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As a result of a series of narrow, short-sighted and overly theoretical decisions, the UK has ended up with a pensions system that is incapable of generating the supply of long-term risk capital on which development depends or of providing the population as a whole (not just a few favoured groups) with adequate and secure pensions. Symptoms of this disaster include a moribund stock market, under-invested companies, an undue dependence of foreign capital and even a stagnant economy.

The origins and consequences of this policy failure are documented in Investing in the Future: Boosting Savings and Prosperity for the UK, from the Tony Blair Institute for Global Change. I have discussed aspects of it in a number of columns, most recently in late March. In particular, the narrow focus on making pension promises absolutely safe made them unaffordable. This crippled the businesses liable for these exorbitantly expensive promises. It also deprived new businesses of the risk-taking capital they needed. Finally, as defined benefit plans collapsed, the public was pushed into defined contribution plans that impose too much risk for individuals to manage easily.

None of this matters in fantasy financial economics, in which borders are unimportant, domestic investment is independent of domestic savings, corporations have frictionless access to liquid financial markets and markets are rational and far-sighted. But these are fairy stories, not a reflection of reality.

Between 2001 and 2022, notes the paper, “UK private sector pension fund holdings of UK equities fell from an average of 50 per cent of the portfolio to just 4 per cent today. Over the same period, their holdings of fixed-income securities (mainly gilts and corporate bonds) increased from 15 per cent of total assets to approximately 60 per cent.” Not surprisingly, with companies forced to use their cash flows for filling the nearly bottomless pit of pension fund deficits, rather than investing, the businesses became ever less dynamic. The UK stock market’s performance has been startlingly bad relative to those elsewhere. But the market is moribund because the corporate sector has become a zombie.

Who has benefited? The answer is pension consultants, insurance companies (profitably picking up the pieces) and the government, enjoying a captive source of ultra-cheap funding. Meanwhile, the returns of such defensively managed pension funds have been far below those otherwise possible.

Meanwhile, the country has moved from one corner solution, in which all the risk fell on scheme sponsors, to another in which it falls on individual contributors. The sensible alternative, however, is in the middle — collective defined contribution schemes: eternal funds that promise pensions based on actual long-term returns. This arrangement would share risks across individuals and generations and takes advantage of the economies of scale available to large long-term investors able to bear risks others cannot.

All this is spelt out in detail in this important report. The question is how to move to something better. Here the authors have a clever idea. They note that the Pension Protection Fund (PPF) now invests £40bn and has, since its founding in 2004, enjoyed an impressive performance. It has generated a surplus of assets over estimated liabilities of £12bn. At present, however, the PPF fund only takes over when the corporate sponsor goes bankrupt. Instead, suggest the authors, the PPF could be turned into the first of a number of UK pension “superfunds”. This would be done by allowing voluntary transfer of solvent funds into the PPF with a required payment of a capital buffer for continuity of benefits. This commitment would replace the previously open-ended obligation of the sponsor.

Rather than ending up in the hands of insurance companies, assets would then be actively managed. In addition, they argue, the National Employment Savings Trust could also be folded into the new superfund, to be called GB Savings. The ultimate aim should be to consolidate other defined benefit pension funds. It would make sense to give people now investing in defined contribution schemes the option of shifting into the new collective superfunds.

A big question is how far the new superfunds should be encouraged or required to invest in UK assets. Some such requirement might make sense. But it would be dangerous for the government to force funds to invest in specific assets or specific classes of assets beyond that national mandate.

Myopic decision-making has led the UK into a pension cul de sac. It is time to exit and so to think big and act boldly.

martin.wolf@ft.com

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