The problem of the European pension gap cannot be tackled by the kind of financial engineering proposed by the European Financial Services Round Table. This is not the moment in history to argue that private pension funding is necessarily superior to state provision.
The European Financial Services Round Table has drawn attention again to Europe’s “pension bomb”. According to Pehr Gyllenhammar, chairman of both the Round Table and Aviva, European governments must act fast unless they want deliberately to erode the livelihood of 377m people.
But the rapid gyrations of financial markets are a greater, and more immediate, threat to livelihoods than the slow swings of demography. And the financial leaders at the Round Table are part of the problem rather than part of the solution.
The cost of pensions will rise as the postwar generation retires and demands support from its few children and even fewer grandchildren. The Round Table’s figures show the proportion of European output needed to finance state pensions, rising over 40 years from about 10½ per cent to 13½ per cent.
While this is a problem, it is hardly a crisis. It is not hard to see how, over 40 years of continuing economic growth, the gap can be met by a combination of later retirement, less generous provision and higher taxes.
But the substantive problem of unfavourable population trends cannot be tackled by financial engineering. The bread a French pensioner eats was baked that morning. Long-term care for the elderly must be provided by people who are then working. A high proportion of old (or young) people necessarily involves redistribution from those at work to those not in work. Funding arrangements can disguise these problems but cannot conceal the fundamental reality.
There is what economists call a problem of aggregation or composition. As individuals, we can provide for our own retirement by saving today to buy financial assets. But since most financial assets are claims on ourselves, our ability to do this collectively is limited. For a nation the only ways in which wealth can be transferred to the future are to build physical infrastructure (with a future intention of running it down) and to buy foreign assets. These holdings are easier to establish than to cash in, as the Japanese, with massive holdings of US bonds, will inevitably discover.
The equity culture of Britain and the US, and the extensive funding of private pension schemes in these countries, are associated with lower overall national savings rates. The main effect of increased demand for equities in the 1990s was to bid up prices, not to create tangible assets that will feed us in 2040. Still, perhaps our grandchildren will appreciate all that cable we put into the ground.
The true significance of pensions funding is that it gives the claims of pensioners priority. Pensioners will always depend on the willingness of the current generation to feed them but if they own title to assets, an attack on their financial security is an attack on the whole institution of private property. The US Social Security Trust Fund, which mostly consists of specially issued Treasury bonds, is in a sense a fiction but it is a fiction that makes it harder to dishonour pensions claims. The government must either breach a trust or default on a bond.
These devices enhance the central objective of pensions policy: to give the prospect of security in retirement. The outburst from the Round Table is the latest episode in a 20-year campaign by the financial services industry to persuade opinion-formers that state pension provision is failing and that government should instead privatise the process. Despite the manifestly self-interested nature of this propaganda, it has undermined confidence in the future capabilities of the state as pension provider.
But confidence in the capabilities of the private sector has been undermined more. The incompetence and lack of professionalism of people employed by the Financial Services Round Table have created such extreme equity market volatility that these markets cannot now provide a secure basis for the retirement savings of 377m people. After Enron and Equitable Life, as bonus rates tumble and occupational pension schemes are closed, a period of silence from the financial services industry on the superiority of private to public pension provision is appropriate. Some disappointed customers might hope that Mr Gyllenhammar would spend less time on public policies and more on restoring the values of the private policies his companies have sold.