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February 23, 2015

Pension regulations' unintended economic consequences

Every private defined benefit pension scheme (including final salary schemes) is expected to be funded at all times. That means having enough assets to cover the liabilities there and then if need be. The idea is that if something awful happens to the sponsoring employer the scheme can be wound up in an orderly fashion. It is solvent and all the pensions can be paid from the money raised by selling the assets - notionally at least.

If there is a deficit its trustees have to put in place a recovery plan requiring extra contributions by members and employers.

This regulatory regime is partly enshrined in the law, partly the convention that now places a large emphasis on avoiding all sources of risk wherever one can be identified. This protects the Pension Protection Fund from claims but it has unfortunate wider economic consequences. It affects both long term economic growth and short term cycles.

The system of regulation focuses entirely on short term risk and volatility. Pension schemes traditionally used to invest for the long term to get the best returns. Now they are advised to avoid the short term volatility inevitable in such investments. This leads to a short-termist mentality that is harmful to economic growth.

Yet 'short-termism' has long been recognised as one of the main problems with the UK economy. Governments have tried to address it by various initiatives, most recently by the Kay Review of UK Equity Markets and Long Term Decision Making. Pension funds have a key role to play in supplying long term capital but they are being given incentives not to fulfil it for example to 'de-risk' their investment portfolios by switching from equities to government bonds.

The second unintended macro-economic effect of the funding regime is that funds are in deficit and have to make extra payments during a recession. Currently (February 2015) the combined deficit of all DB schemes stands at over £300 billion. This is treated as a gap that has to be filled as soon as practicable by a recovery plan to increase savings into the scheme. These payments come out of company cash and wages and so are a subtraction from effective demand. This is a substantial sum: the latest figure for deficit reduction payments is £25.6 billion to reduce deficits for the 2014/15 year.

Thus the regulatory regime is a pro-cyclical factor that makes recessions worse.

November 10, 2013

The dangers of austerity policies: a lesson from history

A lletter published in the FinancialTimes recently spells out the likely consequences of the EU's austerity policies.

Comparing the present severe deflationary policies forced on the southern European countries with what the Treaty of Versailles did to Germany after the First World War, it quotes the prophetic words of Keynes in "The Economic Consequences of the Peace":

“If we take the view that Germany must be kept impoverished and her children starved and crippled . . . If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp.”

Fourteen years later Hitler and the Nazis came to power in Germany which led to the Second World War.

October 24, 2012

More evidence that Austerity Will Not Work

Writing about web page

Coming in the wake of the recent IMF U-turn, here is more evidence that the Keynesian fiscal multiplier is much larger than previously assumed. This paper by Almunia, Bénétrix, Eichengreen, O’Rourke and Rua shows that in the depression of the 1930's the multiplier effect of government expenditure on GDP was around 1.6. This suggests quite strongly that the austerity policies being followed in the UK and other countries will only succeed in making the problem worse, depressing the economy without reducing the deficit. This is consistent with what we are seeing.

September 26, 2012

Is the recession made worse by company pensions recovery plans?

Many occupational pension schemes in the private sector are in difficulties because they are in deficit. The value of their investments in such as company shares and government bonds is not sufficient in present circumstances to cover their projected pensions to their members.

The consequence is that the companies sponsoring them are being required by the Pensions Regulator to make additional payments as part of a recovery plan - over and above their normal contributions.These payments have to come out of either wages, capital investment or dividends. The effect is likely to be heavily deflationary, taking spending power out of an already depressed economy, making the recession worse.

Although many defined benefit or final salary pension schemes are now closed to new members, they still represent over half of the assets in private funded pension schemes.

There is evidence that the effect in the whole UK economy could be very large. The publication Pension Trends from the Office of National Statistics suggests it might have been of the order of £15 billion per year in 2010.

Also an article on the website Pensions World (Pension Scheme Deficits Double over Last 12 Months) estimates that these payments for the FTSE100 companies alone last year were £11.6billion.

These big payments are a consequence of the rules governing defined benefit schemes. Every pension fund has to be fully funded at all times. But low interest rates (as now) artificially inflate the liabilities creating a funding gap. This is compounded by low asset prices and poor investment returns.

So far there has been no research on the macro-economics effects of these special payments. It would be good to have estimates of their effects on GDP and unemployment.

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