revised
The financial industry in a still young emerging
economy:
Demographic and other long-term trends in Brazil
Gustavo H. B. Franco
(Rio Bravo Investimentos
& Catholic University of Rio de Janeiro)
Presentation at the panel
“Demographic Trends and Their Impact on the Financial Services Industry”; a
session in the 2002 International Monetary Conference, Montreal June 2-4.
1.
Good morning, ladies
and gentlemen, it is a pleasure to be here and to address this distinguished
audience. My special thanks to the IMC Secretariat for having invited me, and
especially to Sir John Bond, President of the Conference.
2.
My role in this
panel is to bring you some elements of the very singular experience of my
country, Brazil, in the field of the relationship between demographics and the
financial services industry. In Brazil, the issue of ageing population has been
mixed with several others – all pertaining to the domain of fiscal
sustainability – already overcrowding the country’s reform agenda. It would be
nice if we had plenty of time to address the problems created by ageing,
notably in the field of pensions. Indeed, the comparative analysis of the
pensions problem in Brazil and other OECD countries would indeed suggest that
our problem is considerably smaller. Even though Brazil’s age profile would
reach OECD’s average only in 40 or 50 years, considerable urgency has been
given to the issue in view of its wide implications to fiscal equilibrium.
3.
What follows put the
Brazilian pensions problem into perspective and lay down the basic demographic
trends in order to offer insights into the financial services industry under
these circumstances.
4.
Recently released
census results of 2000 Brazil’s population show a total of 169.8 Million,
growing less than 2%, with approximately 57 Million under 15 and 14.5 Million
(8.56%) over 60. Working population estimated at 79.3 Million out of around 100
Million at working age. A continuous slowdown in growth is expected in view of:
(i) fertility rates falling from 3.3 in 1985 to 2.18 today (long term
projections are this to stabilize at 2.1); (ii) life expectancy increased to
68.5 today from 64 in 1985, still to increase to OECD levels (70-74); (iii)
child mortality was reduced to 32.7 per 1000 in 2000 from 65 in 1985.
5.
Other important
facts: (i) medical science progress affect the young and the old, an reduction
in child mortality works just like an increase in fertility and an expansion in
life expectancy works towards increasing the share of the elderly in total
population; (ii) the issue is not only the advancement of science frontier but
access to it to underprivileged in Brazil; (iii) long term IBGE projections
show an age profile for 2030 such as 15- with 21.5%, 15-59 with 62.4% and 60+ with 16.1% (25% dependency). In
2050 these percentages should move to 20.0%, 58.0% and 22.0% (38% dependency
ratio); (iv) only sometime between 2030 and 2050 Brazil is expected to have the
elderly on proportions similar to those of OECD countries in the 1990s!
6.
According to UN
projections (reported in the G-10 study, see below) for 2050 the “dependency
ratio” (population 65+ divided by
15-64 group will reach 28.9% (18.2% in 2030) in Brazil. It would be 42.6% for
the G-10 (37.8% in 2030).
7.
It is argued the, in many OECD countries with
aging populations the present value of the public pension liability would be
the equivalent to 60% to 100% of GDP. This is also true to Brazil even though
the proportion of population over 60 in such countries is 2.5 times higher than
in Brazil now. Hard conclusion: there is something highly dysfunctional in the
Brazilian public pensions landscape. Maybe a feature of young economies facing
the first signs of aging, combined with excess demand for savings (debt prone
society), as natural in emerging economies, and also, to some degree, some
populist leanings and mismanagement.
8.
In emerging
economies like Brazil, in contrast to mature economies, demographic factors are
not the only influence to the size and scope of the financial services
industry, as argued later in this summary.
9.
Pensions have
received a great deal of attention in emerging economies, from academia and
governments in the last decade, after the landmark World Development Report
study in 1994 on the issue of the economic consequences of population ageing,
whose language was somewhat appealing: “Averting the Old Age Crisis” was the
title. Shortly after, also voicing similar concerns, the G-10 Denver Summit in
1997, proposed a study, completed in 1998, on the “Macroeconomic and financial
implications of ageing populations”. The study emphasized that “Currently, there are about 2 people aged 65 and older for
every 10 people aged 15-64 in the G-10 countries. By 2040, this ratio is
projected to reach 4 to 10 on average and more than 5 to 10 in some countries”.
Furthermore, “Decreases in labor force participation rates associated with
projected demographic trends alone would depress the growth of GDP by as much
as ½ to 1 percentage point per year in many of the G-10 countries between 2010
and 2030”.
10.
More recently, the
1994 World Bank study was revisited in a 2001 volume edited, and partly written
by, Robert Holzman and Joseph Stiglitz (“New Ideas about Old Age Security:
towards sustainable pension systems in the 21st century”). Several
attempts at reforming pension systems world wide, plus further developments in
demographics, all made interesting to revisit the issue and examine attempts at
pension reform during these years.
11.
The 1994 World Bank study, as the 1998 G-10
Study, both had as motivations: ageing, pensions and (mis) management, both to
be found in varying degrees in developing and developed countries. The WB study
indeed created a “benchmark” (its inspiration was academic literature on
optimal pensions) not a formula to be applied everywhere, as later recognized
both by the 2001 study and the WB practice, based on a “three pillar approach”:
(i) a mandatory PAYG, redistributive, tax financed first pillar; (ii) a
mandatory “occupational”, fully funded, defined contribution, privately managed
though highly regulated second pillar, with these two systems dividing the
burden of offering health care, disability and unemployment insurance; and
(iii) a voluntary, privately offered “third pillar”.
12.
Implementation
proved difficult as inherited features and existing obligations could not be
simply overridden. The 2001 study revised many of earlier criticisms on PAYG
systems and also found new unpleasant features in fully funded defined
contribution systems and especially in the transition from defined benefit
systems. Politics and the complexity of inherited institutions were ultimately
at the root of such problems.
13.
Before we get into
the pensions problem in Brazil it is useful to lay a few basic facts about the
labor market. As of 2000, the working population was of 79.3 Million, of which
71.7 Million were “occupied” (10.6% minus the ones unoccupied for less than 4
months, 6.7% unemployed). The occupation is distributed as follows: (i) the
“employed”, or the so-called “formal” employment, are 36.8 Million or 46.4%;
(ii) the “autonomous” are 16.6 Million (20.9%); (iii) the employers are 2.9
Million (3.4%); and (iv) the “domestic” and other are 15.3 Million (20.0%).
14.
It goes without
saying that structure of occupation, in the presence of high “informality”, is
tantamount to capacity to sustain (with contributions) any pensions’ system. We
start with a population at working age of nearly 100 Million that, with a
participation rate of 80%, result in a working population of 79,3 Million. But
with since only approximately half that number is of contributors to the
pensions’ system, the “effective” dependency ratio is actually twice what it
appears, thanks to informality. Thus,
addressing labor laws is an important part of solving the pensions problem.
15.
The Brazilian
pensions landscape comprises 5 elements worth observing separately: (i) INSS
(the National Institute for Social Security), the mandatory PAYG,
redistributive, tax financed, providing entitlement to public health care; (ii)
the PAYG public employees system; (iii) the pension funds; (iv) the voluntary
“open” retirement plans with myriad features; and (v) the public “forced
savings” schemes (known by their acronyms FGTS[1]
and FAT[2]
funds) designed to address job security and unemployment.
16.
Strictly speaking
(i) and (ii) compose the World Bank “first pillar”, pension funds and
retirement plans are more like the “third pillar”, insofar they are voluntary
arrangements. The mandatory “second pillar” is not geared at old age security
but job security as offered by FGTS in individual accounts; it is a surrogate
but not the same thing. One wonder how useful it could be if both systems were
merged.
17.
In fact, FGTS and
FAT have always been seen more as “forced savings” to be deployed as
development finance, in the form of subsidized lending by BNDES (The National
Economic and Social Development Bank) and CEF (the national mortgage bank);
their mentioning here is very much because they draw their financing from
sources traditionally tapped for pensions financing and use the resources
intensively for other public policy objectives.
18.
The INSS, in the
year 2000, had revenues of R$ 59.5 Billion and expenditures of R$ 77.1 Billion
(7.3% of GDP), with a deficit of R$ 17.6 Billion equivalent to 1.5% of GDP.
Revenues are mostly collected by firms (84%) referring to a wage bill composed
of 27.2 Million workers (the true contributors); i. e. this being the
collection coming form the “formal” employment segment of the labor market.
Approximately 6.4 Million “autonomous” contributors from “informal” labor
relations provide additional R$ 2.8 Billion in revenues. The INSS has,
therefore, 33.6 Million contributors to sustain approximately 19.8 Million
receiving pensions, 13 Million of whom receiving the “minimum wage”
(approximately US$ 90.0 per month).
19.
It seems clear that
“informality” subtracts much more contributors from INSS than unemployment. One
has to inquiry on the causes of “informality” and there is no explanation other
than excessive costs involved in “formal” labor relations, as opposed to
“informal”. Labor Courts plus the contributions to FGTS and FAT, among other
disguised forms of taxation of labor costs, are very expensive to corporations.
20.
To make matters
worse, INSS is also subject to obligations (such as disability insurance,
poverty alleviation programs) that should belong in the budget. It is true
that, even in the World Bank model, one considers “redistributive” mechanisms
in the “first pillar”, so that the presence of such programs should not be that
much of a problem. Indeed, even with such obligations, in view of Brazil’s age
profile, INSS should be producing surpluses, so as, for instance, to finance
health care, as it was the case in the mid 1980s.
21.
It is interesting to
reflect a bit on how and why Brazil used the INSS notional surplus. No
question, generosity as regards benefits, the entitlements and minimum
retirement age definitively were crucial factors especially after the 1988
Constitution. In this respect Brazil is no different than other countries with
distressed PAYG pension systems. What is uniquely Brazilian is the indirect
though painful way through which development finance was materialized through
mechanisms like FGTS and FAT whose collateral damage was labor “informality”
and a blow into the base of contributors to the pensions system. As they stand,
FGTS and FAT are “competitors” to the INSS insofar they tap the same resource
base, though they are also “complements” to the extent they pretend to offer
similar benefits. It is indeed interesting to consider collapsing these systems
into one, brand new, bound to be the Brazilian version of the missing “Second
Pillar”, i. e. a mandatory, fully funded, “retirement with features” plan,
based on individual accounts and, more importantly, with management chosen by
savers. This reform should be at the top of priorities of the next president to
be empowered in 2003.
22.
The landscape as
regards public employees is a true disaster. Estimates for 2002 are of 4.5
Million such workers in active service to produce contributions of around R$ 10
Billion while expenditure with the less than 2 Million pensioners is expected
to reach R$ 54 Billion; thus an astonishing deficit of R$ 43.3% Billion, or
4.5% of GDP.
23.
The comparison of
numbers of the two components of the “first pillar” is a sad picture of income
redistribution upside down: 2.0 Million pensioners of the public sector cost R$
54 Billion, while 20 Million pensioners at the private sector cost R$ 77
Billion. As aptly put by Amadeo, “the per capita deficit at INSS is R$ 565 and
of R$ 21,700 at the federal public service [respectively US$ 226 and US$ 8,680
per capita on an annual basis]. These are the values of the subsidies that the
Brazilian society pays to the individual beneficiaries of both sub-systems”.
24.
Absurd as it may
appear, the issue of “grandfather rights” had blocked changes in courts of law
(judges are not unrelated parties to these cases!). In any event, it is true
for Brazil that capitalizing the public pension liability would imply an
increase in domestic debt surely larger than one entire GDP, not to mention the
coordination difficulties in joining together the Federal Government, 27 states
and more than 8,000 municipalities.
25.
Pension funds and privately offered
retirement plans are growing industries in Brazil. The initial impulse to the
former came from state enterprises. Of 360 pension funds with R$ 127.7 Billion
in assets (11.3% of GDP) in the year 2000, 87 are sponsored by such enterprises
though with roughly 2/3 of the assets. Total population covered is 6.5 Million.
Open retirement plans have assets of R$ 11 Billion with 1.6 Million people
covered.
26.
Even first
generation state enterprises’ sponsored pension funds are moving into the
defined contribution model. Moral hazard had been a key problem generating
mismanagement and political interference. Privatized enterprises helped changing
the industry for the better (of 123 privatized enterprises in the last 10
years, a similar number of pension funds moves also to private sponsorship and,
usually, defined contribution mode); pension funds today are at the forefront
of corporate governance activism and capital markets development.
27.
“Funding” of PAYG
systems, as well as pension funds’ development, should come hand in hand with
capital markets’ and financial markets development in every sense. Sound
regulatory framework is crucial, especially in view of past developments in
Brazil.
28.
Along with
demographics, inequality and continued macroeconomic disequilibria were
important elements to set boundaries to the financial services industry. In a
1995 McKinsey Global Institute study it was shown that the “bankable
population” in Brazil was between 20% and 23% of the total, even if adding a 9%
to 12% “semi-bankable” group, the “non-bankable” reach something between 65% to
81% of the population, against something between 20% to 25% in the USA, The
Netherlands and Korea. Age and income are the key factors here, and very
clearly Brazil has a huge growth potential as we converge to proportions of
“bankable population” seen elsewhere..
29.
The long years under
high inflation “specialized” financial intermediaries in defending economic
agents from inflation, partnering with government in the collection of the
“inflation tax” and manufacturing indexation synthetics and derivatives. As %
to GDP bank credit reaches only 27% as late as 2000, after the removal of
several “financial repression” instruments and a phenomenal increase in
consumer credit, factoring and credit card transactions following the onset of
stabilization. It is 36% in Mexico, 66% in Chile, 82% in the US, 124% in Spain.
30.
Brazil still lives a
classic “crowding out” plus financial repression situation, thus maintaining an
overly high real rate of interest combined with an domestic public debt both
large and with a very short duration. This environment is hostile to capital
markets’ products and services (stocks, mortgages, insurance, everything with a
long horizon); the government finance bias continues, for the time being, in
ways strangely similar to those of the high inflation years.
Amadeo, Edward “A previdência em números” O
Globo, 2001.
Camarano, Ana Amélia (ed.) “Muito Além dos
60: os novos idosos brasileiros” IPEA, Rio de Janeiro, 1999.
Dychtwald,
Ken “Age Power: how the 21st. Century will be ruled by the new
old” Jeremy P. Tarcher & Putnam, New York, 1999.
Franco, Gustavo H. B. “O maior dos
esqueletos” Veja June, 5th 2002 (also in www.gfranco.com.br)
_____ “O socialismo brasileiro” Veja
July, 17th 2000 (also
in www.gfranco.com.br).
Group
of Ten (G-10) “Macroeconomic and financial implications of ageing populations”
Basle, April, 1998
Holzman,
Robert & Joseph Stiglitz (eds.) “New
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century” The World Bank, Washington, 2001.
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Social “Anuário Estatístico da Previdência Social – 2000” INSS,
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a chave do desenvolvimento acelerado no Brasil” São Paulo & Washington,
1998.
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Janeiro, 2000
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May 10th 2002
The
World Bank “Averting the Old Age Crisis: policies to protect the old and to
promote growth” A World Bank Policy Research Report, Washington, 1994.
Valdez-Prieto, Salvador (ed.) “The Economics of Pensions: principles,
policies, and international experience” Cambridge University Press, 1997.
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Públicas após o Real” in J. P. Reis Velloso (ed.) “O Brasil e o Mundo no
Limiar do Novo Século” José Olympio Editora, Rio de Janeiro, 1998.
[1] FGTS – Fundo de Garantia de Tempo de Serviço, is a job security fund formed of contributions directly levied on companies with “formal” employers at the rate of 8% of their total wage bill. Funds are deposited in individual accounts in favor of workers and can be withdrawn in cases of unjustified lay-off, home financing and retirement. FGTS is managed by CEF (Caixa Econômica Federal) the state owned national mortgage bank, which charges a 2% management fee and remunerates the resources at TR (time deposits’ based referential rate, less a “reduction factor”) plus 3%.
[2] FAT – Fundo de Amparo ao Trabalhador, is a fund formed by the collection of a contribution levied of every firms gross sales at the rate of 2,0%. The fund is designed to provide for extra income for low-income workers and for unemployment insurance. The fund is managed by BNDES, and similar to FGTS, FAT is paid a below-the-market interest rate allowing the fund to lend at subsidized rates without depleting BNDES capital.