Communication and National Debt
Put as simply and briefly as possible, the wake of reporting about government debt confirms the central philosophy of the Tomorrow’s Investor vision.
Most are generally agreed on the round sum of £799 bn, or 56.6% of GDP, as the current figure for government debt. The impact of this figure – it’s sheer propensity unnerving- is less assured, more surrounded by conflicting understanding and speculation. Most papers focused on the recent forecasts by The National Institute of Economic and Social Research (NIESR), which predicted that the recession will continue until at least 2014 when annual borrowing will hit over £120 bn, about £23 bn more than the Chancellor’s estimates. The Guardian focused on NIESR’s prediction that there will have to be “aggressive cuts in public spending” whilst the BBC quoted David Kern (chief economist at the British Chambers of Commerce) as saying that public spending will need to be “curtailed across the board”. The Telegraph considered the fear families would be facing amid rumours of such cuts.
In contrast to the tone of these reports, is the tone set by Dora Iakova (IMF European Department) in her report “United Kingdom: From Rescue to Recovery”. In her, albeit tentative, conclusions she envisions the UK’s relatively prompt recovery, should “the authorities continue to handle the crisis successfully”. It is not clear what to make of the various forecasts and their interpretations – indeed, it has been pointed out that NIESR itself estimated only six weeks ago that the recession had bottomed out in March. For a somewhat clearer understanding, the website “Economics Help:Simplifying Economics” provides an concise account of UK national debt and a fairly balanced view of whether or not we should be worried.
Tomorrow’s Investor argues that the key to the future of investment and economic health is held in three core principles: accountability, transparency and trustworthiness – a view apparently also held by the IMF mission chief for the United Kingdom, Ajai Chopra:
“……more frequent and comprehensive disclosure of financial information by banks would help reduce uncertainty and strengthen market discipline.”
Fundamentally, such conflicting accounts and the resulting confusion in what to believe, only serves to undermine the speed of recovery and it’s most fragile stimulant, trust. A failure to improve communication at such a critical time will be a failure to heed the IMF’s warning that recovery “hinges on the trust of the public in the solvency of the government.”
Risks to investors in planning for their retirement
Filed under: Economy, General comments, Growth, Pensions, Risk Management
The current situation in the financial market was described by Karl Marx, almost century and a half ago, where he predicted the current financial crisis may lead to nationalisation of the banks and therefore to communism; this scenario was called “Perfect Storm”. Contrary to that however, an increasing dependency ratio may lead the UK economy to become a free market where there is no welfare system – which includes pensions.
The “Demographic Bomb”, an aging population and declining birth rate, is ticking. The decreasing number of people able to work will leave the future government with less revenue in taxes and therefore less public funds available. On the other hand, the lack of private savings today, especially by the current low earner, will force the future retirees into the extreme poverty. The inability to afford the health and care services will demand further resources from the state in the form of services, allowance and income support. Studies indicate that choice in public services is something that is here to stay. In the absence of appropriate savings, the pressure to provide services, including elderly home care and health services, to meet increasing morbidity (rate of illness) will be enormous. This will place a significant strain on public expenditure and create a large deficit in the budget.
Therefore we can say that an aging population is another storm that Great Britain, like all the other developed economies, experiencing will see lead to a “Demographic Bomb” scenario “Demographic Bomb”.
From above, the consumers planning for their retirements are exposed to high risks of decline in:
1. The Basic State Pension
2. Health and Care services available
3. Income Support
Also, the recent events in the financial market will result in various risks to consumers planning for their retirement including:
1. Lack of trust in the financial system, therefore
2. Decline in savings
3. Financial illiteracy
Not to forget, the current pension system (Basic & Second State Pension) does not deal with the absolute poverty. However, to avoid poverty, the mean testing system has been put in place which guarantees minimum income. Where this provides comfort for some, it discourages savings for the medium earner (£25K – £30K annually). The research discussed on pension reveals that an individual earning £10k a year can have pension up to £8000 (almost 80 per cent) .Where as an individual earning £25K would only get £8400 in pension (almost 34 per cent). Therefore, people with a low income, relative to average earnings, will enjoy a rising replacement rate from the state with little or no private savings, should a future Govt raise the basic state pension to deal with the poverty. Hence, this imposes the risk of:
1. Increasing the burden on the public expenditure
2. Discouraging saving
Therefore, encouraging the low to medium earners to save for retirement through Personal Accounts is vital. This will lessen the future burden on public expenditure as well as on the working generation. Additionally, the FSA should focus on the risk of declining trust in the financial system. This is not achievable until systematic error placed by means-testing, which imposes the risk of discouraging saving, is addressed.
Evils of current pension system in the UK
The current pension system can be described as PAYG (1st tier) mainly as the Second State Pension (S2P) also known as SERP (2nd tier) has not shown much growth since the introduction. Also as per OECD, just 40 per cent of the employed population is currently saving through their occupational pension schemes (3rd tier).
Therefore I would like to summarise the UK pension system using following equation:
Pay as you go + demographic change = disaster
Firstly, the current PAYG depends upon the revenue generated by the working population for the retiring population today. Therefore, aging population and increasing life expectancy rate means less revenue, hence burden for generation at work. The irony of PAYG system is that it does not appear as debt in the govt account and therefore there is’t any guarantee that a future govt will provide you with the pensions according to the contribution made today.
The current pension system does not deal with the absolute poverty. However, to avoid poverty, the mean testing system has been put in place which guarantees minimum income. Where this provides comfort for some, it discourages savings for medium earner (£25K – £30K annually). The research discussed on pension radio reveals that an individual earning £10k a year can have pension upto £8000 (almost 80 per cent) .Where as an individual earning £25K would only get £8400 in pension (almost 34 per cent). Another research claims that Basic State Pension (BSP) is only 15 per cent of average earning. Therefore, people with low income relative to average earning will enjoy a rising replacement rate from the state with little or no private savings, should a future govt raise basic state pension to deal with the poverty.
Finally, current pension system is costly to run, difficult to manage and impossible to understand. This has adverse impact andt discourages saving, especially for those who are not financial literate. The general advice available is not sufficient and the costly fee structure does not allow independent financial advisory to service people with low to medium income. That is why carry on saving for pension in a current form is not appealing to young generation.
Technical faults identified by the pension experts:
1. Raising basic state pension would raise burden on the public expenditure
2. Earning related elements of the system would gradually disappear
3. BSP, linked to prices, will fall in value relative to average earning
I would like to emphasis here that the past governments has taken actions to overcome issues discussed above. We will look into this tomorrow.
Aging Population – A Demographic Bomb
A scenario described by Karl Marx, almost century and a half ago, where he predicted the current financial crisis which may lead to communism is called a “Perfect Storm”. Contrary, the scenario “Demographic Bomb” may lead the developed economies towards total free market (no welfare state, e.g third world countries)
Today, it is not unusual for people to have idle retired life of 20 to 30 years as they are on average living as long as 80 years. This is very high in comparsion to an average age of 50 in early 1900s when the PAYG pension system was introduced.
The situation has worsened by the falling birth rate. It means that less people are available to support the retirees. In 1950, there were 7 people to 1 retiree. Where as now it is 4:1 and by 2050 it will be 2:1.
The official figures reflect that the dependency ratio (How many young people (under 16) and older people (over 64) depends upon working age (16 – 64)) in UK is forecast to rise from 0.34 to 0.65 by 2040.
|
UK Population |
2009 |
2031 |
|
Total |
62m |
71 m (up 1.74 per cent) |
|
Of working age |
38m |
44m (up 16 per cent) |
|
Aged 50 – 65 |
9.2m |
13m (up 41 per cent) |
|
Over current State Pension Age |
11.3m |
17.9m ( up 58 per cent) |
The key implication of an increasing dependency ratio on the state pension systems that operated on pay-as-you-go (PAYG) basis will become less viable. Under PAYG system, today’s pensions are paid out of today’s revenues. In simple terms, if the working population declines relative to the number of pensioners, there will be less revenue from taxes, yet an increasing bill for pensions.
Therefore we can say that an aging population is another storm that the Great Britain, like all the other developed economies, experiencing will lead to a stormy scenario “A Demographic Bomb”.
The high number of poor retirees will not able to participate in generating the economic wealth (Taxes and NI Contribution) and contribute in the productivity (GDP) and therefore the impact on the total revenue available will be adverse. Hence this will enforce the future government to borrow more and will result in increase in the taxes for working population to serve these debts.
On the other hand, the lack of private savings today, especially by the current low earner, will force the future retirees in to the extreme poverty. The inability to afford the health and care services will demand further resources from the state in the form of services, allowance and income support.
To deal with this a current low earner with minimal skills may go and find work. However, the changing economic structure will only require technical knowledge and skills which is not currently acquired by the majority of people working in manual jobs.
In a nut shell, an aging population and declining birth rate, will place significant strain on public expenditure and create a large deficit in the budget. The decreasing number of people able to work will leave the future government with less revenue in taxes and therefore less public funds available. Studies indicate that choice in public services is something that is here to stay. In the absence of appropriate savings, the pressure to provide services including elderly home care and health services to meet increasing morbidity (rate of illness) will be enormous.
Tha above scenario raises key concerns about the future of penion system in UK. Let us discuss this in detail tomorrow.
Pension System in the UK
First Barclays and now IBM closing down their final salary schemes for only one reason that is rising cost of providing the pensions. This is an alarming indication of tough times ahead, especially for those who have been relying on their employers to take care of their retirement. Alternatively they are expecting the state to provide better pensions in the future.
The news is bad. Like the employers, state is faced with the issue of high cost as the budget deficit continues to rise. Additionally, the current PAYG (Pay As You Go) pension system faces threat from the fact that people are living longer and birth rate is declining.
A lot has been said and written about the above issues and thier impact on the current pension system; all in the language that ordinary person can not understand. Therefore, I have decided to attempt not only to understand the myth but also to write in a language which can be understood by Joe public.
The series of blogs, over the next few weeks, will aim to unfold the myth of the current state system (PAYG) and policy frame work whilst comparing this with the system serving the successful pension schemes in the world.
Pension System in UK:
The current 4 tier pension system consists of state, occupational, private and guaranteed benefits which is supported by three pillars; state, employers and individuals.
The pensioners (beneficiaries) may receive income from various sources including basic state pension, income support in case your basic state pension does not meet minimum income require in order to keep you above the poverty line, occupational pension supported by the employers (contributions) and govt (tax relieves), personal pension income (pension funds), other savings, investment income and other capital including property, support by the family etc.
What is the PAYG system:
Currently the state pension is funded by the money raised today in order to meet pension demand for today.
The pension (state and income support) is provided by the Department of Social Security funded by the national insurance contribution and taxes.
The above structure indicates the critical challenge of raising funds to support the future demand for pensions, especially demographic changes in UK is emerging as an imminent scenario in future.
Let us talk about it tomorrow
Where is your money being invested?
The concerns surrounding responsible investment have long been at the heart of the Tomorrow’s Investor project. However, once again, a free event at the RSA really highlighted the significance of this issue – alongside recent findings from Tomorrow’s Investor research.
A couple of weeks ago the RSA hosted what was a moving discussion to celebrate the birthday of Aung San Suu Kyi. A question from one of the audience regarding corporate investment was left largely unanswered from the panel but struck a chord with an article I had just been reading about the involvement of Chevron in Burma. Chevron is reputed to be the sole remaining American company operating in Burma. Last December, shareholders of the company filed a resolution expressing concern over the company’s dealings, not only with Burma, but Ecuador and Nigeria also. Chevron has since, unsuccessfully, attempted to block this resolution.
The argument for responsible investment can essentially rely on two lines of argument- that financial revenue injected into business deals with countries such as Burma clearly contributes to the maintaining of their governments. Evidence has also shown that this can lead to the inevitable destruction of share value for these companies. The latter argument however will rely on investors being aware of exactly what is being done with their money and where. This is particularly true for pensions, with a recent survey carried out by the Tomorrow’s Investor project showing that the majority of people (61.4%) with pensions do not know how their investments are being used.
UKSIF has done significant work in promoting responsible investment amongst pension funds. Their most recent report indicated that there has been real improvement in the last two years, with a good increase in the number of funds now having responsible investment policies since 2007.Its results and key recommendations can be seen here.However, despite the positive news, its most revealing find is that:
“Detailed communication to members and other stakeholders about the RI policy and its implementation remains relatively low. A tenth of funds communicate annual voting records. Less than a tenth disclose the fund’s engagement strategy or about participation in collaborative investor initiatives.”
In the Tomorrow’s Investor survey, 75.7% of people said that they wished to be better engaged with the investment of their money. As more people complete the survey this figure is expected to rise further.
However the question remains of what investors can do now, in light of the resolution filed at Chevron. During the talk at the RSA, the level of difficulty faced by governments in dealing with Burma became very apparent. The involvement of business in these types of debates needs to be larger, and their answerability to investors improved. As the Under-Secretary-General of the United Nations Achim Steiner stated in the recent report published by the United Nations Environment Programme Fincance Initiative:
“environmental, social and governance considerations have to be a part of mainstream business and investment.”
In addition to this, however, more investors now need to start asking questions of their pension providers and campaigning for better communication.
Glastonbury: An indicator of demographic change in UK
“The average age of lead singers performing on the pyramid stage in Glastonbury festival is 44, close to the age of most fans’ parents”. Times online, 25th of June
After reading the above, I could not resist the fact that the generation gap in UK is expanding. The falling birth rate and increasing life expectancy rate are the two factors which will be influencing the policies on public expenditure for the future governments. The biggest blow is going to be to our Pay as You Go pension system. The facts such as closing down of the final salary schemes, declining saving rate and increasing public debt are the indicators of risks pension system is exposed to.
Therefore the questions todays working population need to be asking to themselves that:
• How are we going to support our retirement with our enough saving today?
• Are we going to be able hold the future govts responsible for failing to provide us with enough penions as there is less income generated by the thin working population?
• Will we be asked to work longer, beyond the current age of average 62?
I hope there are enough Jobs for me to go to when I am 65.
Marshmallow?
A few weeks ago now, the economist Robert Shiller gave a fascinating talk at the RSA called “How human psychology drives the economy”. In answer to one particular question, he recounted an experiment done in the Sixties which is hugely pertinent to the Tomorrow’s Investor project. The ‘Marshmallow Experiment’ is in fact one of the foremost of its kind and, given its significance, I thought it was worth quickly outlining here;
In the 1960’s, academics at Stanford University carried out an experiment to test the process of delayed gratification on a group of four year olds. The academics left a child alone in a room having given them a marshmallow but said that if they didn’t eat it and waited twenty minutes, they could have two. The results were naturally mixed, with some children holding out and others succumbing to the temptation of eating their marshmallow before the twenty minutes were up.
The Stanford academics followed the progress of these children as they grew up and the results are what make this simple experiment so compelling. The children who had waited for their marshmallows in the experiment had been more successful in their lives compared to those who hadn’t (academics mainly judged this on the candidates’ academic success, ability to cope with problems and health).
In light of recent events and economic development, many have been highly critical of a modern compulsion for instant gratification – This experiment clearly highlights the value of investing now for the future – However, if we are to invest our money over and for a prolonged period of time, then we also need to be sure it is being handled with due care and respect. In other words we need absolute trust in our pension/savings provider. Tomorrow’s Investor is working to change and develop the trust needed to get more people saving for their retirement.
Can greenshoots grow in sand?
Hurrah, the British economy is showing signs of recovery. The green shoots are visible in the form of a small increase in manufacturing; a rise is FTSE index by 30 per cent since March, and signs of increasing house prices. Before we get carried away, let us recognise that economy built on house prices alone is a economy built on sand.
Where good news of economic recovery is a breath of fresh air among all the depressing news over that last two years, my natural scepticism and prudence tells me that it could be a blip unless the root causes of the problem are fixed. These causes to me seem to be:
- The availability of money through credit for people to spend
- Bonus culture in the city
- Lack of local savings and therefore relying on foreign investments
To ensure that the another financial crisis is not repeated, we need to
- Save and invest in the future.
- Recognise that too much risk in financial services is not rewarded (talent overrated)
- for spending with in limits and bring down public service debts
- More mixed economy relying on manufacturing as well as services and public sector
Lord Myners – The Headmaster
Filed under: General comments, Pensions, Risk Management
Yesterday evening saw my first ever opportunity to sit amongst the city’s most successful institutional investors, listening obediently to Lord Myners. He was outlining the key issues with the current governance structure, one of the most popular – and problematic – subjects of late. Unfortunately I was not taught this in great detail whilst studying for a Masters in Business Administration. Clearly this was also the case with those who I listened with yesterday.
It became apparent that the key principle of serving the shareholders (‘Principal’) also a key responsibility of an institutional investor (‘Agent’) has been totally ignored. The increase of 300 per cent in the salaries of chief executives (under the current capitalist structure) against only 60 per cent increase in the dividend value for ordinary shareholders, was not questioned by the institutional investors.
Are we (Institutional Investors), as agents, acting as highly specialized investors on behalf of their princpals (shareholders) , are forgetting our key responsibilities, which are to:
- Engage actively, and often, in corporate governance by fully participating in the shareholder meetings.
- Influence the management of corporations by exercising our voting rights in a company. At the same time influencing the conduct of corporations, providing them with capital – all part of the job of investment management.
Instead the fear to lose highly paid clients has been both myopic and damaging. This is the great lesson I learnt yesterday and it reflects a clear division between views of socialist and capitalist leaders.
RSA Vision
News- NYS lowers pension fund's rate of return to 7.5 pct - Reuters September 2, 2010
- Low interest rates squeezing pension funds - msnbc.com September 2, 2010
- French government vows to face down pension strike - Reuters Africa September 2, 2010
- FT.com
- One million over 65s to continue working August 23, 2010
- A third of Britons using savings to supplement income August 23, 2010
- Final salary decision is looming faster August 20, 2010
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