Financial and economic education for
better and more successful reforms
Elsa Fornero
(University of Torino and CeRP-Collegio Carlo Alberto)
Madrid, Ramón Areces Foundation, 10th March 2014
The never ending plea for (economic)
reforms
• As a result of the financial/economic crisis and the harsher
global competition, many countries have (had) to undergo
structural and far-reaching reforms
• Main areas: welfare system, labor market, public employment,
liberalization of protected sectors and of the so-called “liberal”
professions
• With economic reforms, citizens face, in general, immediate
costs versus uncertain future benefits
 their understanding thus becomes a (necessary, but not
sufficient) condition for the reform to succeed
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Elsa Fornero, University of Torino and CeRP
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Definition of “reform”
i. «To improve (an existing institution, law, practice, etc.) by
alteration or correction of abuses»
ii. «To give up or cause to give up a reprehensible habit or
immoral way of life»
(Wordreference.com)
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Elsa Fornero, University of Torino and CeRP
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The respective role of political parties and of
expert/technocrats in realizing reforms
• Economic reforms are usually a mix of political and technical elements,
the former in the forefront of communication, the latter more behind
the scene
• When “selling” the reform to the public, political parties typically tend
to look at reforms from an ideological perspective and to conceal their
more “technical” aspects
• This schemes weakens or break up in emergency situations, where the
technical aspects of reforms become dominant; it is then the task of
technocrats (or of experts from international institutions granting aids)
to prepare the reforms
• Technocrats however do not rely on ideological message to
communicate the reform and if the public does not understand its
basic principles, it risks being repealed or having little effects
 Financial literacy thus matters not only for individual wellbeing, but
also for society
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Elsa Fornero, University of Torino and CeRP
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Financial and economic literacy in
individual and collective choices
 Lack of financial literacy has typically been associated to the risk
of poor saving choices during the life cycle. This risk is indeed
increasing, together with individual responsibility, as a result of
both the retrenchment of the welfare state and the greater
sophistication of today’s financial markets
 Financial-economic literacy may be crucial for the success of
economic reforms (particularly emergency-driven reforms). Lack
of understanding may cause the reform to be reversed/greatly
revised or its incentives not to work
 A conclusion strongly derived from my own experience as an
economist (unexpectedly) turned the Italian Minister of Labor,
Social Policies and Equal Opportunities
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Elsa Fornero, University of Torino and CeRP
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Understanding pension reforms/1
why are reforms needed
• Financial unsustainability: ever growing “implicit” debt
• Economic unsustainability (poor scheme design):
 inefficient allocation of risks: inability to cope with the effects of
demographic and economic changes
 inefficient incentive structure : incentives to early retirement
 bad redistribution (segmentation of schemes, privileges)
 lack of transparency
 “excessive” political interference
• Social unsustainability (inadequacy of old age provisions):
 inadequate insurance coverage
 type of pension benefits (indexation of benefits to wages?)
 inadequate provisions for Long Term Care
 inadequacies in the amount and composition of wealth in old age
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Elsa Fornero, University of Torino and CeRP
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Understanding the PAYG system/2
A matter of financial-economic literacy
• PAYGs return depends on demographic and economic
trends. The generosity of today’s system cannot be
independent of the (structurally worsened) situation, with a
rapidly aging population and a decline in economic growth
• Understanding two elements of unsustainability of a public
pension scheme:
i) the political tendency to favor the present generations
at the expense to the young and future ones
ii) the inability of badly designed systems to effectively
respond to the economic and demographic challenges
means understanding its implicit debt dimension
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Elsa Fornero, University of Torino and CeRP
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Understanding the PAYG system/2
• “Acquired rights” or unsustainable privileges? A call
for equity and intergenerational re-balancing behind
the reform
• When people understand that their pension
“entitlements” were built on debt to be honored by
future generations they can be less hostile to
pensions restructuring
• An expensive pension system is financed mainly
from contribution on workers; trade-off between
generous pensions and high cost on labor.
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Elsa Fornero, University of Torino and CeRP
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Understanding Defined Contribution
• The knowledge of compound interest is crucial to understand
that pension wealth is accumulated by paying contributions
and that each euro paid into their “retirement account”,
particularly at younger ages, will be capitalized.
• The concept of risk diversification, properly understood even if
only at its core, could help people in their decision to
participate in a pension fund, as a way to combine both an
unfunded and a funded pension, as they are characterized by
different risk/returns combinations. (Retrenchment in the
public system may lead to more diversified pension wealth)
• Postponing retirement contributes twice to the benefit increase.
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Elsa Fornero, University of Torino and CeRP
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Italy - November 2011:
the looming financial crisis and the sense of urgency
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Elsa Fornero, University of Torino and CeRP
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The 2011 “cold shower” reform
• Application, as of Jan 2012 and for future seniorities, of the DC formula to all
workers, with periodic (every 2 years) updates of annuity rate coefficients
• Increases in the statutory retirement ages (66+longevity, in 2018) and phasedown
of seniority pensions
• Alignment, as of 2018, of ages and seniority requirements for women in the
private sector to those of men/women in the public sector
• Indexation of eligibility requirements to life expectancy (three preceding years var)
• Increases in payroll tax rates for farmers and the self-employed
• Temporary freeze of indexation for average-high pensions (>1400 €)
• Solidarity tax on higher pensions (sadly cancelled, later, by the Constitutional Court)
• Free “totalization” of contributions for NDC benefits
• Elimination of “exit windows”, by which workers had to wait 12/18 months to retire
after reaching pensionable age
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Elsa Fornero, University of Torino and CeRP
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Transitional and communication
problems
• Due to the emergency situation (prospect of a financial crisis), the
social dialogue had to be foregone
• Insufficiency of data caused insufficiency of safeguarding clauses and
the need for subsequent amendments
• The reform aims at dismantling the rooted notions that:
 workers over 54-55 are lost to the labor market and just destined to
retirement
 elderly workers take away jobs from younger ones
• Difficulties in:
 having the reform understood
 overcoming the notion of “acquired rights”
 explaining the implied generational rebalancing
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Elsa Fornero, University of Torino and CeRP
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Labor and pensions:
two sides of the same coin
As Franco Modigliani’s life cycle hypothesis has
taught us long ago, work and retirement are two
matching segments of our life.
No pension system can deliver adequate benefits
if the labor market – which generates the
resources on which current pensions are paid does not perform adequately
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Elsa Fornero, University of Torino and CeRP
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The “lump of labor fallacy”
The “lump of labor fallacy” – the idea that jobs are in a fixed
number so that early retirement by the elderly makes room
for jobs for the young – has long dominated, in some
countries, the public debate in the field of pension reforms
and brought about policies directed at reducing the
retirement age.
This belief creates hostility towards the reform and
obscures its generational rebalancing by making people
believe that if retirement age is postponed there will be
fewer opportunities for the young (and/or for women: as
the same erroneous reasoning has also long been applied to
women and reduced female labor market participation).
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Elsa Fornero, University of Torino and CeRP
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What is a labor market reform?
• Changing market regulation:
- how: incentives and disincentives vs legal requirements and
prohibitions
- how much?
• Initial circumstances matter: structurally weak economy
experiencing a deep depression
• Social/political constraints should be taken into account
• Trying to find a balance: a) between short-run and medium-run
effects b) between conflicting goals of social partners and
political parties
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Elsa Fornero, University of Torino and CeRP
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Understanding labor market reforms
• High expectation for the reform to immediately
create new jobs: is this justified?
• Short term vs medium term: swift deregulation of
the labor market vs building better work
relationships (apprenticeship)
• How to increase workers employability
• How to design an effective (and not discouraging
job search) social safety net
• How to enhance productivity?
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Elsa Fornero, University of Torino and CeRP
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Spring 2012: tackling Italy’s long
standing labor problems
• Market dualism: protected (mainly men, over forty, in
industries and government jobs) vs marginalized groups (the
young, women and older workers), causing rigidities on one side
and precariousness, on the other
• Low participation rates, particularly among women and older
workers
• Unwarranted separation (also ideologically motivated)
between school and work; insufficient vocational training and
lack of adult education
• Predominance of passive policies and poor or absent ALMP,
regionally provided, with few exceptions
• Very high fiscal wedge
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Elsa Fornero, University of Torino and CeRP
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A complex reform resting on five pillars
1. Flexibility in labor market entry
2. Flexibility in labor market exit
3. Social protection schemes
4. Employment services and activation
policies
5. Follow up, monitoring and evaluation
The reform has been the result of extensive consultation with the social
partners and wide ranging debate leading to broad agreement in Parliament.
It was then, however, rapidly disowned irrespective of a positive international
evaluation as an important step in the right direction
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Elsa Fornero, University of Torino and CeRP
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Opposition and latent contradictions
The trade unions opposed the reform for doing away with “guarantees”;
employers for trying to limit abuses of flexible contracts that had
fuelled an abnormal proliferation of short term, vulnerable and badly
paid jobs
A satisfactory equilibrium was finally reached that, if properly applied, will
rebalance opportunities in favor of the young and improve the
quality of labor, solving medium term problems
Sadly, the reform was introduced right in the middle of a deep recession
The absence of immediate results has been at the root of widespread
criticism (and also of vicious personal attacks)
However, the ultimate success of the reform rests upon the possibility of
change in individual and collective behavior
Reforms are living processes, not legal exercises. They need to be endorsed by the
social partners as well as by institutions, the media and the public at large
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Elsa Fornero, University of Torino and CeRP
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Political double standards
Political parties were well aware both that the pension and labor
market reforms were long due and indispensable, and that they
would entail a period sacrifices
Parliament voted both reforms, but the same political forces that
approved them, instead of helping to explain their content to
people, immediately started to disown them and to criticize the
technocratic government for its “austerity“ measures
This is an example of lack of political courage. No political force in
Italy was brave enough to say clearly that with this type of
reforms things get worse before they get better
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Elsa Fornero, University of Torino and CeRP
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Lessons for an economist accidentally
turned minister
 Has the “medicine” been too harsh? Reforms were the result
of an emergency situation coupled with structural weaknesses,
not of extravagant ideas
 The stop to the “Infraction procedure for excessive deficit” by the EU
Commission (May 29th, 2013) shows that sacrifices are starting
to pay; this is a good message to deliver to people
 In a democracy, however, technocratic governments may enjoy
a parliamentary majority but are politically friendless and ministers
introducing complex reforms stand alone
 In certain circumstances, this may however be the only real way
to make deep structural and unpopular changes in advanced
countries
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Elsa Fornero, University of Torino and CeRP
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Lessons that citizens should learn
 Concepts of tradeoffs and their time dynamics,
pervasive in our life, should be part of our literacy:
there is a cost to be paid for any benefit and the two
are not necessarily synchronized
 Choices today have an impact in the future. This is also
reflected in public budgets, so some basic
knowledge of public finance (concepts of deficit
and debt) should also be part of our financial
literacy to avoid populist policies and their bad
consequences.
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Elsa Fornero, University of Torino and CeRP
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Financial and economic education for better and
more successful reforms
Without the support of the public opinion and without transparent
information by the media, reforms can easily be reversed or deprived from
their intended effects or simply ignored
Financial and economic literacy can crucially strengthen that support
It is a structural reform, so do not be discouraged by lack of immediate
results
Start with children and targeted groups more at risks (women)
Examples:
 The tax on housing wealth (IMU), introduced with the “Save Italy” decree
(Nov 2011) by the technocratic government, has been suppressed to comply
with a (populist) electoral promise, and later reintroduced with a different
name (TASI) in 2014
 Pension reforms in the past have also suffered from step backs (for example,
it happened in 2008 when the retirement age was lowered)
 The labor market has seen abuses of various kinds, while the conditionality
attached to unemployment benefits has hardly been applied)
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