As a further comment on “funded” public pensions (link to previous note), I just want to comment on the side effects of such “funding.” (To recap, a central government could create fictitious bonds to match “pension contributions,” which has the same cash flows as a pure “pay-as-you-go” scheme. The alternative Canada has switched towards is to buy financial assets with the “pension contributions” — although some of those assets would be reinvested in bonds guaranteed by the Government of Canada.) As I discussed, this is economically equivalent to the Government of Canada levering up its balance — issuing bonds to the private sector to buy private sector assets.
In this article, I will make some random comments about the implications of that policy. Although I believe that the procedure is somewhat silly from an economic standpoint, there is a logic behind it.
Sub-Sovereigns: No Choice
Sub-sovereigns that want to run pension funds (mainly for their employees, but Quebec opted out of the Canada Pension Plan) have very little choice but to fund pensions like the private sector. Although provinces can hope for more demographic stability than private corporations, entities that can theoretically default have a hard time making credible long-term uncertain growing payments. (My previous employer was the asset manager for Quebec.)
The rest of this article will just refer to the currency-issuing central government, and not sub-sovereigns.
Why Do We Need Contributions?
One commenter (“DFWCom”) on my previous post argued that the central governments do not need to enforce pension contributions — just pay the pensions. However, that is implied by the pure pay-as-you=go system: the “pension contributions” are just a tax that ends up in the government coffers. If the government abolishes them, they need to raise taxes elsewhere to keep cash flows unchanged (to have the same economic outcome).
Why have this regressive tax? Realpolitik. The Canada Pension Plan is not seen as a handout — it is earned. This makes it politically untouchable — all the free marketeers can hope to do is try to get the funnel of money into a trough that private asset managers can get their snouts into. When you look at the fate of the rest of the welfare state over the post-war decades, this is not something that should be ignored on ideological grounds.
If we do not track “contributions” versus the pension payments, payments are purely arbitrary, and would be the result of democratic outcomes. Such an arrangement does not offer long-term security. (One may note that the incessant attacks by free marketeers against the alleged insolvency of public pensions since this is an obvious angle. Although this works for deluded loudmouths on the internet, politicians will end up getting hammered by actuaries if they start lying about the pensions in Parliament.) For government employees, pensions are part of overall compensation — and a point of competition versus private sector employers. Handing out pension benefits that appear to be cost-free is a great way to store up future trouble (as many sub-sovereigns and private employers discovered when pension accounting was more lax).
Pension accounting involves a lot of guesstimates, but the exercise needs to be done.
We Cannot Send Goods to the Future…
If we do a simple closed economy model of an unfunded public pension plan, we run into the reality that we cannot send goods and services from the present to the future. In an imaginary world where we could, the baby boomers could have saved up in their peak earning years and sent their production to themselves when they are drawing on their pensions (essentially now). However, the goods and services bought by pensioners have to produced in the present, which implies reallocations of income flows within the economy.
Buying domestic financial assets might appear to solve the problem, but financial assets are just claims on future income. The income flow displacement still has to happen, and the income flows are large enough to implicate to the Federal Government to balance them.
… But We Can Get Them From Foreigners!
As my previous text hinted, we can use foreigners to act as our “economic time machine.” We buy foreign financial assets when we have a large working population (which of course, Canada did not), and can then sell the assets and use the proceeds to import goods and services. To the extent that the aging population has an inflationary impact, we export the inflationary pressures. This strategy is well known, and normally called a “sovereign wealth fund.”
Although this would have been a bright thing to do in the 1970s (and not 1997), one may note that this is not a policy that all large countries can pursue at once (unless there are major demographic differences between the countries, which is the case in emerging markets).
“External Constraint” Whacked
One of the advantages of such a fund is that it will tend to have an internationally diversified risk asset allocation matched versus local currency liabilities. So long as the neoliberals managing the plan are working in the national interest, this creates a chunky public buyer that can lean into any short-term currency panics. Canada already has a lot of assets managed by private and sub-sovereign pension and insurance funds that have that asset/liability mismatch — which explains why currency panics die out. (Unlike the fantasies of the Canadian economic establishment.)
My retirement savings are split between pension funds and a self-directed account. If anyone wants to organise a simultaneous plunge in Government of Canada bond prices and the Canadian dollar, please try to do it when I am not on vacation. Thanks.
Concluding Remarks
For a small extremely open economy like Canada, I see the attractions of funded public pensions. A country like the United States is in a different boat.
Australia has a massive compulsory pension system we call superannuation (because marketing? It's an annuity, but super?). Everyone puts in (currently minimum of 10.5% of income) to private funds, which then trade in financial assets, infrastructure, and things like monopoly tollways, banks, electricity; and commercial property. Then we allow "the miracle of compound interest" to give us a comfortable retirement. It is essentially a big privatised pension.
Of course, this is all bullshit smoke and mirrors. The returns on these investments are all our money, paid in tolls, mortgage interest, power bills, and retail prices inflated by mall rents. The miracle of compound interest is our own money being given back to us, minus a wodge of asset management fees. In the meantime, the economy is smaller, by the amount of enforced savings, so when we all retire, we have heaps of money with which to buy - what? We will have reduced our production significantly in the meantime! We are not "saving" anything, we are taking 10.5% of our production and setting it on fire.
I won't even go into the significant social equity issues, as the wealthy basically using this as a tax-effective inheritance fund, while the poor get bugger all and fall back on a now emaciated public pension.
The real problem is that it is, effectively, a massive ponzi scheme. The assets that our super funds invest in are inflated by all that super invested in them. So what happens when demographics turn and there is more money going out than in? Asset prices fall, super fund unit prices fall accordingly, all our "hard-earned savings" start going down the toilet. Compound that negative return with a bit of debt deflation (say a big real-estate bust), and the whole bullshit system is insolvent. In the meantime, I can't access my enforced savings to pay off the last bit of my mortgage, so my super vanishes while I'm still on the hook to the bank.
Superannuation is supposedly saving future generations from the "tax burden" of pensions, but when the whole illusion evaporates, which it will, the government will end up nationalising the whole thing - because if they don't, there will be 25 million pissed-off Australians demanding a refund of our entire life savings.
A gracious and interesting post. We can agree that: 1) we cannot send goods and services into the future and 2) the issue for pensions is political not economic, as noted by FDR that entitlements were lousy economics but great politics. That was ninety years ago.
It was Keynes who reminded us (and economists) that we can't predict the future and so can't discount it either. Anyone who makes future promises, eg, for pensions, is taking a risk and somebody has to be ready to bail out the system if it begins to sink. Whether pensions are public or private, there's really no alternative than it be the sovereign state. We saw a great example after Liz Truss's budget in the UK, when the Bank of England had to step in to save pension funds because of their exposure to bond prices.
So while I agree, the political risk of "unfunded" pensions is real, what a tangled web we weave when we issue bonds to de-risk private pensions and (in the US) mortgages and, these days, the whole shadow-banking-swamp. We've just seen four (or is it five) banks collapse without any notion as to how much more instability is lurking in the financial sector's house of cards.
It gets worse, a tenet of MMT - acknowledged by the Bank of England, Bundesbank, and others - is that banks create money, albeit mostly for unproductive speculation rather than productive enterprise. It would be bad if the ill-gotten excess money was simply placed under mattresses (rather than be taxed) but governments instead issue bonds requiring interest be paid - we're currently in yet another rinse-repeat cycle of sending entitlements to wealthy 1% while imposing fiscal constraints on the 99%.
It was ever this. I listened last evening, to Clara Mattei discuss her new book, “The Capital Order, How Economists Invented Austerity And Paved The Way To Fascism”. The “trinity” of austerity - fiscal, monetary, and industrial - was crafted after WW1, celebrated under Mussolini, and has been imposed, whenever needed, ever since. As in right now!
The same tenet of MMT states that banks cannot lend deposits for the simple reason that deposits are liabilities. It seems to be poorly understood by most Central Bankers, including prominent exes who are leading the charge to invest financial liabilities into saving the planet.
It all begs the question, given our climate/biodiversity/inequality crises - the poly crisis - how much more privatization, bond malarkey, and immiserization of the public will it take?
One of MMT’s founders, Warren Mosler, advocates a zero interest rate, no more bonds (or as an easy step, limiting Treasuries to 3 months) with much, much stricter regulation over how private-sector banks create money, and for whom, and for why.
But today’s MMT debate is over fiat digital currency - eliminating private-sector banks from payments systems and with far more stringent control over credit creation. Or maybe just nationalize banking, collapse Central Banks into their respective Treasuries and move forwards without bond or monetary anchors around our ankles.