As an economics professor at the University of Turin, Elsa Fornero wrote much about the need for urgent pension reform. When Mario Monti tapped her on the shoulder to join his technocratic cabinet as Italy’s minister of labor, social policies and equal opportunities, she recognized an unprecedented opportunity to put theory into practice.
But as she announced pension reforms as part of the Monti government’s $26 billion austerity package, the human impact became all too real. On national television, she stumbled on the word “sacrifice” and was too overcome to continue. Prime Minister Monti intervened to finish the announcement.
“I would like to convey the distance between doing research on a specific subject and undertaking a reform that impacts people’s lives,” Fornero says, recalling that moment. “They are two completely different things.”
Doing research on a specific subject and undertaking a reform that impacts people’s lives are two completely different things
Speaking at the 2012 World Pension Summit in Amsterdam in November on the anniversary of her appointment to cabinet, Fornero outlined the challenges she faced in effecting swift, profound reforms of the public pension system, while the country existed in what she describes “a state of emergency.” The government’s mandate was clear and ambitious: “To rescue Italy,” Fornero explains, “[we had] to significantly reduce the likelihood of even a partial default on public debt and restore the country’s international credibility.”
Working in a tense situation made reform easier in one way – she was able to be “rapid and sharp.” On 4 December 2011, 20 days after assuming office, the government held a meeting to pass reforms as sweeping as they were necessary. However, they were not as they have often been described, “radical,” but rather based on the significant acceleration of the phasing in of previous reforms.
In 1995, under Lamberto Dini’s leadership, Italy established a notional defined contribution (NDC) pension system. The country was aware that the relative generosity of its existing defined benefit (DB) system was unsustainable, particularly when coupled with a high – and still climbing – old-age dependency ratio.
In 1994, Italy had 25 people aged 65+ for every 100 of working age. By 2010, this number had climbed to 31. And by 2050, it is expected that there will be one person 65+ for every two of working age (
United Nations, World Population Prospects, 2010).
As of 1 January 2012, benefits accruing to all Italian workers are calculated using a DC formula. over the medium-to-long term, government pensions will be paid on a DB-DC blend.
Italy’s seniority pension was abolished. By crediting years worked against the retirement age, it enabled funded retirement as early as 56 after 40 years of contribution. no inducement to continue working existed, since by not claiming benefits from minimum retirement age, pension wealth was effectively lost. The retirement ages (now 66 for men, 62 for women) will be aligned over the next five years.
Facing such a dramatic demographic change, successive governments failed to take the ‘Dini reform’ far enough and applied the DC system only to new workforce entrants, before hitting the snooze button. The rest of the workforce would transition over a 30-year period. “Of course, reforms are necessary, but let’s not be too severe,” was the mood of the country. The hard stuff could come later.
By the time Fornero arrived, there was no ‘later.’ Along with other changes (see Infobox), she axed the transition period, making her reforms “the most significant transfer of burden from the young generation towards the older ones,” she says. “The exact opposite of what’s been done for decades in Italy.” Nevertheless, the projected expenditure savings were met with a blunt response from cabinet colleagues: It’s not enough for the financial markets!
To reduce the country’s short-term expenditure, a simultaneous increase in retirement age was necessary and the minimum age was lifted for both sexes. It was, Fornero says, “the single factor most effective in convincing the financial markets that Italy was serious about reform. That Italians were accepting sacrifices.”
It was almost impossible to convey the message that this … is for us Italians
The sacrifices Italians are making extend to pension adequacy. This is no small concern in a country where 52% of the population lives on a retirement pension of €1,000 ($1,290) or less per month and where purchasing power dropped 3.8% in 2011.The elimination of inflation indexing for all but the lowest pensions removed the old system’s implicit higher return for the wealthier. And by continuing to work, Italians also keep contributing to their funds, while simultaneously reducing the period those funds are required for.
Where this system breaks down is for those with poor or discontinuous working careers. And in a country where youth unemployment is currently hovering around 35%, this could have serious long-term implications. The system is also lopsided, with an over- reliance on the first pension pillar. But with the government currently hamstrung by an inability to reduce the pay-as-you-earn tax rate, it has little scope to encourage workers to divert money into private pension funds. Budgetary constraints also rule out providing tax incentives for the pension fund industry.
As Fornero sees it, the problem is macro- economic and tied to the labor market, whose reform is also in her charge. “People have a lot of uncertainty, but not a lot of earnings,” she says, “so they don’t think in terms of a future private pension that complements the public one.”
The World Bank and the IMF believe the reforms now make Italy’s pension system one of the world’s strongest, providing a good example to other countries facing reform. According to the IMF, over the next three years the reforms will lead to a reduction in pension expenditure of €22.2 billion ($29 billion) (
IMF Country Report #1, Italy 2012).
Yet, for Fornero, these plaudits are sour as well as sweet. She laments the indelicacy with which the changes were handled and the insufficient time to explain their necessity. “I don’t think I was successful enough in communicating the reform to the Italian people,” she says. “Maybe the young perceived it was in their interest, in the sense of reducing the burden on their shoulders. But, in general, it was almost impossible to convey the message that this is not just for the financial markets … this is for us Italians.”
She also wanted a smoother transition to the retirement age increase and wryly notes that had it been possible, she might enjoy more popularity in her own country. Time wasn’t the only enemy – financial literacy also played a part. “If people don’t have the basic concepts, they get the wrong idea and it’s very difficult to convince them that reform is in their interest.”
To those countries watching, Fornero’s message is clear. “The Italian lesson is this: If you have problems, but are not in an emergency, then act before you are. … If you do, you can be more effective in terms of communication and ability to convince the public.”