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.