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No other area of policymaking suffers from more “difficulties” than pensions. Pension systems shape national prosperity and personal security for multiple generations. “Long-termism” is the only sensible approach.
Unfortunately, what the UK has done is the opposite. As I pointed out in a June 2023 column, this myopic thinking has forced people working in the private sector into one of two “corners.” At one end are defined benefit plans that offer guaranteed pensions, with investment and longevity risks borne by the plan sponsor. However, this proved out of reach. As a result, such programs are now disappearing, especially with the exception of governments. In the other corner are defined contribution plans where the risk is borne by the individual saver. The country also ended up with a large number of small funds, resulting in higher unit prices and a narrower range of assets.
Fortunately, policymakers have finally recognized these flaws. So this is one of the greatest opportunities for beneficial change that this government enjoys. Finance Minister Rachel Reeves showed she understands this in a speech at Mansion House. For example, she highlighted plans for “86 local government pension scheme authorities to consolidate all their assets into eight pools.” He also emphasized the intention to consolidate the DC system and improve the pipeline of infrastructure projects. In particular, she spoke of the review being undertaken by Emma Reynolds, Joint Pensions Minister at the Treasury and Department for Work and Pensions.
This is a once-in-a-generation opportunity to create a pension system that can enhance both prosperity and security. The need to do so is now widely agreed upon (although, necessarily, not universally). What considerations are needed to support future reforms? Here are five.
The first is to remember that pension systems shape saving and investment patterns in the economy. These should not be viewed solely from the perspective of ensuring a specific beneficiary’s retirement. These long-term contracts affect the welfare of overlapping generations far into the future. They also influence the fate of people within a generation. In particular, pension systems affect people who are not their direct beneficiaries. In other words, everyone benefits when others save and invest wisely, which makes the economy more dynamic and prosperous.
Second, pensions help determine the level of national savings. In the UK, too little attention has been paid to the chronic lack of savings in this context. The average percentage of gross savings as a percentage of GDP from 2014 to 2023 was 38 percent in Norway, 36 percent in South Korea, 28 percent in Germany, 22 percent in France, 19 percent in the United States, and 15 percent. Please be careful. In England. The share of net national savings (after depreciation) from 2014 to 2023 is close to zero in each country, with 19% in Norway, 17% in South Korea, 10% in Germany, 4% in France, and 3% in the United States. Ta. England.
Savings rates aren’t everything. However, the UK’s savings rate is hopelessly low. Unsurprisingly, the current account deficit also persisted, reaching an average of 3% of GDP from 2014 to 2023. The conclusion is simple. Currently, if the country wants to invest more, it would have to run an even larger current account deficit, which would be risky and costly. Or you need to save more. There are only three plausible ways to accomplish this. One is to significantly shift income to corporate profits. Significant fiscal tightening. or more household savings. The only reliable means of the latter would be higher standard pension contributions, ideally at least twice as high as the current 8 per cent for the higher-paid. Fortunately, this is necessary in any case to provide a decent pension.
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Third, there is a need to balance the desire to use pension savings as a catalyst for domestic investment with the need to ensure good returns. The accusations against the latter by those who argue that the best way to manage DB funds is to invest in government bonds at a time when the latter are at their most expensive in history are ridiculous. Nevertheless, the issue is important.
Fourth, managing investment and longevity risks requires inter- and intra-generational cooperation. That is why an integrated bulk DC system is the answer. It is very unfortunate that we were not able to migrate the remaining DB scheme to CDC. Rather, they are mercilessly disappearing in the arms of the insurance industry.
Finally, pension reform is very likely to be this government’s most important economic legacy. Be bold. Think long term. Please understand correctly.
martin.wolf@ft.com
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