Thoughts on economics and liberty

The Agility of Modern Public Services #5

Flexible Arrangements for Retirement Savings

One of the less widely known but extremely powerful drivers of the exchange of managerial talent between the public and private sectors in Australia is the system to save for retirement.
 
Indian Retirement System
In the Indian public services, eligibility for pensions begins only after a person completes 20 years of (qualifying) service. Thereafter, the government pays a certain proportion of the last salary drawn as a pension for life, as well as a lump-sum gratuity. In addition, there is a General Provident Fund (GPF) to which an IAS officer must mandatorily contribute at least 6 per cent of his salary at a fixed rate of interest. This fund can be used for contingencies leading up to retirement. 
 
The key problem with this system is its great rigidity. It blocks the free flow of managerial and professional talent across the public and private sectors. For instance, most IAS officers who would have liked to gain private sector experience have no choice but to wait to complete 20 years and take voluntary retirement. On the one hand, they can’t return to public services if they resign prior to that, since no new recruitment takes place after the initial examinations. On the other hand, they cannot leave before 20 years without losing considerable benefits (as I have lost, for instance). These principles completely prevent the intermingling of experience between the public and private sectors in India. And after working exclusively in a tenured, low-performance public service for 20 years, even the high quality talent that is recruited into the IAS becomes valueless to the private sector. So if they were not ‘brave’ enough to get out by after seven to ten years, they are essentially stuck to perpetual mediocrity for life – and they can become very cynical about life. Very sour.
 
Australian Retirement System
On the other hand, in Australia, public servants do not get any pension.[i] Instead, everyone in Australia, irrespective of the sector in which they work, can draw annuities upon retirement from their privately managed superannuation fund, based on the actual contributions made to this fund during their lifetime. Two types of contributions can be made to this fund:
  • Employer contributions: Since 1992 employers are compulsorily required to contribute (a minimum of) 9 per cent of the wages of an employee into a fund selected by the employee. This is treated as an employee contribution for tax purposes.
  • Employee contributions: Both the employee and employer can contribute beyond the mandated minimum; there are tax benefits for such contributions.
This forms a system of compulsory employee saving. Here we could well ask: why can’t people be left free to save for themselves in a free society for their own retirement needs? (noting that GPF also acts as a compulsory saving.) Such coercive savings seem to violate the principles of freedom. And yet, if we add the argument of equality of opportunity, things become clearer. A free society’s government necessarily has to pick up the tab for any employee who falls below the poverty line after retirement; at least to bring that person above the poverty line. That creates a situation of moral hazard whereby some people may intentionally save insufficient amounts given that the government will always pick up the tab if they become poor. By forcing people to save at least a minimum amount through the superannuation system, a reasonable compromise is achieved. But leaving aside the question of whether this system of forced savings can be justified in a free society, it also has great practical merit. It enables people to move freely between the private and public sectors without any loss of retirement benefits. That is a great boon to the Australian economy.

[Note: This is an extract from my book, Breaking Free of Nehru]


[i] Civil servants who were recruited before compulsory superannuation was implemented were eligible for pensions but these have largely been transitioned to the new scheme and are expected to provide for their old-age themselves.

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