Social Security System in India: Policy Making Processes and the Policymakers

1
Social Security System in India Policy Making
Processes and the Policymakers

• Mukul Asher
• Professor,
• Lee Kuan Yew School of Public Policy
• National University of Singapore
• Presented at
• International Conference on Research, Public
  Policy and Asian Public Policy Schools
• 14-15 March 2005, Bandung

2
Organization

• Introduction
• Indias Social Security System An Overview
• Policy Framework and Processes
• Reforms and Prospects

3
Introduction/1

• This presentation analyzes policymaking processes
  and policymakers in India which have led to the
  evolution of the current social security system
• It also describes how recent years witnessed
  initiation of reforms in this sector and
  prospects for further reform

4
Introduction/2

• There are indications that recent initiatives
  have set in motion a process whose dynamics will
  be determined to a great extent by evidence-based
  policy processes, which also rely more on
  institutions and less on individual policymakers

5
Indias Social Security System An Overview/1
6
Indias Social Security System An Overview/2

• Abbreviations Used
• DB Defined Benefit
• DC Defined Contribution
• EDLI Employees Deposit Linked Insurance Scheme
• EPF Employees Provident Fund
• EPS Employees Pension Scheme
• GPF Government Provident Fund
• GS Gratuity Scheme
• NCPS New Civil service Pension Scheme
• NGO Non-Government Organizations

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Policy Framework and Processes/1

• I. How Was it Set?
• Post Independence, India adopted democratic
  polity and socialistic pattern of economy and
  society. This was the common practice during the
  late 1940s and 1950s
• Social security came under the category of labor
  welfare. Media also covered social security
  issues from the narrow perspective of benefits to
  those employed in the formal sector

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Policy Framework and Processes/2

• The EPFO was set up in 1952 under the Ministry of
  Labor to provide a DC Scheme (EPF) for private
  sector employees
• EPF covers employees in a specified set of
  industries
• Reflects a static economic framework
• Civil Servants had a DB Pension Scheme, based on
  the British System
• With nationalization of the insurance sector,
  there was no competition in the market for
  pension products, such as annuities. As a result,
  expertise in this area did not develop to the
  detriment of professionalism in this sector

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Policy Framework and Processes/3

• Each component of the social security system
  developed independently and different agencies
  were created to be responsible for their
  functioning. There was little or no coordination
  among them
• Until very recently, little effective attention
  was paid to administrative and civil service
  reform. So modernization and professionalism in
  aligning various components with international
  developments and with national needs was very
  limited
• Overall policy framework and clear identification
  of problems or issues were lacking. So policy
  responses were ad-hoc

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Policy Framework and Processes/4

• II. Who were the Key Policy Makers?
• Due to a lack of co-ordination, there were
  multiple centers of decision-making for the
  system
• Private Sector Employees While the EPFO has a
  tripartite board (with representation from the
  government, labor unions and employers) the
  labor minister has a predominant influence and
  appoints all members

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Policy Framework and Processes/5

• Ministers of Labor around the world are usually
  not heavyweights in the political arena and
  could easily be captured by organized labor
• Unions in India represent very small proportion
  (less than 5 percent) of the labor force, but
  exercise disproportionate influence. Their
  leadership has traditionally had low economics
  literacy

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Policy Framework and Processes/6

• Civil Servants are the beneficiaries of the civil
  service pension scheme but also in charge of the
  evolution and provisions of the scheme. This
  creates a significant Principal-Agent and moral
  hazard problem
• Occupational pension plans Employers are the key
  decision makers. Guidelines are provided by the
  Income Tax Department that does not have the
  capacity for effective supervision

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Policy Framework and Processes/7

• III. How have Policy Processes evolved over time?
• Each component of the Indian Social Security
  System has evolved differently over time.
• In particular, EPFO schemes do not reflect the
  changing economic paradigm

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Policy Framework and Processes/8

• Because of variety of economic and demographic
  factors (such as urgent need for fiscal
  consolidation and flexibility) individual and
  population ageing, a growing need for civil
  service pension reform was felt, particularly at
  the centre. States usually follow the Centres
  lead

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Policy Framework and Processes/9

• It was in the later half of the 1990s that senior
  officials in the Ministry of Finance began to
  sense that civil service pension reforms were
  needed (Given impetus by the 5th Pay Commission
  Report which increased salaries and pension of
  even the already retired civil servants
  substantially, but predictably its calls for 30
  reduction in civil service size had limited
  success)
• Concrete action on pension reform was initiated
  by a group of committed individuals under the
  leadership of S.A.Dave, and an entrepreneurial
  Minister in the Ministry of Social Justice and
  Empowerment, Ms.Maneka Gandhi

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Policy Framework and Processes/10

• The result was the Old Age Social and Income
  Security Report (OASIS) which perhaps for the
  first time provided a framework for thinking
  about old age security in India
• The Report had recommended a radical change in
  the pension philosophy to a fully-funded DC
  scheme, with consequent transfer of risks to
  individuals. It evoked considerable debate, but
  the Ministry of Labor remained unconvinced

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Policy Framework and Processes/11

• In January 2004, a new Civil Service Pension
  Scheme, which resembled key philosophy and design
  features of the OASIS report, was introduced. It
  is a portable DC scheme designed to eliminate
  pre-retirement withdrawals with mandated purchase
  of annuities at retirement
• The scheme is initially applicable to new
  entrants to the Central Government but in an
  encouraging development, several states have
  expressed an interest in implementing it for
  their civil servants

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Policy Framework and Processes/12

• This will imply transition to the new Scheme will
  be a long one (around 40 years) and in the
  meantime, pension expenditure will increase
• The pool of long-term contractual savings will
  increase rapidly

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Policy Framework and Processes/13

• In December 2004, the Pension Fund Regulatory and
  Development Agency (PFRDA) was set up as a
  regulator for the provident fund and pension
  sector
• India is one of very few countries that have
  established a separate regulator for this sector

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Policy Framework and Processes/14

• The PFRDA has been given the mandate of promoting
  old-age income security by establishing,
  developing and regulating pension funds. So
  professionalism and system-wide perspective are
  likely to receive an impetus
• The PFRDA is expected to balance the interests of
  all stakeholders by ensuring that pension funds
  remain in a secure and separate account funds
  are invested according to investment guidelines
  appropriate record keeping and disclosure takes
  place Provident and Pension Plan administrators
  provide timely information and shortfalls are
  identified on a timely basis and appropriate
  action is taken

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Policy Framework and Processes/15

• Only a fifth of the labor force is covered by
  pension and provident fund schemes workers who
  are not employed in the formal private or
  government sector thus need to be provided with
  market-based but well-regulated pension schemes.
  New civil service pension scheme has a provision
  for voluntary contributions
• Informal and/or unorganized sector is very
  heterogeneous. There is great diversity in terms
  of size and regularity of income, savings
  potential and overall awareness of the need for
  and ability to save for retirement

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Policy Framework and Processes/16

• The challenge of structuring a pension scheme for
  the unorganized sector has been taken up by the
  government of India. A group of pension experts,
  representatives from non-government
  organizations, micro-finance professionals,
  policy makers and industry practitioners are
  currently in the process of designing a
  retirement financing scheme for workers in the
  unorganized sector
• A critical task will be to educate potential
  subscribers in this sector and market pension
  products to the group

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Reforms and Prospects/1

• Pension reforms have commenced at the tail-end of
  Indias reform and after substantial progress
  has been made in liberalizing financial and
  capital markets
• The recently announced central budget 2005-06 has
  taken modest but essential steps towards the
  rationalization of provident and pension funds
  sector

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Reforms and Prospects/2

• Rationalization of tax structure for long-term
  savings, simplification of income tax structure,
  opening up pensions sector to foreign direct
  investment, prioritizing job creation and an
  initiative to develop Mumbai as a regional hub
  are some measures proposed in the budget that
  will have a positive impact on pension coverage
  and quality and professionalism of service
  providers
• While budget measures have set up reform of the
  provident and pension funds sector in the
  appropriate direction, some issues need to be
  tackled on a priority basis

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Reforms and Prospects/3

• The Ministry of Labor and EPFO will have to be
  brought into the reform process. The policy
  environment facing EPFO is moving in the right
  direction, policy entrepreneur and political will
  are needed for substantial reform
• It is critical that PFRDA be made fully
  functional as soon as possible, and vested with
  appropriate human capital and regulatory powers
  to enable it to successfully develop a dynamic
  pensions sector

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Reforms and Prospects/4

• Financial and investment education has assumed
  greater urgency in India as demographic and
  economic factors force workers to plan, design
  and finance their retirement needs
• Thus it is not sufficient for PFRDA to regulate
  pension fund operators and their information
  dissemination there will also be a need to
  provide investor education

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Reforms and Prospects/5

• A beginning in this direction has been made by
  the Indian Pensions Research Foundation, which
  has put together a pensions policy toolkit to
  assist members in analyzing the impact of a
  variety of variables on terminal accumulations
• In addition, an online encyclopedia on India's
  pension sector which provides information on
  civil service pensions, occupational pension and
  PF schemes, gratuity, excluded trusts and
  superannuation plans, private pensions, etc. has
  been created by Invest India Economic Foundation.
  The toolkit and the encyclopedia are hosted on
  http//www.iief.com

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Reforms and Prospects/6

• Gradually, expertise is building up in the
  pensions sector, particularly in the private and
  non-profit sectors. This is also having an impact
  on those in the government, academic and media
  sectors. But greater interaction among them is
  needed

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Reforms and Prospects/7

• The prospects for pension reform appear good.
  However, there needs to be sustained focus on
  this sector and greater urgency if the potential
  of the provident and pension funds sector towards
  providing economic security to members and
  towards Indias overall growth objectives is to
  be realized
• Specifically, the emphasis should be on adopting
  sound governance norms, with accountability and
  transparency in pension service providers being
  given highest priority
• It is hoped that policymaking processes will be
  more purposeful and effective, and that policy
  makers will have a lot more conducive policy and
  political environment in which policies in this
  sector can be made consistent with Indias
  overarching objectives

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Reforms and Prospects/8

• The following quote from the Finance Minister in
  a column in the Wall Street Journal, March 4,
  2005, Page A14, suggests possibilities for
  substantial improvement in the policy making
  processes within a coherent policy framework. The
  Finance Ministry is the heavy-weight ministry and
  will set the tone for developments in the
  pensions sector, which in turn could create a
  positive policy environment for the Ministry of
  Labor and the EPFO. It is also encouraging that
  UPA government is continuing to build on NDA
  governments initiatives in this sector

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Reforms and Prospects/9

• A major ongoing structural reform is the move to
  a defined-contribution pension system with fully
  funded individual accounts. The transition to
  this new system, after a bipartisan process of
  discussion and policy analysis from 1997, has
  been fairly smooth. A specialized regulator has
  been set up for the new pension system. We will
  attempt institutional innovations to contain
  administrative costs and improve portability of
  pensions