Worrying economics of the USS trustees and UCU negotiators
Today's Times Higher Education quotes Jimmy Donaghey, chair of the UCU superannuation working group, and 11 higher education committee members as saying in a letter, “the reality of us changing what is regarded as economic orthodoxy…is an immense task”. On that basis they are apparently willing to swallow the belief that the estimated deficit has suddenly increased to £20 billion without needing any explanation for this 66 percent increase in a few montths beyond 'market conditions'.
For trade unionists to argue thus is remarkable. First there is no such thing as economic orthodoxy. Economics is a very diverse field and it is unhelpful to refer to the market fundamentalism of the USS trustees as orthodox. And these ideas have been controversial for a long time and widely criticised ever since the financial crash of 2007/8.
Secondly their position is absurd because advocates of the orthodoxy they are referring to regard trade unions as a form of market imperfection and tend to argue in favour of 'flexible labour markets'. The whole point of trade unions is to challange laissez faire market orthodoxy. There is nothing unrealistic about that.
But there is a much more serious point here. That is that the economic ideas underpinning the approach to the USS valuation are deeply worrying in themselves because they are self-contradictory and will lead eventually to another crisis.
The trustess argue that the key assumptions about things like asset values and liabilities should be taken from market prices because thses are 'objective'. The idea is that the market price of an asset, say a company share, will inccorporate all the information about the future returns expected to come from owning that asset. The price of the share is taken to incorporate all the information about the whole future of the company. (In its purest form the theory even assumes that the share price also incorporates private information.) But for that to happen the other particpants in the market place must actively optimise their decisions about buying and selling all the time. Then an investor like the USS can free ride on their efforts.
But this is a self-contradictory theory. If the other participants all decide to take the same view of the market prices as being objective - and why not since that is the best thing to do according the trustees - then obviously the theory does not work. Market prices will be arbitrary because all market traders will be passively following rather than active participants.
Another example is in the way the USS forecasts inflation. It looks at the prices of government secutiries with different maturities and gets what it considers an objective estimate from that. But this only works if the rest of the market does not behave the same way. If all market participants do the same as the USS then this approach is pretty arbitrary and will result in volatile and incrreasingly arbitrary valuations. Maybe this is what is behind some of the volatility we are seeing in the valuation of liabilities.
This is a very serious point. It has been said many times that financial institutions have learnt nothing from the crash that cost us all so much and they are carrying on with 'business as usual' with inevitable consequences. Many economists have been saying this in the Finanical Times and elsewhere.
It is not simply a matter of "the reality of us changing what is regarded as economic orthodoxy…is an immense task”. The belief in this orthodoxy is not only a threat to the USS - because actually the orthodoxy does not have a place for defined benefit pension schemes at all, since they are another market imperfection in the way of perfect equlibrium - but actually a danger to the whole macroeconomy. It is simply creating the conditions for another crash.
Dennis Leech
22 Jan 2015 10:26
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Dave
There is also a problem with the valuation in that it is statistically ignorant. One of the central arguments from the experts (maths, finance, physics and more) in academia who have looked at it is that there is no assessment of uncertainties – in either the model or the assumptions that go into it. Even if the model is perfect (which is highly doubtful) uncertainties in the inputs (wage increases, inflation…) will make its predictions uncertain, possibly by a large amount. The claimed sudden increase in the deficit may well be an example of this effect.
Taking account of your uncertainties, and quoting them, is something that first year science UGs get taught. For USS to let UCU get away without doing this is a basic and fundamental error. I worry that it demonstrates that UCU have sent the wrong people to negotiate, but then I work in a field where facts are facts and not the starting point for a negotiation.
More broadly, it has been shown that markets only work as well as it is claimed if they break a basic result in computational theory: http://arxiv.org/abs/1002.2284 Specifically,this paper states that ‘markets become increasingly inefficient as the time series lengthens’ which is exactly the situation we have with pensions. Purely market-based predictions for long term investments thus cannot work well, despite USS’ claims.
23 Jan 2015, 10:14
Dennis Leech
You are absolutely right. You would have thought that estimates of the pension liabilities and assets would be published with error bounds.
Another point that is not made sufficiently is that the deficit is calculated as the difference between one large random magnitude (the assets) and another (the liabilities). A first year statistician knows that the variance of the difference is the sum of the (large) variances of the two magnitudes (assuming independence). So the deficit is going to be much more volatile than either the assets or the liabilities figures.
24 Jan 2015, 03:06
Dave
Quite.
One is left with the impression that the UCU negotiators either aren’t numerically competent enough to understand and make these points or they don’t care enough. I’m left wondering what the point of UCU is.
26 Jan 2015, 20:06
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