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Greek myth

It will take the biggest miracle of all to restore the health of Greek pension funds. Last year the country spent 12.6 percent of its $115 billion GDP on its pension system, the highest ratio in the EU.

On the wet days, when the sky blackens and the wind slices white nicks into Homer's wine-dark Aegean Sea, Yiannos and other former sailors huddle around their backgammon boards in the cafés of Piraeus, the ancient port of Athens that they call home. But on sunny days, when gulls and terns skim the shimmering turquoise water, Yiannos and his buddies, a decade into retirement but still only in their mid-60s, stroll the docks with their grandchildren and point out the big ships in the mouth of the harbor.

"Look, a freighter just like grandpa sailed on," says Yiannos, hoisting his six-year-old grandson on his shoulders.

"Hey, watch out you don't hurt your back," jokes a pal.

Yiannos retired 12 years ago at full pay when he was 53, after alleging that lower back pains rendered him unable to do his job. His friends wangled similar deals after pleading an assortment of back, neck, arm and leg disabilities -- from which they have staged miraculous recoveries.

Greece is experiencing its own share of miracles: the fastest economic growth in the European Union -- an annual average of 4 percent over the past two years -- dramatically improved relations with longtime nemesis Turkey and the likelihood that the infrastructure for the 2004 Olympic Games in Athens will be completed on time.

But it will take the biggest miracle of all to restore the health of Greek pension funds. Last year the country spent 12.6 percent of its $115 billion GDP on its pension system, the highest ratio in the EU. This prompted the International Monetary Fund to assert that pension reforms should be the government's "first priority." No matter what improvements are ultimately proposed, an IMF report noted in March, "the importance of introducing them as soon as feasible, especially given the long transition periods needed with such reforms, cannot be overly stressed."

Like Yiannos and his hale and hearty friends, a majority of Greece's 2 million pensioners took early retirement, according to government statistics. Often it was for bogus reasons. Evasion of contributions to the pay-as-you-go system by employees, employers and the government itself is so rampant that unfunded pension liabilities are estimated at 300 percent of GDP -- three times as much as in Italy, the EU's second-worst offender.

Moreover, the state-run system is fragmented into more than 200 pension funds, ranging from public employees' funds that are dead broke to well-financed lawyer, doctor and bank-worker funds, which fiercely resist government attempts to reduce their benefits or force them to merge with high-deficit pension groups.

Despite its grave flaws, the social security system could probably muddle through if pension funds invested their reserves wisely. But their choice is strictly limited -- by law the bulk of the money must go into government bonds -- and a maze of regulations can stall investment decisions for months. "In all developed countries pension funds play a very important role in the capital markets -- except in Greece," says Giorgos Zanias, secretary general of the Ministry of Economy and Finance, where he holds the second-ranking post. "The investment process here has been so bureaucratic that by the time a fund is allowed to invest, the market opportunity has passed."

Faced with a pressing pension crisis, the Panhellenic Socialist Movement, or Pasok, the ruling party, decided it could no longer delay. In June the government pushed a reform plan through Parliament that it asserts will ensure solvency for the beleaguered pension system at minimal sacrifice. "We are moving toward a new and viable social security system, which guarantees the maintenance of the maximum pension age, subsidizes working mothers, raises low pensions and keeps today's retirement rights completely intact," declared Prime Minister Costas Simitis in a May speech unveiling the reforms.

But according to critics, the new legislation merely passes the economic and political costs of true pension reform on to future governments and taxpayers. "Greece has the worst pension problem in the EU," says Giorgos Alogoskoufis, a leader of the opposition center-right New Democracy Party. "But instead of reform, the government offers window dressing and confidence tricks." The result, predicts Alogoskoufis, will be a whopping increase in public debt in the decade ahead and stiffening resistance from future pensioners, who will inevitably be asked to accept later retirement with lower benefits.

The government plan seeks to bring virtually the entire pension system under the control of the Social Security Institute. Known by its Greek acronym, IKA, it already covers more than 2.5 million salaried employees, or just under two thirds of the nation's workforce, and accounts for most of the system's deficits. By 2008 the vast majority of the 200 pension funds will have been merged and will be administered by IKA, which will offer uniform benefits and contributions to all salaried employees in the public and private sectors. Although IKA will remain a state-owned, pay-as-you-go operation, those employees who wish to or can afford to will be allowed to make contributions to private funds that will supplement the government's retirement assistance. These private funds, however, aren't expected to equal more than 10 percent of total contributions.

Among the main elements of reform, from the viewpoint of IKA pensioners: Beginning in 2008 workers will be allowed to retire after only 37 years in the labor force -- the current official retirement age is 65 -- but monthly retirement income will fall to 70 percent of the average monthly salary during a worker's last five years, compared with the current 80 percent of his last paycheck.

Meanwhile, to fund what will still be an overly generous social security system, the government will offer a three-part financing plan for IKA. First, through government bond issues it will pay IKA E9.6 billion ($9.6 billion) to cover past state debts to the pension fund and IKA's own unpaid bills for goods and services contracted for with government agencies. Second, to build up a reserve fund to help IKA meet future obligations, the government will begin issuing in 2008 nontradable, zero-coupon, 15-year bonds -- about E1 billion worth a year -- with an inflation-adjusted, 3 percent real return. And last, beginning in 2003 the government will contribute 1 percent of GDP a year from tax revenues to help cover IKA's cash deficit.

IKA, in turn, is supposed to have access to new computerized databases that will allow it to clamp down on employers and employees that fall behind in their contributions. And the government is dismantling many of the bureaucratic obstacles to investments by IKA and other pension funds, in the hope that they will quickly emerge as dominant forces on the Athens Stock Exchange and be better able to partially cover their pensioners' benefits out of investment earnings.

Skeptics abound. Most of their doubts center on the additional strain the plan may place on Greece's already bloated public-debt-to-GDP ratio of 100 percent -- well above the 60 percent advocated by the EU and the IMF. For example, the government plan to set aside 1 percent of GDP a year from tax revenues to help cover IKA's deficit doesn't look like an insuperable burden in an economy expanding at 3 to 4 percent annually. But if growth slows to, say, 1.5 percent, then almost no funds will be left over for debt reduction.

There are concerns that Moody's Investors Service and Standard & Poor's will react negatively to the reforms. The country's A2 Moody's credit rating is already at the bottom rung of the EU, below those of Portugal and Spain. "If the rating agencies estimate that future unfunded liabilities of the pension system are likely to impose a burden on public finances, that will obviously be taken into account in their credit ratings of Greece," notes Lucas Papademos, who recently stepped down as governor of the Bank of Greece to become vice president of the European Central Bank.

"The reform plan fails to do anything about rising pension expenditures relative to GDP," says Miranda Xafa, an economist at Schroder Salomon Smith Barney in Athens. "The system will face significant financial pressures due to demographic trends that are reducing the ratio of the working to the retired population." Currently at 2.1, that ratio is the worst in the EU.

"These are valid criticisms," concedes Gikas Hardouvelis, chief economic adviser to Prime Minister Simitis. "But at least we now have a plan in place that we can improve upon down the road. Things looked a lot worse last year."

Indeed, in May 2001 the government was almost toppled over its mishandling of pension reform. Back then, it announced its intention to reduce benefits, raise the retirement age and consolidate the social security system into eight pension funds. But the powerful labor movement, a traditional ally of the ruling Pasok party, was irate both at the substance of the proposed reform and at the government's failure to consult with it. Goaded by the Greek General Confederation of Labor (GSEE by its Greek initials), more than 1 million protesters marched in Athens and other cities, forcing a cabinet shake-up that led to the appointment of new Labor and Social Affairs and Economy and Finance ministers. "The government failed dramatically to communicate the need for pension reform and what it was supposed to be about," says Odysseas Kyriacopoulos, chairman of the Federation of Greek Industries, the main employers' association.

The new pension reform plan is largely tailored to gain labor's acquiescence. "The trade unions should be thrilled with the new proposals because they represent an approach they have always advocated -- a massive transfer of resources from taxpayers to retirees," says Salomon Smith Barney's Xafa. But not wishing to be viewed as bullying the government, the labor movement has engaged in political theater aimed at demonstrating a willingness to make concessions, despite pressure from hotheads in its ranks.

"Nobody here is enthusiastic," insists George Romanias, the GSEE's pension expert. "We had our own ideas about pension reform, but we accepted the government proposals." The GSEE's proposals to put the social security system on firmer financial footing included more taxes on high-income earners, a tax on "capital-intensive" industries (defined as those that allegedly create unemployment by replacing workers with machines) and a higher government contribution to pension funds.

Few people outside the labor movement took these suggestions seriously. But within the GSEE's leadership council, there have been well-publicized, raucous debates about the relative merits of the government and labor plans, calls for strikes by dissident labor factions and resignation threats by some trade union officials.

In the days before Parliament passed the pension plan, work stoppages stranded thousands of travelers at airports and harbors, and tens of thousands of demonstrators brought Athens traffic to a standstill. Polls showed Pasok falling behind New Democracy by more than 8 percent, and Health and Welfare minister Alekos Papadopoulos, who made statements distancing himself from government policy, was fired before he had a chance to resign. But there was never any sense that the pension reforms would be aborted or that the government was in crisis.

The employers' association engaged in political dramatics of its own. Kyriacopoulos and his federation, political allies of New Democracy, were not about to jump on the government's pension reform bandwagon. They shared the conservative party's concerns about the plan's shaky financial underpinnings. Yet they did not want to be seen as undermining the reform effort, because they are lobbying the government to lower corporate taxes -- an issue of more immediate concern to the business community than pension overhaul. "We will take some time to verify the government's numbers and offer some suggestions," said Kyriacopoulos in an interview a few weeks before the pension bill was pushed through Parliament. "Only then, maybe, we'll agree to the plan."

In the end, though, there were enough labor strikes and visible displays of dissent within Pasok to allow the industries federation to withhold support for the pension reform bill without endangering its passage or unduly angering the government.

Neither business nor labor leaders supported even a partial privatization of the pension system -- a political taboo in a country where most people view the state as a stronger guarantor of pensions than the private sector. The limited role for private funds under the new plan will draw only the more affluent employees who can afford to make optional contributions beyond the compulsory payments to the state-run pension system. "We just don't trust Greek companies -- especially insurance firms -- to manage pension funds," says the GSEE's Romanias, summing up labor's position.

But government guidance hasn't won plaudits, either. Regulations encumber every investment move by the pension funds. To begin with, 77 percent of their estimated reserves of E18 billion must be invested in Greek government bonds -- a proportion unaltered by the reforms. The underlying reason: Bonds issued by the state and held by the pension funds are deemed to be intragovernmental debt; hence if the pension funds diversified into foreign bonds, Greece's official government debt would rise to even more worrisome levels.

The remaining 23 percent of pension fund reserves must be invested in Greek real estate and equities -- with the funds themselves allowed to determine the proportions. The government's reasoning on stocks is that it would be a good thing if pension funds became a growing domestic investment pool for companies listed on the Athens Stock Exchange. Pension funds now hold less than E3 billion in stocks on the ASE, which has a total market capitalization of E90 billion.

The possibility of much larger equity investments understandably excites stock exchange president Panagiotis Alexakis. "Pension funds tend to take long-term positions and operate as a stabilizing force, which would be very beneficial to the market," he says.

Indeed, the ASE's poor performance in recent years has made it an object of derision among investors. Its market capitalization reached an apex of $160 billion in mid-1999 and then began falling sharply, well before stock exchanges in the rest of the EU and in the U.S. experienced their high-tech plunge. In mid-July the market was down 11 percent for the year in dollar terms. Much of the blame for the market's woes lies with the Greek government, which intervened in the ASE before the 2000 elections. "The government used the pension funds to support IPOs of state firms and drive share prices upwards," says Ioanna Telioudi, head of research at HSBC Pantelakis Securities in Athens.

A scandal ensued when the opposition New Democracy charged that pensioners' savings were being used for electoral purposes. Under parliamentary investigation, the pension funds had to detail the size and timing of their stock purchases and sales. Subsequently, the funds were saddled with new regulations aimed at making them less susceptible to political manipulation but in effect paralyzing their investment decisions by forcing them to submit all proposals to the Bank of Greece and committees composed of representatives from various government agencies.

As part of social security reform, the government is promising to simplify and speed up the investment process. "The problem is that a lot of pension fund managers don't have a knack for finance, so we are going to pass legislation that requires them to pick professional money managers to manage their money," says economic adviser Hardouvelis.

Officials at IKA readily concede that their investment department is inexperienced and understaffed -- it has only five people. "The best solution is to place most of our capital in mutual funds," says Miltiadis Nektarios, IKA's governor. "That way we don't have to get permission every time we make an investment, and we can rely on professional asset managers to handle our money on a daily basis." Although the pool of money managers will include foreigners as well as Greeks, their investments will be limited to Greek assets for now.

But the prospect that pension funds will only be permitted to purchase Greek equities doesn't please labor leaders. "Everybody knows the ASE's reputation," says the GSEE's Romanias. "That's why we think the funds should be allowed to invest anywhere in the EU."

The IKA's Nektarios agrees that it makes little sense to keep all of IKA's capital in Greece. "It's our responsibility to get the best return on investments and reduce risks for our contributors," he says. But government officials point out that, in their initial stages, social security reforms in countries as disparate as Chile and Poland limited investments by their pension funds to domestic bonds and equities. The government has also assured EU countries that the ban on foreign investments by Greek pension funds will be gradually lifted over the next few years.

But just how much capital IKA will have available to invest will largely depend on steep improvements in contributions from its 2.5 million-plus members. According to the IMF report in March, the pension system "has fostered incentives for early retirement, contribution evasion and other abuses." Typically, employer and employee -- who are each responsible for a third of contributions to a pension fund, with the government adding the remaining third -- collude to keep down contributions by underreporting a participant's earnings until the last month of employment, the benchmark upon which pensions have been calibrated until now. In practice, both employer and employee know, the government will cover any pension shortfalls.

Still, a great deal of finger-pointing goes on when it comes to assigning blame for the huge shortfalls in contributions to IKA and other pension funds.

Trade union leaders assert that employers, wanting to cut back on their companies' social security payments, pressure employees to duck contributions. Employers fault the government. "The government owes IKA the equivalent of 3 percent of GDP," says the industries federation's Kyriacopoulos. "It's much worse than labor or employers when it comes to meeting commitments."

Lately, the new scapegoats are Greece's illegal immigrants -- an estimated 700,000 to 1 million men, women and children, many of them from Eastern Europe and the Middle East -- who account for about 10 percent of the labor force but aren't entitled to pensions. Because pay-as-you-go funding leaves the pension system no resources other than current contributions, the government is anxious to legalize the immigrants and enroll them in pension funds. But many immigrants haven't decided to permanently settle in Greece and thus aren't interested in contributing a portion of their sparse earnings to pensions that they might not collect. In the eyes of some government officials, these immigrants are in effect part of the evasion problem. "If immigrants have the same rights as Greeks, they should also have the same responsibilities," says Rovertos Spyropoulos, deputy minister of Labor and Social Affairs. "They are responsible for a large percentage of the shortfall in contributions."

Government and IKA officials aver that a serious campaign is under way to combat evasion and ensure that all employees sign up for social security payments. Salary payments, income tax rolls and pension fund contributions are now supposed to be cross-checked through extensive computerization, thus diminishing the possibilities for fraudulent underreporting. "We expect contributions to increase by 5 or 6 percent this year," says IKA governor Nektarios. But at IKA headquarters in downtown Athens, few if any employees have computers, the essential means of tracking down pension fund slackers. "It's true that the pension fund system hasn't used information technology extensively," concedes Nektarios.

Many Greeks seem to feel that the golden age of social security largesse is nearing an end. Yiannos and his ex-sailor friends in Piraeus don't believe that their middle-aged children will be able to retire before their 60s or receive pensions close to their living wages. "My oldest son says he will sell his house in his old age rather than leave it to his children," says Yiannos. That's an option he and his peers consider a shocking break with social mores.

But a morose view of future pension payments extends even to high officialdom. "People in my generation are under no illusion that they will be supported by the next," says economic adviser Hardouvelis, whose previous career was largely spent as an economics professor at the University of Piraeus. "If my pension is based on the last ten years of my working life, I know that whatever I contribute now won't be nearly enough."

One eventual alternative, he concedes, might be to seek out a higher-paying job in the private sector. But Hardouvelis better hurry if he intends to build up a larger pension -- he's already 46.

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