Thu, 27 May 2004

Mandatory contributions to social security

Hasbullah Thabrany, Jakarta

A recent article by Alex Arifianto that appeared in The Jakarta Post criticized the National Social Security System (SJSN) as disregardful of the role of a free and competitive market, the budget deficit, individual accounts and management of monopolies. Other observers have argued that the introduction of the SJSN may affect Indonesia's attractiveness to investors and would thus influence economic growth.

Most of these criticisms, however, come from a lack of comprehension of the SJSN and the basic characteristics of a social security system.

Reading the criticisms, one might be impressed that the government had behaved stupidly, resulting in a very vague social security system or additionally burdening employers and employees in such a way as to make the latter suffer the most.

Is the system so bad?

Conflicting interests always exist between the public and the private sectors, and even within the private sector. A classic example is that employees typically demand higher wages and benefits, such as social security and workers' compensation, while employers tend toward reducing wages and benefits in order to maximize profits.

Several groups, such as the International Chamber of Commerce, oppose mandatory social security contributions by employers and employees, and instead encourage that employers and employees establish or select their own schemes.

The words "mandatory" or "compulsory" may seem horrible, but without mandatory contributions, people will be unable to prepare adequately to anticipate the future. Most people -- not just in Indonesia, but all over the world -- are unaware of their future needs and therefore will not prepare nor demand adequate coverage.

In Indonesia, for example, the Pension Fund Law was passed in 1992, but after 12 years, only about three percent of employees in the formal sector are covered. Most of those employers that have established a pension fund are state enterprises, because contributions to the fund is basically the taxpayers' money. Meanwhile, very few private and foreign companies provide pension funds for their employees.

Why is this the case? Employees are not aware of future financial risks that might come as they age and retire, and employers are not interested in spending more for their employees. This is the nature of the voluntary scheme, which is the basis of the market mechanism.

On the other hand, the national Jamsostek retirement plan, which is mandatory, covers more than 60 percent of employees in the formal sector. Unfortunately, the Jamsostek plan does not mandate a public pension fund.

The nature of social security is mandatory, because it was conceived with a design to overcome a lack of demand -- so social security is the opposite of market concept, which is based on demand and individual choices, and is voluntary. Thus, it does not make sense to apply market mechanisms to social security, that is, by leaving employers and employees to choose their own coverage.

It is also possible to have a monopolistic social security system, such as those of the U.S., Korea, Canada, Australia, the Philippines and Thailand, to name a few. Monopolistic systems do not operate according to market mechanisms, and are a means to administer mandatory arrangements, such as taxes.

Resorting the administration of a social security system to market mechanisms would ensure the failure of the system, because social security is designed to overcome market failures to provide security for all.

Therefore, it does not make sense to maximize individual contributions in a national social security scheme by giving a financial manager the freedom to manage individual accounts -- as was suggested by Arifianto -- because the main goal of social security is to secure a fund for the future and to protect loss of income for the general public.

The emphasis of a social security system is to achieve social, or group, goals while the emphasis of the market is to maximize individual goals. Maximizing individual or group yields can be conducted in a private pension fund as the second pillar of income security.

We must keep in mind that the number of employees who really understand and need higher yields is very small: Of the local labor market, less than 5 percent have a university education. Therefore, leaving employees to decide upon their individual accounts as the first pillar of social security will satisfy only a minority, presumably less than 5 percent of social security members.

The social security law must favor the majority, but it may proscribe that the funds of the first pillar of social security may be invested in market instruments to produce higher yields for all members.

Lessons from the Chilean market model, which has allowed private financial managers to manage some funds since the early 1980s, teach us that a balance in the primary goals of income security and redistributive incomes have not been optimally achieved.

The essence of the SJSN is to create a common social security platform for various groups, namely public servants, private employees and workers in the informal sector. The second key aim of the national scheme is to transform social security organizations from being profit-oriented to quasi-private, not- for-profit organizations, or BPJS.

The third aim is to put stakeholders in control over policy and management of social security through the formation of a board of trustees consisting of five representatives each from employers and employees.

The fourth aim is to mandate the government's fulfillment of its obligation to the poor by integrating health care benefits into the national scheme so that there is no discrimination.

A common mistake made by its critics is that the National Social Security System will provide benefits in addition to that of the existing Jamsostek scheme. It will not: No duplication of contributions or benefits is allowed under the SJSN.

In addition, many critics mistakenly assume that the scheme will require employers to provide benefits to all citizens regardless of their contributions, but only those contributing parties, or employees, will receive benefits. Non-contributing citizens are not eligible for the benefits.

Lastly, many critics are unaware that a social security scheme is a dynamic system that pools and disburses benefits, so that solvency and liquidity will be always maintained; there is no reason to fear that the system will face financial problems if it is managed by a government or a quasi-private agency.

The writer is Professor of Public Health at the University of Indonesia.