Another interesting Ritchie theory

had the additional benefit of highlighting the real pension crisis in this country, which is that it is the private pension sector that is really failing.

There are good reasons for that, and all intensely logical.

First, employers have removed provision to increase profits. It’s not that they can’t afford it. Over the last 15 years or so about 5% of GDP has been shifted from payments to labour to payments to capital in the form of profits in the economy – that’s near enough explained by the refusal of employers to fund pensions.

Hmm, not convinced myself.

Chart 1 on page 18. Corporate contributions to pension funds rose in the 90s to 1.2% of GDP.

So it\’s nothing at all to do with 5% nor with falling contributions (if someone has more recent numbers then bring them on, please do).

There\’s also an interesting technical question there: does anyone know the answer? Corporate contribuitions to pensions: are they counted as labour income or capital income? I know that they\’re really labour income ( delayed labour compensation) but is that how they\’re actually counted in those accounts which show labour and capital income? I can imagine, but have no idea whether it\’s true, that as they\’re sliced off a chunk of the company profits they might be counted as capital income.

5% of GDP would be about £70 billion a year. Which is much more like total pension contributions than corporate ones.

And the rest of it is that we should all be investing in bonds now not equities. Because, as any fool knows, investing in bonds when long term interest rates are 3% and inflation is 5.5% is just a massively wonderful and surefire way to make pots of money.

Isn\’t it?

29 comments on “Another interesting Ritchie theory

  1. Bash his numbers all you like.. but let’s not pretend that the private pension ‘industry’ is anything other than a complete dog, which does not best serve the interests of the people putting the actual money in.

    The state may well have great form for getting pensions wrong, but the market doesn’t score too highly either.

    This is a place where we do need a social contract. Either we agree that pensions are something that we want to provide (and/or underwrite) collectively and we figure out how we do it… or we decide that it’s every man for himself.

    Give Murphy some credit.. he’s offering up his ideas for a solution, which is a rare old thing in this badly-framed debate. Even if you think it’s a complete crock of shit, it’s a step further than most (right or left) have managaed recently.

  2. about 5% of GDP has been shifted from payments to labour to payments to capital in the form of profits

    Would it really matter even if that was the case? Profits still inform pension funds, don’t they?

    Even if you think it’s a complete crock of shit, it’s a step further than most (right or left) have managaed recently.

    The problem with giving him credit ‘for trying’ is that there are more than a few people willing to take bad ideas seriously.

    I could offer up some elaborately-worded solution to how we go about finding the Higgs Boson Particle. I’d be worried if anybody took me seriously, though.

  3. Would it really matter even if that was the case? Profits still inform pension funds, don’t they?

    Have shareholder returns increased by that amount? If not, then the answer is no.. the ‘beneft has gone elsewhere.. higher wages for labour? lower prices to consumers? I guess it’ll be a combination of many things.. but if you play ‘follow the money’ over the past 20 years you generally see it flowing either to the top few %, or the state.. n’est pas?

    The problem with giving him credit ‘for trying’ is that there are more than a few people willing to take bad ideas seriously.

    If enough people take to a bad idea to make it happen, then that’s a failure of those people.. not the idea. As it happens, whilst he might be barking up the wrong tree… I happen to think he’s found his way into the right forest.

  4. Of course it is blatantly obvious and has been for many years that private sector pensions are failing. Why did defined benefits schemes collapse in the early 00s? A combination of falling investment returns and increased labour productivity meaning that, for example, the BT fund had to provide retirement benefits to millions of members, while its workforce in the UK had decreased dramatically – a classic Ponzi scheme.

    Why are defined contribution plans so bad? A combination of falling investment returns and really bad and expensive fund management by the professionals. The other day, being at aloose end, i did a simple calculation of how much I have put into defined contribution schemes over the years and what they tell me I will get out…I made the assumption that 5% compound was a good rate of return, and none of the schemes gets anywhere close. They charge ridiculously high charges for the privilege of managing the funds that one is effectively compelled to shovel their way. And the residue is not invested with any great skill.

    However, if you then assume that public sector schemes are in better shape then you are just blinding yourself to reality. How much of those schemes is funded by tax revenue? If the state continues at is present size, how much can be funded by tax revenue?

  5. diogenes

    Agreed. The public sector ponzi schemes have sustained themselves better because even without taxpayer subsidy, their membership has continued to expand. But it’s obviously still not a sustainable model. I’m under no illusions there.

    So we look for an alternative. More needs to go in (so, say, send all NI contributions (or a new version) in to a ringfenced scheme. Less needs to come out.. so cap benefits at (say) 2/3 of average salary. Of course, you must also cap contributions accordingly.

    Then do the sums… what rate of return to we expect? what age can pensions be drawn? How much do people need to therefore contribute?

    If you take NI into account then that’s up to 25% of salary already going in… add another 12% (equivalent to a 6% matched private scheme) and we’re getting towards a level that might just work… even if ‘returns’ only keep up with inflation.

    Right now we have two types of ponzi pension. One with a taxpayer backup, one without. They both suck.. so let’s either build something that isn’t a ponzi scheme at all, or agree that nothing works and leave everyone who wants to retire above the poverty line to themselves.

  6. Why are state pensions not sustainable? All pensions are Ponzi schemes, if you want to throw those terms around.

    It’s best not to think about returns, which are a derived concept at best, you need to think about flows – what proportion of population will need a pension, how much do they need, what % is that of national income, how can you persuade current workers best to pay that.

    The potential advantage private pensions have over state ones, especially State PAYG ones, is they can more easily make foreign investments. But we run a current account deficit, so I’m not confident they’re doing that.

  7. Private pensions aren’t Ponzi schemes. I’ve seen this on Matt Yglesias’s blog before (except he used the term “pyramid scheme” because apparently he doesn’t know the difference) and it’s bollocks.

    A Ponzi scheme is a system where the fraudster knowingly and with malice aforethought promises investors a higher return than he knows he can earn in order to induce them to “invest” money which in the long run he doesn’t intend to repay. A defined benefit pension scheme may run out of money if its investments go bad but that doesn’t mean the fund intended for that to happen when it took your money. I don’t see how a defined contribution scheme can be described as a Ponzi scheme in any case.

    State pensions are a Ponzi scheme because they purport to be investments but the money is spent on current consumption. Both the fact that they can pay their way via taxation, or the canard that “they depend on economic growth” to pay out, are irrelevant.

  8. Why are state pensions not sustainable? _All_ pensions are Ponzi schemes, if you want to throw those terms around.

    Idiot.

    Some schemes, public as well as private, are funded by defined contributions. Your money held in their fund.

  9. R.A – There’s no reason why State pensions can’t pay their way. The cost as a % of public spending is small. There’s not notion of return, so I don’t see how they can promise a higher one than hey give. I’d be interested to know if in 1950 the govt did promise a higher pension to people starting work then than it actually gave them?

    SE – Really, you are the idiot here. Money is not the object of a pension, buying goods and services is when you no longer produce any.

    On that you are entirely dependent on workers in the future – hold bonds they can default, hold shares they can avoid payouts, hold cash it can be inflated away.

    “Your money in their fund” is simply promises people have made to you in a fund”

  10. the ‘beneft has gone elsewhere.. higher wages for labour? lower prices to consumers? I guess it’ll be a combination of many things.. but if you play ‘follow the money’ over the past 20 years you generally see it flowing either to the top few %, or the state

    I can’t agree with this. Trickle-down does happen, and most consumer goods have been getting cheaper both in real terms and as a percentage of income in the past 20 years. Just look at the affordability of mobile phones, for example. The benefit of competing companies making profits has been enjoyed mainly by the consumer, not the owners.

  11. agrees with the Thougt gang and strugglesw to work out what the other contributers are saying…the essence is that any pension scheme looks affordable when the contributing base is expanding. If it is not expanding…or shrinking fast…then it becomes unfundable very very fast.

  12. Richard Allan…At current rates of return, in order to retire you will need to amass a sum of at least £500k if you wish to maintain a reasonable standard of living. Does your current pension scheme suggest you will be able to amass anything like this amount of capital?

  13. ” Rupert Fiennes // Dec 1, 2011 at 4:47 pm

    Didn’t Gordon impose a 5 billion a year tax on pension funds on day one back in 1997?”

    Not quite on day one, but the cumulative effect of his tax changes has been to take out a massive chunk of the value of the private pension funds over the years. Odd that no-one else mentioned this.

  14. Matthew, your response is clever but still wrong. Yes, all investments are dependent on other people honouring agreements. That doesn’t make them Ponzi schemes. Ponzi scheme pensions cannot be wound up — they rely on new members. Private pension schemes can.

    You also say “There’s no reason why State pensions can’t pay their way. The cost as a % of public spending is small.” That’s not paying their way, is it.

    “There’s not notion of return, so I don’t see how they can promise a higher one than hey give. I’d be interested to know if in 1950 the govt did promise a higher pension to people starting work then than it actually gave them?” Yes, actually, politicians in 1950 did promise a return, and a higher return than private pensions.

  15. “Why are state pensions not sustainable?”

    Demographic transition.

    “It’s best not to think about returns, which are a derived concept at best, you need to think about flows”

    This sort of thinking is exactly the problem. Yes, private pensions rely on future workers. But they are mutually beneficial: the future workers are happy to pay the capital-owning pensioners because the presence of more capital makes the future workers better off too.

    Private pensions accumulate capital which would otherwise not exist.

  16. That’s just not true. There isn’t more capital in economies with large funded pension schemes than in ones without funded pension schemes.

    On the other points – why isn’t that paying their way? It’s just a different way of paying for them.

    Could you provide a link to the pension promises in the 1950s? The private pension industry was tiny so it would be an odd thing to say.

    Finally, I don’t really see what difference the fact it can be wound up makes. It can’t be wound up with a guarantee that you get back the amount you put in.

  17. Really, you are the idiot here. Money is not the object of a pension, buying goods and services is when you no longer produce any.

    And how do you intent to to buy goods and services without money? Especially as you can no longer produce anything to barter.

    Promises? Contracts, rather. But, yes, we could have a communist revolution and all contracts could be voided. We could have massive inflation. We could have idiot pension fund managers who invest in Greek govt bonds. None of these make pensions a “Ponzi scheme”. Or a bad idea.

  18. You can’t contractually guarantee purchasing power over the lifetime of a pension investment, except through govt inflation-linked bonds (which are almost guranteed, but of course can be defaulted). To give one example demographic changes mean that.

    I suggest you read this famous paper by Nicholas Barr as we’ve discussed many of the ‘myths’ he explains.
    http://www.imf.org/external/pubs/ft/wp/2000/wp00139.pdf

  19. You can’t contractually guarantee purchasing power over the lifetime of a pension investment

    Did I say, or even suggest, that?

    So this will be the paper where he agrees with you that all pensions are Ponzi schemes? Well, at 57 pages, I’m not going to read it until after work but a quick search doesn’t return anything on “Ponzi” at all.

  20. “That’s just not true. There isn’t more capital in economies with large funded pension schemes than in ones without funded pension schemes.”

    Yes, there is. If I choose to invest my money in stocks and shares rather than spending it on consumption today, this will lead there being more capital in the economy.

    Similarly, if lots of people choose to start eating meat, it will lead to a long-run increase in the amount of animals being grown.

  21. There is in any event a direct link between the pressure exerted by the unions and unemployment. A key example of this is the Tube driver issue where tube drivers are being paid 50k a year to twist a knob, distinguish red from green and learn some safety procedures. As a result they are now looking at automating tubes. Which I think is a terrific idea.

    It has long been known that the higher a labour rate is pushed, the more an employer will seek to replace labour with capital.

  22. He doesn’t think state schemes are Ponzi schemes either though.

    “Did I say, or even suggest, that?”

    – I think ‘your money, held in their fund’, was meant to imply that.

    If by Ponzi you mean ‘fraudulent’ then of course almost all pensions aren’t, state and private. If though you mean ‘pyramid’, this article might help you a bit (http://www.economist.com/node/21530106)

  23. “Yes, there is. If I choose to invest my money in stocks and shares rather than spending it on consumption today, this will lead there being more capital in the economy.”

    Of course. But we are not discussing that, we are discussing whether having more funded pension schemes means more capital than an unfunded one, e.g. does France have much less capital than the UK? Or do savings go to other areas than pensions?

    There’s no clear-cut evidence it increases net saving – see p.12/p13 of Barr.

  24. Matthew, we understand the point that pensioners are always supported by current workers. The crucial disagreement between us is whether sound pensions lead to there being more capital in the economy than otherwise.

    “On the other points – why isn’t that paying their way? It’s just a different way of paying for them.” But it’s not them paying their way. They are being paid for by other people. Being paid for by other people is not “paying your way”. The difference is coercion. If a pensioner owns capital, current workers choose to give them money in exchange for use of the capital. Everyone benefits. Unlike an uncapitalised pension scheme, which requires force to keep it going.

    “Could you provide a link to the pension promises in the 1950s? The private pension industry was tiny so it would be an odd thing to say.” It was in a book I read — I’ll see if I can dig it out.

    “Finally, I don’t really see what difference the fact it can be wound up makes. It can’t be wound up with a guarantee that you get back the amount you put in.” You’re making too much of the fact that private pensions can’t guarantee an income. We don’t claim that they can. No investment is risk free. But it’s not a significant problem, so it’s not a convincing argument. If it can be wound up satisfying everyone’s contractual obligations, it’s not a Ponzi scheme. If it can’t, it is a Ponzi scheme.

  25. Posts 24 and 25 overlapped.

    “Of course. But we are not discussing that, we are discussing whether having more funded pension schemes means more capital than an unfunded one, e.g. does France have much less capital than the UK? Or do savings go to other areas than pensions?

    There’s no clear-cut evidence it increases net saving – see p.12/p13 of Barr.”

    Ah, you are misinterpreting the evidence. My argument is sound, therefore you are misinterpreting the evidence.

  26. I’m going off topic here but I can’t let this pass without comment:

    There is in any event a direct link between the pressure exerted by the unions and unemployment. A key example of this is the Tube driver issue where tube drivers are being paid 50k a year to twist a knob, distinguish red from green and learn some safety procedures. As a result they are now looking at automating tubes. Which I think is a terrific idea.

    If you think a train driver’s job is that simple, freemarketblogging, I suggest you take a look at the rule books.

  27. I think ‘your money, held in their fund’, was meant to imply that.

    To imply “contractually guaranteed purchasing power”? Wow. I’m glad I don’t have you writing reports for me.

    An investment doesn’t even, as you point out, guarantee that you get the sum invested back (never mind inflation adjusted). However, you are contractually entitled to your share of the fund value.

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