A broken public pension system
11 de septiembre de 2019

The Spanish Social Security system, based on the distribution model, is bound to fail. In fact, it has already done it on three occasions: with the reform of 1985, that of 1997 and those of 2011-2013. This model basically consists of a mandatory contribution by active workers; contributions which are later on allocated in a common fund to meet the pensions and retirement of retired workers. If a collection surplus occurs, it is stored in the Reserve Fund, better known as “the piggy bank of pensions”. If, on the contrary, a deficit is incurred, the corresponding amount is withdrawn from this same fund to meet the remaining obligations. In short, active workers periodically pay benefits to those already retired. It is what is known as the principle of intergenerational solidarity.

By contrast, there is the individual capitalisation model. Through this, the worker contributes each month to a personal savings account, in the face of old age and retirement, and this money is invested in different financial products to obtain an annual return and, thus, grow the ‘mattress’ of the worker’s reserve.

To understand why the distribution system is bound to default, the different possible financing systems must be classified. This taxonomy is applicable to any economic agent.

1. Covered scheme: Incoming cash flows are greater than outgoing cash flows for all periods. (Debt term = investment term).

2. Speculative scheme: Incoming cash flows are higher than interest payments for all periods. (Debt term < investment term). The principal needs to be refinanced until maturity.

3. Ponzi scheme: Incoming cash flows are higher than interest payments only for certain periods. (Debt term < investment term. In addition, an extraordinary risk assumption is added). The principal and interests need to be refinanced until maturity.

In the first scheme, there always have to be entered more than is owed, so the debt is fully repaid. In the second, although incomes do not allow to pay the expenses of the debt in full, they make it possible to pay the interests and to repay part of the debt in each period. In the third, income is not always able to cover accrued interest, so it is necessary not only to refinance the principal, but also the interest itself, which thus increases in each period.

Social Security receives income thanks to the contribution of active workers. By virtue of this, they system ‘owes’ a debt with these, as it promises them future compensation in the form of pensions. The periodic expenses that it has are in concept of payment of the pensions of the retired workers.

While the population pyramid of Spain maintained a triangular shape, Social Security could be financed without problems. However, in its development process, it is being invested, with more pensioners and less active workers.

What this great dependence between the demographic pyramid and the financial viability of the pension system shows is that this financing formula is unsustainable in the long term: it only works as long as the number of people who contribute is larger than the number of people that receive. Otherwise, the Social Security financing model corresponds to the Ponzi scheme. This constitutes bankruptcy: the inability to cope with payments by declaring total or partial default.

The State, however, is not a debtor like any other. By having a monopoly on violence, it can modify the conditions of everyone’s debt so that it benefits against its citizens, at any time, and without any damage. Pension reforms involve partial bankruptcies of the system, because workers who contributed to the previous model did so under conditions of remuneration that are modified painfully. For example, before the 1985 reform, the salary of the last two years was used as a reference for the calculation of the pension and, with a decade of contributions, pensioners received 100 percent of the benefit. After the reform, the last 8 years of salary were taken into account, and it was necessary to have 15 years of social security contributions. With that of 1997, the last years of salary that served as a reference were increased to 15, and up to 35 years of social security contributions. Finally, the 2011-2013 reforms extended these periods to 25 and 37 years, respectively.

Not to mention that, in addition, there has been variation in terms of retirement age, indexation to the CPI, and the inclusion or not of health in social security contributions. With each reform, the State has been reducing the remuneration that corresponded to the workers who retired, through the tightening of the payment conditions. In a nutshell, this model only encourages retirees to end up being completely dependent on the huge state in force, as well as favouring intergenerational violence by opening the conflict of who takes advantage of whom.

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