The Financial Times has reported this morning that:
Royal Dutch Shell has cut its dividend for the first time since the second world war as the drop in oil prices triggered by the coronavirus pandemic nearly halved its quarterly earnings.
Oil companies are in crisis mode as lower energy prices and a collapse in demand for fuels and chemicals puts intense pressure on their finances. Shell's net income adjusted for cost of supply – its preferred profit measure – dropped to $2.9bn in the three months to March 31. This compared with $5.3bn in the same period the previous year.
Some will of course celebrate the fact that the days of big oil may be numbered.
That there is less pollution is very definitely good news.
But I want to mention a consequence. I do not call it a problem, deliberately. This is that Shell, along with BP, have been the providers of many of the dividends that have underpinned U.K. private pensions fir a long time past. And that may no longer be the case. And that matters, most especially to those who have, or hope to have such pensions in the future. Right now, their hopes do not look as good as once they did.
And this matters. That's because if the model of investing in shares to provide pensions is not going to work in the future - as I have long predicted, I must admit - then we are very definitely going to need alternatives. I have worked on those for a long time now.
I stand by this suggestion from 2010. In that work I argued that in any society there is what I called a fundamental pension contract:
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', and since then in work related to the Green New Deal, that has to be secured by attaching a condition to the tax relief 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 £25 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 relying on dividends looks to be an act of supreme folly right now.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Interesting! I had a quick look at your 2010 report and was quite shocked at the cost of pension tax relief measured in context with private pensions paid.
Thanks for doing the numbers and highlighting these – I instinctively don’t ‘like’ what you say but am bound to agree with the calculations.
One time where the accountant knows the cost of everything and the value of nothing gets turned on it’s head because the cost in this case does matter.
Cheers
The cost is now £55 billion a year….
Richard, you have claimed that “The cost is now £55 billion a year….” which is somewhat disingenuous
1. Looking at the gross number not the net number is misleading – you ignore the tax paid on pensions
2. The relief you refer to will be reclaimed (in part) on future pensions when they are drawn down). In contrast, the pensions paid figure relates to a different set of pensions entirely – those currently in payment which obtained tax relief some time ago.
It’s a classic example of comparing apples and pears to get the picture you want.
And let’s not get started on the massive subsidy that goes on public sector pensions…
The gross number is wholly avoidable
The tax still comes in any way from past contributions
It is you who is comparing apples and pears
The government’s accounting here is grossly wrong
What follows is an e-mail exchange I had today (with somebody that is supportive of the need to move to renewables and hydrogen) & made before reading your blog. The first para is to do with gas people wanting to keep the status quo 2020 – 2030.
“The status quo boys are very happy with this as it means 10 more years of BAU (business as usual) , and we only have to worry about hydrogen from 2035 when we’ll all be retired and enjoying our golden handshake”
This is my response:
RE; golden handshakes & pensions. You will have followed what is happening in the oil & gas industry. Most pension funds hold a lump of oil & gas because the dividend (6%?) is very very nice. This is going to vapourise. Unless we have new zero-carbon systems/industries I’m sorry to say, it is very unlikely that you or the 40 – 50 cohort will enjoy a substantive pension. Please don’t take this the wrong way – I’m just stating a reality. There is another problem, the RES mob deliver very very low returns 1 – 2% is the norm (scandinavians see!). Not a good look if as a pension fund you need to feed pay outs & historically you have depended on oil & gas, cars, airlines etc.
Last comment: I try to balance my investments between 2nd hand (ahem) and new i.e. new companies doing something interesting (& ethical). Not everybody can do that – and the pension “industry” needs to give some thought on how it proposes to undertake investments in the future – 2nd hand or new. The latter implies a much much more active role – rather than herd behaviour. Spot on article Richard – enjoyed it.
We have much thinking in common
Did you mean to say gas dividends would vapourise? I was amused
“There is another problem, the RES mob deliver very very low returns 1 — 2% is the norm (scandinavians see!). Not a good look if as a pension fund you need to feed pay outs & historically you have depended on oil & gas, cars, airlines etc.”
This is a really good point. Part of the reason is that some, perhaps especially among the cutting-edge, fledging businesses are in no position to pay dividends. I was bemoaning on another thread the failure of the oil and gas industry to support tidal technology development in the Pentland Firth, when the oil industry is rich not just in finance, but the right kind of engineering expertise. Cracking that investment, development, financial support from the pension sector conundrum could be critical to success.
Terry Smith has also an article today published in the FT on the folly of investing in shares just for the dividend. He argues very much for total return. Many Pension Funds will own his fund and will be pleased to have done so.
https://www.fundsmith.co.uk/news/article/2020/04/30/financial-times—investors-never-let-a-crisis-go-to-waste
The point is well understood here
And when most companies are showing that they have deeply flawed balance sheets and an absence of anything close to resilience that’s not going to help
Notably, BP which I have always felt represents the apotheosis of ‘State Capitalism’, has not cut its dividend for the same quarter. I think that is a function of its importance in the British economy, not least in the financial sector, to pension funds and other major investors. I take BP to be the canary in the British economic colliery. Watch this space?
Do
I very much doubt it can keep its dividend going
So you are arguing that private sector pensions should lose their tax relief – forgetting that those penioss pay tax when they are taken.
At the same time, you also seem to forget that public sector pensions are subsidized by £30bn a year (2018 figures), and are already worth a huge amount more.
But you don’t think anything should be done about public sector pensions, I guess?
Sounds fair.
I am not arguing pensio0ns should lose their tax relief
I am arguing that all pensions should get the same tax relief
And that the tax relief is conditional
Now tell me why not
Oh, and the public sector argument is spurious – that’s a contractual cost of employment. Do you have a problem with that?
You are arguing that private sector pensions should lose their tax relief or be forced to invest in certain things as directed by the state.
Public sector pensions don’t have any conditions attached, other than length of service. They are also on the whole guaranteed final salary schemes.
They are also totally unfunded, and the government is subsidizing them by a huge amount – more in fact than private sector schemes. The contributions from public sector employees doesn’t come near the cost of the pensions.
“Oh, and the public sector argument is spurious — that’s a contractual cost of employment.”
This is a spurious argument itself. If the contract said that government would contribute to a private sector or DC pension in exactly the same manner as any other private sector company, surely that would be equitable and fair? So why aren’t you arguing for that instead of trying to punish the already much poorer private sector pensioners whilst leaving public sector workers untouched?
Do you think it is fair that public sector workers earn more on average than private sector workers, get much better pensions and under your proposals the private sector should pay even more?
Let’s ignore your Daily Mail style prejudice for a moment
Three thoughts
1) Yiu could work for the state
2) Despite those pensions and supposed high pay they can’t recruit
3) They’re not overpaying then, are they?
Add a fourth:
4) Why are you so happy for private sector employees to be treated so badly?
Only if we ignore your hard left “government good, private sector bad” prejudice as well.
1. Only in certain professions. Unless you are saying the state should do everything – which is probably what you want let’s face it.
2. The state seems to have no problem recruiting judging by the explosion in public sector jobs over the last few decades. The only place they have trouble recruiting is where actual skills are needed – like Doctors – and there aren’t enough skilled people to fill those roles.
3. Public sector jobs at the same level have better pay and pensions for a given level of qualification and experience except for the top decile. You can check the government statistics if you like.
4. Don’t you understand that those incredibly generous final salary schemes are affordable in the private sector, who actually have to save and invest to pay for them? Public sector final salaries are unfunded and are paid for by the taxpayer. Do you think that is fair?
Why are you so happy for private sector workers to be treated even worse by removing tax relief on their pensions or forcing them to invest in whatever the government wants them to? Especially when public sector worker, who already get bigger pensions, won’t suffer the same from your ideas?
I’ll add a couple of questions of my own.
If private pensions are so heavily subsidized, why do you never mention the huge subsidy that public sector pensions receive? The total of that subsidy is £2trn at the moment. That’s a lot of money that could be used to invest. But instead you would prefer to cause more suffering to private pensioners, who already do worse than those in the public sector.
Why should public sector workers have large final salary pensions, heavily subsidized by other taxpayers? Wouldn’t it be fairer for everyone for them to have to save just as everyone else does?
Are you just a massive hypocrite?
I am completely in favour of a mixed economy and am delighted we have a private sector
Like other trolls you simply do not bother to read what I write
Instead you come to display your own biases
And your own incomprehension of facts
Please don’t call again
Responding to Mark:
“Do you think it is fair that public sector workers earn more on average than private sector workers…”
That would be news to me. As a software engineer working in the UK public sector, my salary was half to two thirds of what I could have had in the private sector.
I know that for a fact; I used to have headhunters trying to recruit me into being a “self-employed consultant” for their clients’ research and development projects.
So why did I stay in the public sector? Why did I persuade my colleagues to stay as well?
“…get much better pensions…”
We got better pensions. Those headhunter private sector types were never willing to pay enough to cover the cost of replacing my pension provision.
That’s not a defect of the public sector, it’s a consequence of the private sector’s shortsightedness when it stopped offering decent pensions in the name of “maximising shareholder value”, i.e. paying as little as it could get away with, given that pensions are essentially deferred salary.
Well, the private sector’s vaunted market economy works both ways. I valued long-term security over short-term cash in hand. If the private sector wasn’t willing to meet my requirements, then the private sector could look elsewhere for people with my skills.
Private sector employment should be leveling back up to where it used to be, not using the politics of envy to drag the public sector down with it.
“…and under your proposals the private sector should pay even more?”
As I understand it, the proposal is not for the private sector to pay more for pensions, but rather to send its pension contributions in directions with more societal benefit and long-term value. That idea works for me.
Not seen your your 2010 pension report before… but I really like the simple statement of what the pension “contract” should be, very succinct. Furthermore, I do think your distinction between saving and investment is important and often misunderstood…. although I guess that is not surprising.
Is it because I am a bond trader? But it seems that everything leads back to the issuance of long term bonds (30 to 100 years) to invest in the long-term transformation of our economy into something sustainable (environmentally and socially). The fact that the sentence includes the phrase “long term” means that the private sector as currently constructed cannot do it – so our government must.
I doubt this could be a question of the day…but is it 100-year bands or perpetuals?
Thoughts really appreciated from someone with your experience
Make it a guest blog if you like – it would be valuable.
Richard,
I’ve seen you use the national income identity repeatedly when talking about MMT:
Y = C + I + G + (X-M)
Where Y = GDP, C = consumption, I = investment, G = government spending and X-M = net exports.
But it is also true that:
Y = C + S + T
where S = private saving and T = taxes paid
Equating, this gives:
C + S + T = C + I + G + (X-M)
Rearranging you get:
I = S + (T-G) + (M-X)
Where T-G is public saving and M-X is capital inflow.
Which states that investment I equals the sum of public and private saving, plus net capital inflow. Which suggests tha investment is directly linked to saving.
However, in your blog above you say that:
“There is no tie between investment and saving”
Which is incorrect, given these accounting identities. So is this statement you have made wrong, or are the accounting identities wrong, at which point they would also be wrong when applied to MMT.
Which is it?
Nick
I will do a blog post on this
When I can
But I have started it…
Richard
Richard
“The Credit Suisse Global Investment Returns Yearbook 2020…finds that equities remain the best long-term investment…global equities have provided an annualised real (after inflation) return of 5.2 per cent over the past 120 years, compared to 2.0 per cent for bonds” (from the Judge Business School website at Cambridge University)
This is on a total return basis, and clearly equities can have (sometimes very) bad individual years. But the average return difference when compounded over many years is enormous. It implies that those trying to provide for pensions far into the future would be very foolish not to be very heavily invested in equities.
And sometimes the past is no indication of future returns
For a start, we have run out of planet to exploit by describing the despoilation as profit
Why do all your proposals seem to involve higher taxes, confiscating money from people and more government control, assuming that government is a hard left government run by you and your fellow travellers?
If you actually read what I am proposing right now I am suggesting lower taxes overall
But not from the wealthy, who need to pay more
Your criticism is, then, wholly misplaced
Look at this: “confiscating money”, “government control”, “hard left”, “fellow travellers”; all that in a one sentence comment. How do you manage to cram so much derogatory vacuity into one sentence? Where is the argument; where is the evidence? Where is the common sense?
I spent my whole working life solely in the private sector, in businesses large and small. I was born in a family business a long, long time ago. I can still tell utter guff from a mile off; and that was guff.
If trolls are going to bother, they really must try harder. I know, I shouldn’t encourage them……
I love all this stuff
I was senio0r partner of a firm of accountants for heaven’s sake
Aye, Janet, Dr Finlay would send you on your way; without a pension!
Are you sure there is no tie between investment and savings?
That doesn’t seem to make much sense.
No, there isn’t
Credit pays for investments
Not savings
Well I ask because I was reading some of the MMT literature out there, and MMT clearly shows the accounting identity that says that investment is the sum of private and government savings.
So how can that be right, and you also be right saying that savings and investments aren’t linked?
Saying credit pays for investments is a bit of a bit of a meaningless and incorrect statement as well – after all credit makes up most of the money supply and the other side of credit is more often than not someone else’s savings – so you are saying that savings and investments are linked….
I will address this issue
“But not from the wealthy, who need to pay more”
The highest earning 1% currently earn around 11% of all earned income and pay 29% of all income tax.
How much more do you think we should squeeze out of them?
https://www.taxresearch.org.uk/Blog/2020/04/22/tax-after-coronavirus-tacs-there-is-significant-room-for-wealth-taxation-in-the-uk/
You’re wrong
I’m not going to comment on whether the distinction between investment and savings that Richard seeks to make is tenable, nor on whether not taxing someone on income which they won’t see again for decades, but on which they will be taxed eventually on receipt of their pension, can be properly regarded as a “state subsidy”.
All I’ll say is that if people are going to retire at 60 years of age and then live until 90, they will have spent quite possibly less than 40 years in the labour force paying into a pension and then 30 years in retirement drawing a pension. Now it seems to me that it doesn’t matter if you subscribe to the traditional pension approach of “saving” into the stock market, government bonds etc, or to Richard’s approach of “investing” in infrastructure, either way you’re going to struggle to make the numbers work if you spend almost as long in retirement as you do in the labour force.
Two final points:
1. The Making Pensions Work paper regards tax relief on the way in, and the income tax and CGT exemption for pension funds, as a “state subsidy”, but does not take into account the income tax paid on receipt of pension. Whether the tax reliefs are really a “state subsidy” is open to question, but if you do count it as a state subsidy, then to disregard tax on the way out is downright disingenuous.
2. We are currently in the midst of a global crisis. Of course dividends are low at the moment. The cash to pay them has run dry due to the fact that vast swathes of the economy are shut down (on government direction). Dividends will eventually return. But it seems to me that you are using these exceptional times to plug an old hobby horse of yours, namely that the state should control ever more investment. Over every single 10 year period in the last century or more, the stock and property markets have always outperformed government bonds. You provide no evidence whatsoever that the returns arising to the state under the so-called Green New Deal or any other state-sponsored infrastructure investment programmes will exceed the return on private investments in the long run. Returns, after all, which will be needed to pay the pensions. And there’s a good reason you don’t provide any such evidence – there is none. For if the return on projects run and provided by the state will always be superior to that generated by the private sector, why not nationalise the bulk of the productive economy?
As a matter of fact there is a state subsidy
However the data is analysed that has always been the cost. The evidence needs. No further discussion
And just because there has been a return will ther still be one?
No. Why? Because if we appreciate the fact that nature is no longer a free gift to be exploited, which has been the basis of that return, then that is not possible.
To believe otherwise is to think financialisation has left us in a good place. It faxn’t. It’s left human life imperilled
As an actuary our it to me recently, his fund is going to make great returns because nine if the younger members will ever make it to claiming a pension
A very poor response to the points raised by jon burrows
It was complete and factually accurate
If that’s poor it simply reveals your bias
This is a brilliant solution. Savings are rather dead money or at worst,are being directed into non wealth generating sectors (which also happen to be the main boom and bust sectors). This would put that right and contribute to whatever worthy causes we can think of.
[…] commentator called Nick asked on the […]