Automatic enrolment is gathering pace. Between 2012 and 2017 millions of employees will be enrolled into a workplace pension scheme, many of them for the first time. We are frequently told that this is to address the UK’s chronic under-saving crisis, exacerbated by population ageing. But this is, at most, only part of the story. Does the UK have an under-saving problem? Arguably. Does the UK have an ageing population? Certainly. Are these the main reasons we are now being ‘nudged’ (in practice, shoved) into pensions saving? Probably not.
Instead, recent pensions policy developments have as much to do with the UK’s staggeringly poor record on investment. The idea of automatic enrolment germinated in the boom years, but the reason it has been taken forward so vociferously by the coalition government – despite the fact it represents a huge increase on pensions tax relief expenditure – is to compensate for the government’s failure to rebalance the economy away from consumption and towards investment.
The ageing society
The statistics on population ageing are well-worn, but alas, it is true that the UK’s ‘old age dependency ratio’ will rise from 28 to 47 per cent between 2010 and 2060. In other words, there will be around two working-age people supporting every person aged 65+, in contrast to four today. The question, however, is whether this automatically means people should be saving more for their own retirement.
At the individual level, telling people to save more for retirement is probably the correct advice. If you know you are going to spend a long time in retirement, you should consume less now so you can consume more later, when you are unable to earn a living from the labour market. But we cannot overlook the kind of pensions saving vehicles that are actually available to individuals. A recent inquiry by the House of Lords Committee on Public Service and Demographic Change on the challenge of population ageing argued that ‘defined contribution’ pensions were not fit for purpose because they involved too much risk-taking by individuals. If we need to save more, then we need to know this saving will actually provide a decent retirement income.
Although individual pension savers can insure themselves against pension risks to some extent, this insurance is prohibitively expensive for low-to-median earners able to contribute only modest amounts to their pension. And it is impossible to insure oneself against annuity market risks, that is, the risk that the annuity rates on offer when you reach retirement are actually much lower than you had envisaged (annuities are the products that convert savings into a stable retirement income).
It would be easy to argue that while pensions saving does not necessarily help individuals to meet the challenge of living for much longer than previous generations, the benefits to the public finances of shifting the burden to private pensions and away from state provision are much more clear-cut. Yet automatic enrolment costs the government significantly more, not less. The Pensions Policy Institute estimates it will increase the pensions tax relief bill by around £11 billion per year (and there will be no corresponding cut in state pension expenditure).
So support for pensions saving is not really about confronting the costs of population ageing, for either individuals or society in general. In fact, it’s not really about saving at all, but rather supporting consumption (in economic terms, the polar opposite of saving) and privatising long-term investment.
The government is keen for us to consume more – and despite the continuing stagnation in earnings, their strategy is working. Household consumption has risen by 3 per cent since the middle of 2009, largely fuelled by a resurgence in unsecured borrowing (confirmed by the Bank of England), and a housing market inflated by the Funding for Lending and Help to Buy schemes. In characteristically sober terms, the ONS has pointed out that ‘the change in household behaviour in the past year [i.e. additional consumption] may be associated with the performance of the housing market. House prices have been rising since 2011, and this in turn may have influenced household confidence and expenditure’.
Crucially, while general saving is a substitute for consumption, pensions saving is merely consumption deferred. It serves to supplement the increasingly influential ‘grey pound’ in the pockets of older consumers. This explains the paradoxical situation in which the coalition government has withdrawn the novel forms of fiscal support introduced by the Labour government – the Child Trust Fund and the Saving Gateway – while delivering, largely intact, their predecessor’s plan to incentivise pensions saving through automatic enrolment.
The investment strike
Yet the desire to support (deferred) consumption is supplanted by an even stronger, and more concealed, policy objective: improving the UK’s investment rate, as part of economic rebalancing away from debt-fuelled growth.
We know that the coalition government has cut public investment dramatically – in fact the UK has lagged behind our major competitors in this regard for many years – but it has also presided over a collapse in private investment. Across the G7, investment (that is, gross fixed capital formation) accounts for an average of 15 per cent of GDP. In the UK, in contrast, it represents around 10 per cent of GDP – and is still 25 per cent below its pre-recession peak, despite the apparent recovery.
The investment potential of the capital locked in pension schemes is enormous. Currently pension funds hold capital worth 95 per cent of GDP. Yet only around 40 per cent of private sector workers are saving privately for a pension (most public sector schemes do not have actual funds, rather hypothetical ones). Clearly this will increase substantially once the 10 million not saving are auto-enrolled.
Furthermore, auto-enrolees will generally be younger savers more able to make riskier long-term investments. We know the government is keen on pension investments in infrastructure, because it asked the National Association of Pension Funds to establish the Pension Infrastructure Platform (PIP). But the PIP has only £1 billion committed, with most of this from local government schemes (which do have actual funds) and the quasi-public Pension Protection Fund.
The new breed of private sector, defined contribution schemes being used for automatic enrolment are the real pot of gold for infrastructure investment. However, while in theory these schemes should be making riskier investments, the fact that investments are entirely individualised means that members face the prospect of an investment decision which goes catastrophically wrong wiping out most or all of their savings. Traditionally, these risks would have been pooled or ‘collectivised’.
A government auto-enrollment advert
This will lead to risk-averse pensions savers. This attitude helps to explain why the government has been so reluctant to improve standards in defined contribution scheme governance – they do not want schemes run by trustees whose only duty is to protect members, because the interests of each individual member might not add up to a common economic interest in large-scale investments that could (but probably won’t) fail to deliver a return. This, in turn, explains why we need a cap on pension charges; this looks like a progressive move, but it would not be necessary if all schemes had genuinely member-centred governance structures.
The motives behind any major policy revolution are diverse and complex. But there is no doubt that the pensions policy, at least in part, being used to compensate for the failure of economic policy to increase investment. Pensions funds should, as far as possible, be looking to invest in the real economy, rather than the (usually) safe haven of bonds and publicly listed equities. But the schemes that will be used for automatic enrolment will be unable to pick up the slack of a faltering economic strategy without putting the long-term welfare of individual members in jeopardy.
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