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The writer is a contributing editor
Chancellor Jeremy Hunt’s latest efforts, like his Mansion House reforms, point squarely at getting people and firms in the UK to save smarter for retirement. This misestimates the scale of the challenge. They also need to save more. The British pension system is already substantial. It boasts the second largest base of funded assets in the OECD by market value and the fifth largest as a proportion of GDP. But the success it promises citizens is uneven.
Despite the triple-lock mechanism to protect against inflation, the state pension doesn’t afford its recipients dignity in retirement. Strong defined benefit pensions outside the public sector, universities and railways are vanishingly rare and have been succeeded by an ersatz defined contribution version. At only 3.4 per cent of salary, companies’ median contributions to the DC pensions of their employees, scarcely eclipse the legal minimum. Auto-enrolment has been an unmitigated policy success in bringing millions of workers inside the tent of pension savings. But it has failed to offer members the prospect of a retirement the likes of which their parents enjoyed.
Stubbornly high inflation, sclerotic growth and rapidly rising government debt narrow policy options. Years of political turmoil, large deficits, an unstable currency and a central bank struggling to re-anchor inflation expectations further reduce room for manoeuvre. This describes not the UK today but Canada in the early 1990s. Reforms that increased pension contributions bequeathed today’s Canadians a sustainable national pension system, an improved international balance sheet and a large pool of well-managed capital.
The modern Danish and Australian pension systems also emerged from difficult economic times. Both countries had persistent current account deficits and uncomfortably high wage inflation. Australia’s superannuation guarantee in 1991 and Denmark’s “Fælleserklæringen” between employers, unions and the government in 1987 aimed to increase national savings and take the heat out of wage growth by increasing contributions. The theory went that pension reforms would improve the balance of payments and help curtail inflation. The theory worked.
The challenges facing the UK today echo those already faced by these three peer nations. The UK has run back-to-back current account deficits for almost 40 years, and has transitioned from being a large net creditor to having the world’s 11th largest net international investment deficit. Wage gains and closely linked service sector price increases are running at levels inconsistent with inflation returning quickly to target.
It’s not unreasonable therefore to ask whether lessons learnt elsewhere might be applied. Mandating an increase to minimum employer contributions would help address the looming pension crisis. And as policymakers in Canada, Denmark and Australia have shown, it could also help achieve other economic goals.
A larger stock of pension savings would increase the pool of capital available for investment in the UK and beyond. It would not only reduce the cost of domestic risk capital with associated productivity benefits, but also improve the country’s balance of payments. Prior to the 2008 crisis, the UK was a net rentier state, but since then it has needed to either sell assets or borrow to service foreigners’ investments in the country. The cost of this has averaged around 1 per cent of GDP, almost a third of the annual current account deficit. Current account deficits are, as former Bank of England governor Mark Carney once said, “one of the most trenchant early warning signs of financial instability”.
Wage inflation is the principal factor now clouding the BoE’s medium-term outlook. Shifting wage settlements to include a higher mix of deferred pay — aka pensions — wouldn’t reduce the costs of employment to firms, but would be disinflationary. Paradoxically, Britain’s lack of unionisation could be the most substantial impediment. Unions in Australia and Denmark were integral in trading-off the ability to secure higher wages against the promise of higher pensions. The value that non-unionised British workers place on greater pension contributions against cash today is harder to estimate.
But lifting the minimum employer contribution rate would make the pension system work for all. It could also improve the UK’s balance of payments and moderate wage inflation. With one more Budget before the end of this parliament, international experience shows how these opportunities can and should be seized.