Stop and Go in the Italian Pension Reform Process

3. A Reform in Danger?

Moving on to the long term perspective, i.e. the full application of the contribution-based formula, the 2007 law proposal has not abandoned the method, but made it more uncertain.
On the one hand, the method appears reinforced by the willingness to revise the transformation coefficients, so that the calculation of benefits will take into account the variations in longevity. According to the 1995 reform, the coefficients should have been updated every 10 years, but the first revision in 2005 did not take place. With the new law, the revision is delayed to 2010. After that, however, it will occur every 3 years, with a first update in 2013, two years before what would have happened without this reform.
On the other hand, however, the new delay in the application of the adjustment mechanism could undermine its credibility. Some could think that this provision, before coming into force, could be revised yet again or even cancelled. Also, the law proposal refers to a newly appointed commission to evaluate the ‘consistency’ of the NDC method with the evolution of both the demography and the labour market, but the tasks of the commission are still quite vague.
A second weakness lies in the (generic) commitment to guarantee at least a 60% net replacement rate, a rather loose statement, which does not embody a true guarantee, but which could undermine the contribution based method and which has been included in the law proposal at the very last moment, without being given enough space in the debate.
As already mentioned, the younger generations are subject to the more severe DC pension rule. This means that if they retire at the same ages as their fathers, their pension benefits will be much less, and possibly inadequate. However, the NDC system embodies the right incentive to delay retirement, and thus underline the basic fact that when longevity increases the length of the working period should also increase. So, working longer rather than the state should be, for the majority of workers, the correct answer, guarantee.
Contrarily, the promise of a state guarantee represents a return to the past, and a hard blow to the design of the 1995 reform, for at least three reasons. First, introducing a generalized guarantee means returning to a defined benefit formula and abandoning the contribution-based method, devised to guarantee the sustainability of the system. Again, the costs for this promise will be charged to the future generations, who cannot protest against the measure.
Second, a state guarantee implies not only direct costs, i.e. the costs to public finances, but also indirect costs, such as distortions in the labour market induced by pension formulae with no match between contributions paid and accrued benefits: tax evasion, retirement at the minimum ages, and so on.
Finally, we have to consider that 60% of a high salary is much more than 60% of a low salary. Since usually higher salaries correspond to higher human capital and more dynamic careers, while lower salaries apply to low human capital and flatter careers, it is apparent that the guarantee implies creating new privileges, unfairly rewarding the more well-off groups.
In order to avoid the disadvantage of such a generalized guarantee, and at the same time to ensure economic security for the elderly, the road to be followed is the contribution-based method. Of course, a contribution from public finances has to be foreseen for individuals who, because of an unfortunate working life, weren’t able to raise enough pension wealth. To be effective without creating new distortions, public aid must be selective, not generalized.

4. Pensions and Labour Market

A very relevant question in this context is whether the Italian labour system is still able to create ‘good jobs’ that, in turn, can generate an adequate income to provide for needs during active life as well in retirement. This is a realistic concern, if we consider the performance of the market, and, in particular, the wage dynamics, over the last decade3.
Focusing on pensions as a remedy for labour market deficiencies is like trying to strengthen the effects of a medicine without considering that the diagnosis may be wrong. On the contrary, the emphasis should be put on the contribution-based method, which, if properly applied, is the only formula able to guarantee the automatic equilibrium and long term sustainability of a pay-as-you-go system.
Precisely because of the long transition envisaged since its approval, this method has never been attributed the right merits; unsurprisingly so, as a reform that will be fully applied only in 2030 is not likely to be ‘owned’ by the majority of citizens. As a further weakness, perhaps in order not to attract further unpopularity, the reform has been “packaged” in a reductive way, as if it consisted only of minor interventions. Thus, after more than 10 years, a fundamental measure of transparency foreseen by the 1995 law, i.e. the periodical delivery of a pension account sheet to each worker, is still lacking. It’s a pity that even the current Government has not put the stress on the contribution-based method.
The main criticism made of this method is that it is too severe, as it only guarantees an actuarial equivalent of paid contributions. This criticism implies that there exist formulae better able to guarantee higher benefits with the same contributions, or the same benefits with lower contributions. This is the old debate between pay-as-you-go and funding: can financial markets guarantee better performances than the GDP growth rate, once they are corrected to take into account the higher risk factor? Franco Modigliani would have answered yes, and was in favour of a public funded system, applying the advantages of financial markets, with lower costs and lower risks.
A more prudent approach takes into account that neither the pay-as-you-go nor the funded system is free of risks. Since the risks borne by either system do not fully overlap, it would be advisable to pursue risk diversification — i.e. a mixed, multi-pillar system —, a criterion that has inspired the recent reforms.
It is clear, however, that the opponents to the contribution-based method are not thinking about market solutions, but rather to political interventions able to ‘guarantee’, better than this method can, the adequacy of future pension benefits. We are thus back to the previous dilemma: the state should intervene in favour of unlucky individuals or categories, but not in favour of a whole generation, unless it transfers the costs of this intervention on to future generations, i.e. raises pension debt. A method from the past, that the 1995 reform had tried to eradicate.
Of course, public assistance interventions should not have been taken out of the pension system. However, instead of recognizing ex ante differences of treatment for whole cohorts or categories, it would be better to credit workers who spent periods of their active life outside the labour market (because of unemployment, child care, training, etc.) with figurative contributions, covering those periods. These considerations are valid for both women (more exposed to the risk of discontinuous careers) and male workers with low-paid, discontinuous careers.
The provision of notional contributions for these kinds of workers could be integrated with other measures, such as those in favour of workers who do tiresome or hazardous activities, or the ‘summing up’ of the contributions to different schemes. All these adjustments are possible within the framework of the contribution-based method, and are an important reason for being part of the public system; they should not constitute an alibi for opposing the method itself because it is less generous.
In conclusion, behind the appeal for a return to guarantees lie hidden the old bad habits responsible for the Italian financial disorder. The legislature should not repeat errors of the past and keep confirming and strengthening the contribution-based method, remembering that, once this method is applied, the best pension reform has to occur within the labour market. If this works, so will pensions.

3 See, for example, the analysis of the Bank of Italy Governor Mario Draghi, delivered at the University of Turin on October 26, 2007,

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