Indonesia needs broader social security scheme

Indonesia needs broader social security scheme

Alex Arifianto, The SMERU Research Institute, Jakarta, Indonesia

Since the onset of the economic crisis in 1997/1998, there has
been a lot of discussion about reforming our social security
system, since the current system has failed to prevent those
affected by the crisis from falling below the poverty line. In
many ways, the current system (the Jamsostek program) is
inadequate since the system does not cover many workers such as
informal sector workers and self-employed individuals.

Additionally, the benefit received by those who make
contributions to Jamsostek is very low. A recent study conducted
by the International Labor Organization (ILO) entitled
Restructuring the Social Security Scheme in Indonesia found that
the average value of a Jamsostek pension only amounts to 5.5
months of the recipients' basic salary or 8.5 months of the
current minimum wage. These workers would earn a better rate of
return on their investment if they put their retirement savings
into a bank account rather than putting it into the Jamsostek
scheme.

Finally, the rate of return on investments in the Jamsostek
fund is also very low. The ILO finds that income from such
investments is valued at 38 percent below the level of inflation
and 63 percent less than the average market rate. This is caused
by the fact that the Jamsostek fund is invested mostly in bank
deposits, which, in the long run, earn less than other investment
schemes such as stocks, bonds or mutual funds.

According to the ILO report, the government is proposing that
the Jamsostek scheme -- which is a provident fund scheme or
compulsory savings for workers -- would be replaced by a social
insurance system, in which a payroll tax would be imposed on both
employers and employees, and the proceeds would be transferred
into a trust fund which would be managed independently from the
government, and observed by a board of trustees whose members
comprise government workers, private employers and their
employees.

This system will operate on a pay-as-you-go basis, in which
tax proceeds from current workers will be used to pay for the
benefits of retirees.

One striking feature of the report is how it easily dismisses
other social security reform schemes, such as the mandatory
individual accounts scheme, in which contributions are not
collected by the government, but instead are managed by private
fund managers which are chosen by workers themselves.

The report argues that such schemes are unsuitable and
unworkable in the Indonesian context, given the nature of the
financial market here nowadays. However, the report does not
disclose that the social insurance scheme also has fundamental
flaws that have led to its abandonment in many countries in the
world in favor of fully funded individual account schemes.

The first fundamental flaw of the social insurance scheme is
that it is vulnerable to changing demographics in which, due to a
lower birthrate and an aging population, there are more workers
who are either at retirement age or who already have retired than
the new workers replacing them.

Because there are less people working and making contributions
to the system and more people that need retirement benefits, the
system would be unable to pay current social security obligations
to retirees due to insufficient funds and it would eventually
collapse.

If one thinks that this problem is not going to happen in
Indonesia anytime soon, think again. The Indonesian Statistics
Bureau (BPS) estimates that by 2020, 30 percent of Indonesians
will be aged 55 (the current retirement age) or older and by
2040, the number will have reached 50 percent.

Even if the retirement age was raised to 60, it is estimated
that in 2020, 20 percent of Indonesians will be aged 60 or older
and in 2040 this number will increase to 30 percent. Supporting
30 percent to 50 percent of the population that are at or above
the retirement age is simply not viable for any social insurance
system to do, even those in developed countries.

The second flaw is that the social insurance system will
continue to be managed by the government. Despite the fact that
the new trust fund is supposed to be managed independently from
the government, the government monopoly over the provision of
workers' social security will continue.

The government alone will continue to make decisions on how
the fund is managed, invested, and distributed among retirees,
while workers themselves are not allowed to participate in the
decision-making of the trust fund, even though most workers here
place little confidence in the current social security scheme.
Yet the bill continues to entrust the government as the sole
manager of workers' social security funds.

Evidence from other countries shows that entrusting the same
party that has misused social security funds in the past to
supervise and carry out reform measures simply would not work.
Reforms to make government-managed social insurance schemes more
workable failed due to unkept promises by the government to
workers and continued corruption and abuse of social security
funds by officials.

Because of these failures, many countries such as Argentina,
Chile and Mexico, have now transformed their social security
system into a mandatory individual accounts scheme, in which,
instead of surrendering their retirement savings to an
unaccountable government monopoly, workers have complete control
of the management and investment of their retirement savings,
because they are the ones that choose, hire and fire their
retirement fund managers.

In fact, in a 2000 report entitled New Approaches to
Multipillar Pension Systems, the World Bank recommended low-
income developing countries with underdeveloped capital markets
to develop privately managed workers' social security funds,
investing in a mixture of international assets, local securities
instruments and bank deposits.

Given the nature of the current government-managed social
security system, its poor governance and low rate of return to
beneficiaries, along with a lack of workers' confidence in the
system, Indonesia should seriously consider adopting the
individual accounts scheme instead of a reform scheme that has
been deemed as a failure everywhere else in the world.

The writer is a researcher with the SMERU Research Institute,
a Jakarta-based public policy institute. The views expressed here
are solely those of the author.