Italy: The Search for a Sustainable PAYG Pension System

During the 1990s the reform of the pension system had been at the core of the effort to consolidate Italian public finances and ensure long-term fiscal sustainability. The reform process began in 1992 when a quarter of perspective public sector pension liabilities was abruptly cancelled. A second major reform, in 1995, aimed primarily at reducing distortions in the labour market and at making the system more fair. This latter reform began a shift from a defined benefit to a defined contribution system. The Italian system will remain on a PAYG basis, but each individual will hold a notional social security account. Pensions will be related to accumulated contributions and to retirement age. The introduction of the defined contribution pensions aims at mimicking the incentive effects of funded pensions, while avoiding the need to pre-fund future liabilities. Over the last decade, pension expenditure trends have been substantially adjusted down. Microeconomic incentives have been improved. Distributive effects have been largely redesigned. However, the reform process is not yet over. Italian pension spending, which is proportionally higher than that in any other western industrial country, is still expected to increase as a share of GDP. This also depends on the very low fertility rate and the relatively high life expectancy. Moreover, some reforms have been implemented without adequate analysis of their implications and they include solutions which may result unsustainable in the long-run. This lengthy reform process generates uncertainty, limits the microeconomic benefits of the actuarial approach introduced by the 1995 reform, and induces elderly workers to retire from the work-force as soon as they are in the condition to for fear of possible cuts in benefits. An actuarially based pension system, such as that introduced in Italy in 1995, can deliver the expected labour market benefits only if the link between contributions and benefits is transparent and perceived as stable by citizens. This may not be the case in Italy, where a large number of workers are not affected by the new pension regime and where public opinion expects further reforms.