Every debt crisis has its own special causes and hurdles, but they all eventually come crashing down on one issue: pensions.
When bondholders can’t be paid, attention is suddenly drawn to the expensive pensions the debt-addled government won’t cut. At that moment, bondholders are pitted against pensioners, and things get ugly.
So why does no one pay serious attention to pension costs until it’s too late? In part it’s because they don’t count as debt when most people assess a country’s fiscal health using conventional measures, the way bonds are. If we want to avoid—or at least mitigate—future crises, that needs to change.
Reducing pension obligations remains a major point of contention in Greece. Greek pensions are some of the most generous in Europe, with pension expenditures making up more than 16% of GDP and (along with wages) 75% of primary spending. The IMF and European governments insist Greek cut pensions by 1% of GDP. But the Greeks believe they’ve already cut pensions enough, preferring other spending cuts or raising taxes.
Pensions were also central to the Detroit bankruptcy—eventually firemen and policemen were spared pension cuts and other workers faced small reductions. Expect pensions to be a major issue in Puerto Rico, which is seeking bankruptcy. The island’s bond debt is about $72 billion, but that doesn’t include at least $37 billion in pension obligations (as of 2012, using accounting standards that understate the liability). Puerto Rico estimates it can only pay 10% of its pension liability.
Pensions are expensive obligations and, despite fantasy accounting that masks their true costs, governments have not set aside enough money to pay for them. We can expect more hard decisions on who gets paid as federal, state, and local-level governments face unfavorable demographics and slower growth.
The fact that unfunded pensions don’t count as debt makes no sense. In economic terms there is no difference, as both are claims on a series of future payments. Reducing a pension is the equivalent of writing down a debt.
Legalities aside, the only real difference is that a claim on a bond payment was based on lending someone capital, while a pension claim is based on supplying labor (if you work a certain number of years, you are entitled to a pension). Public sympathy often sides with labor over capital, but the distinction really isn’t so clear. Pension funds and retirement accounts are often bondholders. Vulnerable old people are on both sides.
Because pensions occupy this murky category—it’s not debt, just a series of payments promised to a bunch of people—it is never clear whether bondholders or pensioners should bear more pain. When pension benefits are guaranteed by a state constitution, as they are in US states and municipalities, it would seem pensioners have seniority. However, if the municipality enters federal bankruptcy, the guarantee doesn’t hold up. The uncertainty causes unnecessary chaos that drags out debt negotiations and leaves pensioners more vulnerable to income cuts they can’t plan for.
What’s happening in Greece and Puerto Rico is precisely why pension geeks like me will never give up on pushing for well-funded pensions and sustainable promises. Putting aside enough money for pensions to begin with may be too much to ask for. But the least we can do is start counting pension promises that the government has not put aside money for as debt. It will provide more transparency on who is owed what and a government’s true fiscal position.
In addition, more accurate accounting could make it harder for governments to borrow cheaply, removing some of that temptation. It might also make them more hesitant to promise generous pensions in the future because doing so would impact credit ratings and bond prices. Counting pensions as debt provides precisely the market discipline governments need to avoid the type of mess Greece and others are in.
If any good can come out of these debt crises, it’s the recognition that pension obligations count.