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No area of policymaking suffers more from “muddling through” than pensions. Pension arrangements shape national prosperity and individual security over multiple generations. “Long-termism” is the only sane approach.
Yet what the UK has done is, alas, the opposite. As I noted in a column published in June 2023, this short-sightedness ended up by putting people working in the private sector into one of two “corners”. In one corner are defined benefit schemes, which offer guaranteed pensions, with investment and longevity risk borne by scheme sponsors. But this proved unaffordable. As a result, such schemes are now disappearing, except, notably, in government. In the other corner are defined contribution schemes, in which risks are borne by individual savers. The country has also ended up with large numbers of small funds and, as a result, with high unit costs and a narrow range of assets.
Policymakers have, fortunately, finally become aware of these failings. This then is one of the biggest opportunities for beneficial change enjoyed by this government. In her Mansion House speech, chancellor of the exchequer Rachel Reeves, showed that she understands this. She stressed, for example, the plan to make “86 Local Government Pension Scheme administering authorities consolidate all their assets into eight pools”. She stressed, too, the intention to consolidate DC schemes and improve the pipeline of infrastructure projects. Above all, she spoke of the review being undertaken by Emma Reynolds, joint Treasury and Department for Work and Pensions minister for pensions.
This is a once-in-a-generation opportunity to create a pensions system able to enhance both prosperity and security. The need to do so is now widely (though, inevitably, not universally) agreed. What considerations need to underpin the future reforms? Here are five.
The first is to remember that pension systems shape patterns of savings and investment in the economy. They must not be viewed solely in terms of security in old age for particular beneficiaries. These long-term contractual arrangements affect the welfare of overlapping generations into the very distant future. They also affect the fate of people within generations. Not least, pension arrangements affect those who are not direct beneficiaries. Everybody, in short, benefits if others save and invest wisely, thereby making the economy more dynamic and prosperous.
Second, pensions help determine levels of national savings. In the UK, far too little attention is paid in this context to its chronic savings shortage. Note that between 2014 and 2023, average shares of gross savings in GDP were 38 per cent in Norway, 36 per cent in South Korea, 28 per cent in Germany, 22 per cent in France, 19 per cent in the US and 15 per cent in the UK. Shares of net national savings (after depreciation) for 2014-23 were 19 per cent in Norway, 17 per cent in Korea, 10 per cent in Germany, 4 per cent in France, 3 per cent in the US and close to zero in the UK.
Savings rates are far from everything. But the UK’s savings rates are desperately low. Unsurprisingly, it also runs a persistent current account deficit, which averaged 3 per cent of GDP from 2014 to 2023. The conclusion is simple. As things stand, it will have to run even larger current account deficits if it wants to invest much more, which would be both risky and expensive. Alternatively, it will have to save more. There exist only three plausible ways of doing this: a big shift of income to corporate profits; a substantial fiscal tightening; or higher household savings. The only credible vehicle for the latter is higher standard pension contributions, ideally to at least double today’s 8 per cent, at least for the better paid. Fortunately, this will be needed in any case to provide decent pensions.
Third, a balance needs to be struck between the desire to use pension savings as a catalyst for domestic investment and the need to ensure good returns. The bleats on the latter from those who insisted that the best thing to do with DB funds was to put them into government bonds when the latter were their most expensive ever are ridiculous. Nevertheless, this issue matters.
Fourth, managing investment and longevity risk requires inter- and intra-generational co-operation. That is why consolidated collective DC schemes will be the answer. It is a great pity that it was impossible to transition the residual DB schemes into CDCs. Instead, they are expiring miserably in the arms of the insurance industry.
Finally, the reform of pensions is quite likely to be the single most important economic legacy of this government. Be bold. Think long term. Get it right.
martin.wolf@ft.com
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