I was talking to a friend yesterday about fundamental economic reforms and the subject of pensions came into debate. That friend was concerned that in the event of fundamental economic reform pension contracts might fail. I explained that in my opinion that failure of pension contracts was inevitable in any case because, as I explained in a publication called ‘Making Pensions Work‘, they have ignored the fundamental pension contract that should exist within any society:
This is that one generation, the older one, will through its own efforts create capital assets and infrastructure in both the state and private sectors which the following younger generation can use in the course of their work. In exchange for their subsequent use of these assets for their own benefit that succeeding younger generation will, in effect, meet the income needs of the older generation when they are in retirement. Unless this fundamental compact that underpins all pensions is honoured any pension system will fail.
As I then argued of private pensions:
This compact is ignored in the existing pension system that does not even recognise that it exists. Our state subsidised saving for pensions makes no link between that activity and the necessary investment in new capital goods, infrastructure, job creation and skills that we need as a country. As a result state subsidy is being given with no return to the state appearing to arise as a consequence, precisely because this is a subsidy for saving which does not generate any new wealth. This is the fundamental economic problem and malaise in our current pension arrangement.
I would argue that pay as you go pensions also do so, but at least they recognise one side of the equation correctly, whilst the private pension system fails to do so altogether. Public sector pay as you go pensions recognise that we divert income of those currently in work through the pension system to the old. By expressing the cost of pensions as an expense of those in work it gets half the equation right. What it does not do is recognise the capital value of the assets those in old age created whilst they were in work. That's what it gets wrong.
What we need to do to get the rest of the pension equation right is to recognise that current pension contributions must be used to create capital value within society to meet the needs of future generations — at the same time as the needs of current pensioners are met from the depletion of the capital stock they left to those currently in work.
This is really not a difficult issue to comprehend: it's a simple investment cycle. And yet we have got this fundamental wrong and for one very simple reason. We confuse saving with investment.
Saving is putting money in the bank. Or it's buying and speculating in second had shares issued by companies many years ago and now quoted on a stock exchange. Or its dealing in land and second hand building. And it's financing speculation which simply seeks a financial return. They're all saving. That's fine but for one thing: none of them earn a return. They do not directly, and many of them cannot indirectly, add value to society by creating gainful employment as a result of which they add to the sum lot of human capital or income. They merely reallocate that income and capital that already exists. And that's not the same thing at all.
So the last thing we need is saving for pensions. That's a complete mistake. Savings for pensions takes money out of the productive economy and deflates that economy as a consequence. Saving diverts resources from productive activity. It inflates the return to unproductive activity within the financial services sector. It reduces well being. And saving can, by misallocating resources, reduce income and so reduce our capacity to pay pensions. Those are all things we'd best avoid.
What we want is investment in pensions. Investment is very different from saving. Investment creates new assets, tangible or intangible. Some tangible assets we can see and touch, and use in the long term. They include private sector assets such as plant and machinery, offices and IT, transport and agricultural equipment, power plants and recycling equipment. Intangibles can include inventions, copyrights and music. They also include education, training, and social infrastructure. This is spending money for a purpose, to achieve a goal, to increase income and to increase well being and the support structures in society.
Investment and savings are terms often used interchangeably. That's wrong. Investment does not need saving to happen, it just needs cash. It's indifferent as to where that cash comes from: it can be from savings and it can be from borrowing and it can be from tax. There is no tie between investment and saving: it's just one can be used for the other, but need not be.
We can afford pensions for the old in this country, now and in the future. But we can't if we save for them. Saving removes our chance of meeting the needs of the old. In fact, as ‘Making Pensions Work' shows, that saving arrangement in the private sector has already failed. The tax subsidy the private sector pension now receives annually has already provided the private pension sector with more cash each year than it has paid out in payments to those in retirement. The result is that the situation has already arisen where every single penny of pension paid in this country is at cost to the state.
The reality is that we can only meet the needs of those already in retirement and those who will retire if we invest for the future, now. And we can only meet those needs if that investment is wisely managed for the benefit of all. And I mean all. That means the state has a duty to direct that investment.
Some of that investment must be in the resources the state sector needs — in dedicated funds showing how state infrastructure is paid for by current taxes the benefit of which is deferred to meet future pension obligations which will arise when the returns on the current investment are generated.
Some of that investment must be in the resources the private sector needs — but as I recommend in ‘Making Pensions Work' that has to be secured by attaching a condition to the tax releif on pension contributions — a condition that at least 25% of all money invested in pension funds must be used to generate new wealth creating and employment generating activity in the UK. It's a price of the tax subsidy. And it will ensure we get more than £20 billion of new investment in our economy each year — investment our economy needs to boost it now and get us out of recession.
There is a solution to the pensions crisis. We can afford to live in old age. But so far none of the solutions the government is looking at are heading in the right direction.
And that's what's really worrying.
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But if pension contributions in have to fund pension payments out, where is the excess for real investment?
There’s a mass there already
Yes….about £2tr of mass at the latest count I have seen….of which £220bn (11%) is in taxpayer funded local government pension funds.
You’re right, of course. We are where we are. I’d just like to see private pensions wound down by providing no tax relief on contributions and forcing the schemes to invest as you prescribe rather than churn second-hand bits of paper; then having a decent state scheme with no leakage.
I am not sure that winding private pensions down is the best course of action. The proposition I set out in a (as yet unfinished) paper being written as a contribution to the Common Weal project here in Scotland is basically to convert funded occupational pension funds (in both public and private sectors) into a form of sovereign wealth fund. I have called this a “National Investment & Pension Fund” (NIPF). The paper includes a suggested programme for this conversion over time and it starts by consolidation of LGPS funds and applying them as an investment fund to support the real economy and social infrastructure, with revenue streams generated by these investments (via cash flow sharing) supporting ongoing pension payments. The proposal is also to include all citizens in the national pension scheme and provide earnings-related pensions universally. The NIPF is both a national investment fund and a source of pension payments.
There is one issue that needs consideration. The disposal by an NIPF of tradeable financial “assets” through sell off to generate the cash for redeployment as investment into the real economy , will cause a fall in “asset values”. This will impact on bank solvency if the current money and banking system is not also reformed.
It seems to me that sorting out our pensions mess will also involve sorting out our banking and monetary mess.
Demographics rule OK. Many of us are living longer and have worked for many fewer years than in the past. Given the demographics this is not sustainable if life supporting payments are necessary to the numbers involved. Those of us who have studied the old Census Returns will be aware of how few relied on pensions or such in the past and how many worked into old age. One of mine, 1772 to 1864 was still working up to his death. The compact you indicate may be valid but only if the demographics add up and increasingly they are not.
Richard – Thanks for the post. This is what I’ve been thinking for a couple of years now, along with other events and other commentary. A rhetorical question – Why are most of the public pensions paid to individuals by private firms?
Richard, I think your publication “Making Pensions Work” sums up the current situation very well. I worked in the pensions industry in the 1980s to early 90s and most years it was possible to make the private schemes achieve a very respectable growth rate, allowing for City charges and inflation. In those days we saw the tax relief as a Government incentive to encourage saving for the future and used it as a sales tool to encourage the setting up of final salary and executive pension schemes.
In the current financial climate, with very low interest rates and very low yields, once the City has taken its cut there is nothing left and you are right to infer that only tax relief is supporting the game.
It would be good to see a new separate pension scheme made available, using the principles you have described, for those who wish to avoid the roller-coaster of the City and in years to come, to compare the relative performances.
Perhaps we should both offer our services!
I would love to see it happen
What is also worrying is that so few people who desire to create a fairer, more equal and environmentally sustainable society recognise the importance of these issues…..the fundamental reform of banking, monetary system and finance as a whole, including the pension system, is not yet on the radar where it should be. There are plenty of appealing “visions”, policy statements and manifestos about but I am yet to see one which addresses these vital issues.
Am I wrong?
Thanks for an excellent analysis. Who in a position to make this national policy shares your view?
I would urge you to avoid attaching negative opinions to the word ‘saving’: it invites cheap soundbites that “He’s against saving” and that kind of mud-slinging can stick to you and your arguments for decades.
It will be used to discredit you in what passes for public debate.
Meanwhile, you are quite correct to show that there is a difference between productive investment on the one hand, and hoarding rent-seeking and speculation on the other.
And I’ll admit that I have given very little thought to the long-term macroeconomics of pensions. Among other things, your point about the failure of tax subsidies to pensions is an unwelcome surprise, and it needs to be more widely recognised.
Much good thinking here, but let’s add in the fact that a proper pension is a permanent capital base constantly available for deployment into the physical economy sponsoring enterprise in the co-creation of new real wealth, as a wealth of physical choices that are fit for purpose as solutions to the physical problems of everyday living that we all must solve if we are to live, and be well.
This capital base is maintained by a combination of current worker earnings and current investment earnings that offset payouts to current retirees. Think of it as a basin, with faucets and a drain.
If investment earnings are off, the basin drains too fast, reducing the capital base, which further reduces investment earnings, which further reduces the capital base, and so on, as our retirement savings disappear down the drain of insufficient investment returns.
The real problem is that all our pension capital is being invested in Growth. It should be invested in Sustainability. Use the permanent capital base of the pension system to draw off a portion of the wealth being currently created in the economy for the purpose of providing income security in retirement, to the limit of retirement, with dignity and affordability.
This requires taking our Pension Capital out of Securities Trading, and investing it directly into real economy wealth creation, earning a share of customer revenues generated within the sponsored enterprises to discharge the fiduciary burden imposed on the capital base.
We can do this. We just have to decide that we want to.
Thanks
Useful contribution – appreciated