice itself. So while Müller set out to “identify the factors determining paradigm choice in the area of old-age security,” what she best explains is the timing of reform (Müller 1999, 53). For it is only when faced with immanent fiscal shortfalls and immense debt obligations that domestic actors in favor of radical reform gain the upper hand. Thus, she confirms what Tip O’Neill, former Speaker of the U.S. House of Representatives, suggested long ago, namely that Social Security is the electrically charged third rail of American politics. Politicians will only undertake serious efforts to reform a pension system when it is clear that failure to do so would result in system bankruptcy, something both Poland and Hungary were faced with when they began searching for a way to adopt the World Bank’s policy advice. While having a better understanding of when reform will take place, this still leaves unanswered the question of how it will be reformed. To answer that question, “what must be illustrated is how specific interests use various weapons by fighting through certain institutions in order to achieve their goals” (Gourevitch 1978, 905). I argue that to do this, one must integrate the ability of different groups of like-minded individuals to overcome the challenges inherent in collective activity, with their ability to credibly convey an electoral threat to policy makers in an effort to have their voices heard. I begin therefore with the domestic pressure for reform and the three mai...

Table of contents

• Cover
• Half Title
• Dedication
• Title
• Copyright
• Contents
• List of Tables
• Preface
• List of Abbreviations
• Acknowledgments
• 1 Introduction
• 2 Democracy and the Politics of Reform
• 3 The Case of Poland
• 4 The Case of Hungary
• 5 The Case of the Czech Republic
• 6 Conclusion
• Appendix 1 A Pension System Primer
• Appendix 2 Coding Scheme For the Model of Collective Action
• Appendix 3 Data for Figure 1.1
• Appendix 4 Sources of Data
• Bibliography
• Index