Ticking crisis of pension: India needs to show extreme caution

Since his re-election in 2022, President Macron of France has been facing severe protests. The primary reason for these continued protests is the change he has brought in the French Pension System that require people to work for two more years, before they can start earning their state pension. While there is an economic argument for these reforms, it seems to have disturbed an inherent social contract across the generations. 

Current social security frameworks in many of the developed nations are built on a social contract where those of working age pay their dues so that retired people can receive their retirement benefits (including pension and healthcare). This system seems to have been working till now, but not more. With development, life expectancy has increased across the world, and so have the costs of social security.

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Coupled with an aging population, this has created a giant mismatch in the pension fund and its future liabilities. Two obvious options include either increase in funds for pension, and the other being cut in benefits. Without a significant rise in productivity and real incomes, taxing more for pension pots is extremely difficult. And thus, governments across the developing world are contemplating real cuts to the benefits. 

Like many other countries, France has attempted to approach this issue by primarily cutting the benefits by making people work for more years, and hence reduction in actual pension benefits. The issue of inadequacy of pension has played out even earlier in Japan, where most people are forced to work till their late sixties or early seventies, or look for alternative/part-time employment after retirement, as the pension payments are simply inadequate to survive.

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However, perceived lower productivity and thus lesser acceptance of older people into the workforce further the struggle of retirees. On the other side, Spain plans to reduce its pension shortfall by raising additional funds, rather than cutting benefits. And, it plans to fund this by making younger people pay more, along with companies. This solution has also the potential to create tension in an intergenerational contract.

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This is an important cautionary tale for India and points to the need for more responsible and prudent financial decisions. This is despite the fact that most Indians don’t have any or enough social security provisions from the government. The Indian government, quite prudently, shifted away from a defined benefit pension for public sector workers, to a defined contribution framework in 2004. However, we have seen recent instances where many of the state governments have started going back to a defined benefit structure, and that raises alarm bells regarding a potential pension crisis later.

This month, Himachal Pradesh is going back to the defined contribution scheme, while Punjab, Rajasthan, Chhattisgarh, and Jharkhand have already reverted to it. While, unlike OECD countries, India has a relatively younger population along with a growing economy, these pension commitments still put a very large burden on our economy, and more importantly on future generations.

While governments across the world continue to struggle with various ways of ensuring stable and reasonable social security provisions, there is also a note of caution for individuals. For centuries, families have remained the strongest unit in terms of individual social security. However, with rising incomes along with welfare states, increasingly more and more people started relying on governments for their education, healthcare, and post-retirement incomes. This is particularly the case in much of the developed world. However, global uncertainties and market volatilities have once again revealed the cost of such dependence, let alone the intergenerational tensions, as we see in much of the Western world.

Traditional responsibilities of families have been gradually taken over by ‘excessive’ welfare states. However, the challenges in doing so are monumental as many of those states now realise. For instance, last year, the Confederation of German Employers’ Association warned the government about the dire state of the country’s pension system and argued it to be “on the verge of collapse” without bold reforms. The case is not very much different in far richer Switzerland, where even after reforms, the pension shortfall was estimated at USD 734 Billion in 2022, which is around 90% of Switzerland’s GDP.

For India, the government’s ability to raise additional funds is often limited by its continued fiscal deficit as well as current account deficits and thus committing the money in the future, without prudent management, could become a monumental mistake. While a vocal and powerful, but very small section, primarily public sector employees, might be seeking to turn the state towards defined contribution pensions, governments across the board must resist.

Disclaimer: The views of the writer do not represent the views of WION or ZMCL. Nor does WION or ZMCL endorse the views of the writer.