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Pension reform is political dynamite, but Macron’s attempt should be commended

Pension reform is political dynamite, but Macron’s attempt should be commended

It would take a heart of stone not to be amused by Emmanuel Macron’s current predicament.

The French President is trying to position himself as the leader of Europe. But at the same time, the streets of the major cities in France are, quite literally, ablaze. France’s public services are crippled by the biggest strike in decades.

The reason is the massive unpopularity of Macron’s proposed reforms to public sector pensions.

The retirement age in France is still only 62, compared to 66 in the UK. In general, the proposal is not to increase the age, but to pay slightly reduced benefits before the age of 64. However, the most contentious part is to modify or even scrap completely the scams under which many public sector workers get to retire much earlier on full pension.

France faces a serious pension funding problem. Spending on pensions costs no less than 14 per cent of the country’s GDP. Only Greece and Italy are higher in the entire developed world.

That is probably why opinion polls put support for these reforms among the population as a whole at around 70 per cent, with even greater support among the young, even if many from the minority directly impacted have taken angrily to the streets.

Still, pension reform is known to be potential political dynamite — and not just in France. Raising the pension age for women has become an issue in the current General Election here.

The Women Against State Pension Inequality (WASPI) campaign argues that when the retirement age was raised for UK women in a series of reforms, the 3.8m affected women, born in the 1950s, did not have enough time to adjust.

Despite that fact that this is not mentioned in Labour’s manifesto, John McDonnell has pledged to compensate these women. The cost is a mere £58bn — around three per cent of GDP — almost all of which would need to be borrowed.

As it happens, considered purely in isolation, a reasonable case can be made for increasing the general level of the basic state pension in the UK. Pension costs here are below the OECD average as a percentage of GDP, at only half the level of France. But this would not be a free lunch. Other aspects of public spending would have to be correspondingly reduced.

The myth persists that people are investing in a funded scheme with their taxes. They pay the money in when they are working, the investments grow, and there is a pot earmarked for them at their retirement. In reality, the cost of paying an individual’s pension falls entirely on those who are working during his or her retirement.

For anyone in work, the government’s promise of a pension in the future is rather like a slightly dodgy IOU. The amount you will end up getting depends upon how fast the economy grows over the coming decades, how long people live, and ultimately on the generosity of those in employment when you retire.

Political debates on pensions are usually rather depressing for economists because of either the inability or the reluctance to understand this point.

Much as it sticks in the throat to say so, President Macron is to be admired for the stance he is taking.

As published in City AM Wednesday 11th December 2019 
Image: President Macron protests by Jeanne Menjoulet via Wikimedia licensed for use CC BY-2.0
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Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

The shambles over the treatment of National Insurance has dominated the media’s reporting of the recent Budget. But only the previous week, Jeremy Corbyn made a complete horlicks of his tax return for the second year running.

The Bearded One makes a saintly fuss over making his tax affairs transparent. In 2016, he forgot to include his pensions in his return. This year, he seems to have entered his allowance as leader of the opposition as a benefit rather than as income.

The real scandal is not his gross incompetence. It is the amount he already earns in pensions and is set to receive in the coming years. It is not necessary to be an educational success to earn a lot of money. There are many prominent examples of this point. But, taking the population as a whole, there is a pretty good relationship between how well you do when in education and how much you earn in your career.

Corbyn left school with two grade Es at A level, and left what was then the North London Polytechnic without finishing his degree. His pensions, including his state pension and a pension from the Unison union, already amount to nearly £10,000 a year. When he retires as an MP, he is entitled to a further gold-plated pension which will pay out almost £50,000 annually, which analysis last year estimated would cost £1.6m to buy on the open market.

The leader of the opposition has spent his entire adult life outside the wealth creating sectors of the economy, insulated from market forces. And he will draw a pension which is more than the amount which the vast majority of full time employees are paid by actually working.

It is the continuing problem of public sector pay and pensions which the chancellor should be addressing, rather than fiddling around with the technicalities of National Insurance rates. The howls of anguish should not be from builders and plumbers, but from bureaucrats who find their gold-plated pensions and salaries cut. The public sector pay bill makes up around half of all total public spending, so this is the place to look to reduce the government’s deficit.

A new report by the Institute for Fiscal Studies (IFS) out this week acknowledged that, in raw terms, average hourly wages were about 14 per cent higher in the public sector than that in the private in 2015-16.

The IFS mounted the classic defence of high public sector pay, however, arguing that “after accounting for differences in education, age and experience, this gap falls to about 4 per cent”. In other words, public sector workers are more highly qualified, so their higher pay is justified.

But this takes no account of the outputs of the two sectors. In the old Soviet Union, value was measured solely on the basis of inputs such as the skills of the labour force, and we know what happened there.

A European Central Bank paper from 2011 illustrates the dangers. In Germany, public and private sector pay was more or less equal. In Portugal, Italy, Greece and Spain, public pay was between 20 and 50 per cent higher. Sharpen your axe Mr Hammond!

As published in City AM Wednesday 15th March 2017

Image: Seesaw by Rwendland is licensed under CC by 2.0
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Does Miliband understand the importance of incentives?

Does Miliband understand the importance of incentives?

Ed Miliband has long had a problem with voters not perceiving him as “normal”. His famous struggle with a bacon sandwich in some ways says it all. But at a much more important level, he seems to have little or no empathy with one of the most fundamental of human motivations. The most profound insight of economics is that people respond to incentives. When incentives change, behaviour also changes. This certainly does not exclude other motives, such as altruism, but incentives are key to understanding how people make decisions. It is this which Miliband appears unable to grasp.

Consider the political situation in Scotland. A rampant SNP threatens many Labour seats. Yet despite the pleadings of his colleagues, Miliband finds it very difficult to rule out forming a coalition with the Nationalists after the election. In these circumstances, the incentives facing a Labour-inclined voter North of the Border are clear. Voting SNP promises a potentially powerful bloc in Parliament to press the case for extracting even more money from the English. And at the same time, you could still get a Labour government via the coalition route. For all except the truly faithful Labour supporter, incentives in Scotland point to voting SNP.

Pensions are another area where neither Miliband nor his political mentor Gordon Brown have shown the slightest sign of understanding the effect of incentives. Miliband proudly proclaims that he will finance a reduction in tuition fees by reducing the tax advantages of putting money into a personal pension scheme. One of Brown’s first acts as chancellor in 1997 was to abolish the tax relief pension funds earned on dividends from stock market investments. This crippled many final salary pension schemes. Pension pots are an irresistible lure for politicians with profligate spending aims. But at a time when life expectancy is rising sharply, it is an act of profound economic illiteracy to reduce the incentive for people to put money away for retirement.

Miliband played a prominent role in the last Labour government, first as a key adviser and fixer for Brown, and then as an MP and member of the Cabinet. Brown was at first an excellent chancellor, keeping us out of the euro and maintaining fiscal probity. But he soon went in for a massive increase in public spending, with entirely predictable results. Workers in the public sector were portrayed as angels, selflessly serving the nation. But they proved only too human, just like the rest of us. They responded to incentives.

The incentive to take advantage of the increases in public spending was strong. The outcome was a huge increase in the pay of the public sector relative to that of the private, even more attractive gold plated pension schemes, shiny new offices, more staff, and endless re-gradings and promotions. Most of the rise in public spending did not go into improving service provision. Instead, it went into subsidising the private consumption of those employed in the public sector.

Like it or not, responding to incentives is a very deep-rooted aspect of human behaviour.

As Published in City AM on Wednesday 11th March

Image: Ed Miliband and Fabian Hamilton by Bob Peters licensed under CC BY 2.0

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The ‘Gentleman in Whitehall’ does not know best

The government is relaxed about people cashing in their pension schemes to buy a Lamborghini. But the left-leaning liberal commentariat is certainly not. Abuse has been heaped onto George Osborne’s Budget measure of removing the requirement for people to buy an annuity. The main thrust of the attacks is that individuals may act irresponsibly. They may take financial decisions that are not in their best interests.

This is certainly true. People do make mistakes. The 1945 Labour government used the infamous phrase ‘The gentleman in Whitehall knows best’. The concept has since been extended to include ladies, and, despite its antiquity, is still very much alive and kicking. This view of the world lies at the heart of the criticisms of Osborne’s innovation. But does the state itself have a better track record when it comes to questions of finance? The answer is plain. An entire issue of this newspaper could be filled with shocking decisions. So just a few recent examples will suffice.

The issue of Gordon Brown’s disastrous sale of half the UK’s gold reserves over the 1999-2002 period was raised last week at Prime Minister’s questions. The average price of our gold was $275 an ounce, and of course the price now stands at some $1,300. Hindsight can make geniuses of us all. But the ineptitude of the process itself was breathtaking. The large sale was announced in advance, on 7 May 1999. This public declaration of a large increase in supply coming on to the market was sufficient to drive the price down 10 per cent by the time the first tranche was auctioned two months later.
The Private Finance Initiative is placing major strains on the finances of the NHS. The concept was created under John Major, but Gordon Brown really loved it. PFIs allowed ministers to secure large sums to invest in popular projects, such as new schools and hospitals, without paying any money up front. The insane financing structure places a debt on the taxpayer which is roughly double the value of the infrastructure which the framework helped to build.

Not everything is Gordon Brown’s fault. In the 2010 Strategic Defence Review, the new government announced that they would adopt the aircraft carrier version of the American F35 fighter, rather than the ‘jump jet’ favoured by the previous Labour administration. But the costs of adapting the design for use on carriers spiralled out of control, and two years later, it was abandoned and the jump jet reinstated.

But who can forget that Brown boasted that he had ‘abolished boom and bust’? The Treasury and the thousands of officials in regulatory bodies such as the Financial Services Authority thought they were so clever that they had designed a system in which recessions would never happen. The cost of the crisis can be reckoned not in billions but trillions.
Hayek won the Nobel Prise for his work on the inherent limits to knowledge of economic systems. Individuals, governments, central banks all face these limits. Osborne is right to trust the people.

As Published in City AM on Wednesday 9th April


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No free lunch. Defaults today mean less jam tomorrow

Potential defaults in the Euro zone have been in the news again. In Portugal, the ruling coalition parties and the main opposition Socialists have been unable to agree on a European Union-led bailout plan after days of talks. Yields on the country’s 10 year bonds have approached 7 per cent, compared to the 1.5 per cent in Germany. There has been some improvement this week on the news that an early general election has been avoided, but yields still remain over 6 per cent.

Even more dramatically, the city of Detroit has become the largest American city to file for bankruptcy. Just as in the case of the Mediterranean countries, the public sector workers had been provided with much too generous wage and pension levels for much too long. The unfunded liabilities in the public pension funds of the city are estimated to be $3.5 billion. There is currently a major legal wrangle about whether the pensioners have a constitutional entitlement to their income. If they are, and the rest of America has to bail the funds out, they can feel fortunate that they live in a monetary union which works, namely the USA. Countries such as Greece and Portugal struggle for every cent of bail out money in the teeth of German reluctance to pay.

But does it matter? Does it matter if a public administration defaults on its debts, either in full or obliges bondholders to take a haircut? Economic research had until very recently contained a paradox in its answers to these questions.

International finance theory predicts that sovereign defaults lead to higher subsequent borrowing costs. They can even lead to the full exclusion of a country from international capital markets. All this seems very sensible and rational. A default today should reduce trust in the creditworthiness of the institution in the future.

The problem was that a large body of empirical research suggested that support for the theory was, at best, weak, and in many studies non-existent. An influential 1989 paper by Jeremy Bulow and Kenneth Rogoff – he of Reinhart and Rogoff fame – concluded that ‘debts which are forgiven will be forgotten’. More generally, the consensus in the empirical academic literature was that not only do defaulting countries not face higher borrowing costs in the future, but they regain access to credit within a couple of years.

So why not just do it and default? Here at last seems to be the answer. A comprehensive piece of work in the latest issue of the American Economic Association’s  Macroeconomics finally provides powerful evidence to support the theory. Juan Cruces and Christoph Trebesch construct the first complete database of investor losses in all restructurings with foreign banks and bondholders from 1970 until 2010, covering 180 cases in 68 countries. They show that restructurings involving higher haircuts are associated with significantly higher subsequent bond yield spreads, even 7 years after a default, and longer periods of capital market exclusion. There really is no free lunch.  Defaults give rise to significant future costs.

As published in City AM on Wednesday 24th July


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Telling the Truth about the Retirement Age

In a democracy, it is always a risky business for politicians to tell the electorate things they do not want to hear. So Steve Webb, the pensions minister, must be congratulated.  He told the truth about the retirement age. In a speech last week he stated bluntly: ‘If someone tells a 30 year old what their state pension age is going to be, they are lying’.

The reason for his frankness is the massive increase which is projected in the population over the conventional age of retirement.  The number of over 65s in England is expected on official projections to increase by 51 per cent over the next 20 years, while the numbers of those aged 85 and above will double by 2030.

The pension age will rise to 67 for both men and women – by 2028. But this will almost certainly prove to be far too low. Life expectancy for those now in their 40s and 50s is very likely to be considerably higher even than the official estimates suggest.

Robert Fogel is an American economic historian who won the Nobel Prize in 1994. A key theme of his work is the interrelationship between the economy and the health and longevity of the population. The time lags involved can be very long.  For example, the period of 1930s in America was the worst depression in the entire history of capitalism. Yet life expectation between 1929 and 1939 increased by 4 years, and the heights of men reaching maturity during this period increased by 1.6 cm. Fogel attributes this to social investments, such as slum clearance, which were made in the decades around 1900. Reductions in malnutrition during childhood also have dramatic impacts on life expectancy decades later.

The age cohorts born in the 1950s and 1960s were effectively the first in the whole of British history never to experience food shortage in any way.  The effects will come through in quite dramatic increases in life expectancy.

The one optimistic note, for the public finances at least, is that Fogel did a lot of work on the relationship between Body Mass Index and longevity. Obesity really does reduce life expectancy sharply. But if you lead a healthy life style, don’t expect to retire until well into your 70s.

Finally, the answers to the Christmas quiz. This was about annual growth in GDP in the Western economies since 1900. The biggest cumulative fall in real GDP in peace time was 28.5 per cent in America 1930-33. The biggest fall in any single year was in Austria in 1945, when GDP fell by no less than 59 per cent, not surprising given that large chunks of the country were overrun by the Red Army. The biggest annual drop in peace time was in 1923, at the time of the German hyperinflation, when output in that country fell 17 per cent.  Finally, on the optimistic note on which to end, there was no recession in Finland between 1945 and 1991.


As published in City Am on Wednesday 16th January 2013

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