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Pensions debate: a political angle

With the election appraoching, the future of pension provisions isbeing looked at closely in terms of the European angle. But, as consultantsWatson Wyatt point out, the pensions-as-a-weapon angle is a red herring inthe overall Euro-debate.

As we approach the General Election, one of the more enlightening debates is focusing attention on future pension provision. While the domestic debate is illuminating, the use of pensions as a weapon within the battle between Eurosceptics and the rest is less helpful.

The really interesting debate concerns the merits or otherwise of compulsory private provision. Instinctively, the Labour party might be more attracted by compulsion than their opponents, but they have fought shy of nailing their colours to the mast as it is rather difficult to differentiate between compulsory pension contributions and taxation within a sound bite. If compulsion is a feature of future pension provision, the role of the employer will be the subject of a secondary debate. While compulsory employer participation may avoid uncompetitive domestic pressures, it may involve a degree of bureaucracy which is out of keeping with today’s delayered management style.

The European dimension of the debate originally focused on the relative merits of funding or pay as you go from an almost quasi-academic point of view. Now the Euro has raised its head, all claims to academia are being jeopardised.

Is there scope for an objective actuarial assessment? Such an assessment should begin with the Maastricht Treaty. It was this accord which laid down the criteria to which participants in a European Monetary Union must adhere. Remember, it is monetary union and not budgetary union which is the issue.

The first Maastricht convergence criterion is that the annual budget deficit should not exceed 3% of a member state’s GDP. On the face of it pensions do not come into this, because current unfunded pension expenditure is being met from social security and tax contributions all round the EU, and no material imbalance currently exists. The House of Commons select committee have for some time been concerned about the perceived future financing problems of the unfunded pension systems of several states.

They are now recommending that these unfunded pensions should be accounted for not just on a current cash flow basis, but also on a suitable actuarial basis which gives a clearer picture. The effect of adopting this recommendation would plainly be that for many states the restated cost of the accruing liabilities would exceed current cost on the pay-as-you-go basis. The shortfall would be included in the budget deficit which is to be counted against the 3% of GDP criterion, and countries such as France and Germany, which are presently struggling to pass this test, would fail.

The second convergence test is that the total government debt should not exceed 60% of the state’s GDP. The select committee have pointed out that the definition of government debt excludes the capital value of unfunded pension promises, and they point to the imbalance between the UK where u600bn of occupational pensions are already funded, and the rest of the EU where unfunded public pensions predominate. Their recommendation is to include these capitalised liabilities with government debt for assessing the 60% GDP test. The effect of adopting this proposal would be to cause the restated debt figures of all EU states except the UK to be vastly in excess of the 60% test. They would all fail and only the UK would be eligible for EMU.

To paraphrase the basic message of the select committee, one might say national pensions should be assessed actuarially as if one were looking at a very large pension scheme with little or no assets. One could surely support that proposal, insofar as it provides better information and understanding.

However, their proposal to use such assessments for the Maastricht convergence criteria seems to be more applicable to a possible future scenario in which pension obligations are monetised and turned into government debt.

In such a scenario one would expect other aspects of state finance also to be capitalised, such as infrastructural assets. It does not seem right to pick on pensions alone for capitalisation.

The select committee raises concern about whether the UK, having made much better advance funding provision for retirement pensions than most other states, will be disadvantaged by joining EMU. The issues seem already to have been reasonably well covered, with the general conclusion that, because of our sounder long-term pension finances and other employment factors, the UK should remain well placed to attract new industrial investment and to prosper either within or without EMU. For instance if other States borrow to finance pension costs they will push up European interest rates including those in the UK, even if we retain a floating pound. We should still have the attractions for inward investment and the economy should grow well.

It seems to follow that one potential disadvantage of the UK joining EMU lies in the possibility that we will draw too much new investment away from other EU areas. This could lead to higher levels of unemployment elsewhere in Europe which Brussels would be able to tackle through the structural funds system. In the end, the UK could indeed end up subsidising other states because of our almost unique pension system. The subsidies will not be direct – that is prohibited by Maastricht. They will be indirect and similar to those which operate in the US. While the proper financing of current and future pensions is of concern to all of us, the use of pensions as a weapon in the shall we/shan’t we Euro debate is at best a red herring.

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