How pensions got throttled

The need for a savings culture.

In mid-2011, Robert Chote, the chairman of the Office for Budget Responsibility (OBR), declared the UK’s economic outlook to be “unsustainable”.  He was referring to the UK’s public sector debt, expected to rise indefinitely in the longer term.  The primary cause is our ageing population, driving sharp increases in the costs of health care, state pensions and long-term care, combined with a contracting tax base relative to total population size.

In addition, Britain is under a competitive assault from globalisation, particularly from countries with younger, more dynamic, populations.  Furthermore, some have little concern for the niceties of a true democracy (no need for planning permission for a new dam or railway in China); this gives them a competitive edge.  Without radical policy changes, we can expect our deteriorating public finances to lead the UK into a vicious circle of slower growth and higher interest rates.

This grim outlook could be accompanied by inter-generational strife.  Today’s Generation Y (broadly, those in their twenties and thirties) could be the first generation to experience a lower quality of life than that enjoyed by their parents.  Over the last five years, the UK’s standard of living has declined by 4.8 per cent and, given the outlook for national debt, there is the potential for considerable further decline.

Only now are politicians beginning to contemplate the pressures facing future governments, and how to avert what the data suggests is heading our way.  They are, however, seriously compromised by facing a 50 year problem alongside a five year electoral cycle.  The blue corner of the Coalition has, however, proffered a suggestion to head off the crisis-in-waiting, encompassed in its prevailing political ethos of “personal responsibility”.  This is thinly veiled code for “you’re on your own, folks”, essentially an attempt to catalyse a cultural shift away from being a nation of borrowers to one of savers, particularly (given our ageing population) retirement saving.

This is important to individuals.… and critical to the nation.  Savings fuel investment, which drives increased productivity and economic growth; without that, our quality of life will certainly deteriorate.  Unfortunately, this means engaging with an under-performing financial services industry which is widely, and justifiably, distrusted.  Indeed, some of it is dysfunctional.  In addition, successive governments (irrespective of political hue) have exhibited a lack a common purpose.  The Department of Work and Pensions (DWP) wants people to save, whereas the Treasury favours consumption, not least to bolster VAT receipts.  This pushmi-pullyu position manifests itself as contradictory policies and ambiguous communication, which does nothing to stimulate a savings culture.

The industry knows that it has to radically change its behaviour, not least because some within it have finally realised that the pursuit of their own self-interest, at the expense of their customers, may ultimately prove to be the industry’s nemesis.  Furthermore, change would be more lasting if it were driven by the industry itself, rather than through state intervention.  But the industry is in the Last Chance Saloon of public opinion.  Many believe that there is no prospect of it challenging its own, deeply entrenched, vested interests.  Ordinarily this would not be of great import, but financial services are an exception.  Not only does the industry directly benefit from an annual subsidy of over £30 bn (via tax relief), but the Treasury fields the consequences of industry failure, via welfare payments, made manifest by an under-saving nation. 

Consequently, the industry is risking muscular state intervention to “shove” (not “nudge”) it into putting the customer at its centre.  Once the new National Employment Savings Trust (NEST) has “bedded down”, the Government could, for example, dramatically enhance NEST’s capabilities (including removing the contributions cap and the subscription charge), thereby exerting considerably more competitive pressure on the industry. 

In the meantime, the majority of the population lack the financial wherewithal (and, in many cases, the will) to make their own retirement saving arrangements.  Certainly, 90 per cent+ of the population has no need for complex, expensive savings products.  Mass mutualisation of their pension pots would be of great service to them.  A small number of large, collective, DC schemes would enable people to pool their longevity risk and harness enormous economies of scale to drive costs down.  Retirement incomes would then be larger, reducing pensioner poverty and the demand for state benefits, and the underlying pools of assets could, in effect, become akin to our sovereign wealth fund.

But, with the economy weak, the Government is not currently pushing to catalyse a savings culture.  There is a brief opportunity (between now and 2017, when NEST is reviewed) for the industry to resuscitate its reputation by exhibiting leadership (and discovering some humility).  It should implement a range of initiatives that put the customer at the centre of everything it does.  This would require the industry to confront its own short-termism, and start delivering value for money to its customers, whilst bearing in mind that customers want to feel in control of their savings.  It would also have to overcome its fear of simplification, standardisation and transparency, and discard the deleterious practices that are enshrined in the principal-agent problem.

A leap of faith is required by the industry, because whilst profits may diminish in the short term, the long-term outcome could be a rejuvenated reputation.…and business growth.  Finally, and crucially, trustees need to start behaving as the principals they really are, helping to drive the reshaping of the industry.  Indeed, trustees ought to be the catalysts for change.

Michael is a Research Fellow at the Centre for Policy Studies (CPS).  He is the author of “Put the saver first” (CPS, July 2012).

Pensioners need to be prioritised. Photograph: Getty Images
Getty
Show Hide image

We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?