Growth holds the key to pensions
Posted on 14 March 2014
Stocks are the longest-duration investment: the growing long-term cashflow provided by dividends is a natural balance to pension liabilities, and remains more stable than stock prices.
The idea that our ageing societies won’t be able to afford their collective pensions is one of the biggest economic concerns of our time. This week I was able to remind an audience of pension fund managers and trustees why it may also be one of the most mistaken.
Misconceptions start with the idea that resources consumed by pensioners directly reflect past savings. But there are no warehoused stockpiles: what pensioners need is made as they consume it by those still in work. In the jargon, pensions are collectively resourced on a ‘pay-as-you-go’ basis. Pension funds, and national insurance contributions, facilitate a redistribution of output from those who produce it to those who’ve retired. The bigger the fund, and the fuller the contribution record, the stronger your claim on that output. But if there is nothing in the shops, those funds – and money generally – would be of little use.
This seems academic, but it helps to zero-in on what really matters in aggregate: economic growth. A growing economy makes it easier to redistribute output to the swelling ranks of pensioners. And an aging population need not be short of labour, or less productive.
When we allow for the wider non-working population, the increase in dependency ahead is much smaller than the shifting age mix alone suggests. In the UK, we experienced a bigger burden back in the early 1980s: there were fewer pensioners then than there will be, but unemployment was very high and participation rates were lower. And if labour utilisation improves from here, the prospective increase in dependency looks still more manageable – on plausible assumptions, it could even fall. The UK of course is also particularly fortunate in that its population is growing, even as it ages, while China for example will have much less room for manoeuvre. Higher retirement ages will help further, though some see this as an indication of economic failure (wrongly in my view, but that’s another matter).
These points are ignored by the ‘demographic time-bomb’ literature. But the rush to worry about an aging society running out of labour is arguably perverse: isn’t unemployment telling us that we’re not fully using what we’ve got to start with? Even if a labour shortage were looming, much economic growth – most of it, in the UK in recent decades – comes from productivity gains driven by new technologies and the learning curve (prosaic but potent examples of those for me are the invention of spreadsheets and the assembling of flat-pack furniture). Why should this change?
There is still the issue of how best to administer the aggregate redistribution from workers to pensioners – and at the individual level, many current retirees face the low levels and seemingly arbitrary gyrations of annuity rates and final scheme values. With the best of intentions, pension accounting of late has distorted asset allocation and hurt sponsoring companies’ cashflow, leading perhaps to the premature closure of defined benefit plans. But there is no easy way of providing certainty in pension provision, nor of deciding who pays for it.
A high equity weighting has always seemed appropriate for pension funds to me – at least in the early accumulation years – provided of course that they are not obviously overvalued. Stocks are the longest-duration investment: the growing long-term cashflow provided by dividends is a natural balance to pension liabilities, and remains more stable than stock prices. But as with investing generally, individual financial personalities and circumstances will vary.
Kevin Gardiner, Chief Investment Officer, Europe