How to fund a happier retirement

A US government plan for civil servants is the unlikely blueprint for a stakeholding pension scheme.

For a few months during 1996 new Labour flirted with Will Hutton and his ideas about "stakeholding". It soon turned out, however, that this meant becoming like Germany, and the brief affair fizzled out. Nevertheless, one token of new Labour's early affection for stakeholding remains: the government's plans for so-called "stakeholder" pensions formed part of Alistair Darling's pensions green paper, published just before Christmas.

Its proposals herald a profound shift in the balance between public and private welfare provision. Though private welfare became steadily more important under the Conservatives, its growth was relatively slow. "Free market" welfare services - financed and provided by the private sector and purchased voluntarily by individuals - grew from 25 per cent of total (public and private) welfare spending in 1979/80 to 29 per cent by 1995/96.

The green paper envisages that this gradual shift in favour of the private sector will continue. At present, it tells us, 60 per cent of pensioners' income is derived from the state and 40 per cent from private sources. But under the government's plans, by 2050 the situation will have reversed, so that private sector support for pensioners will be half as large again as state support. Whether we like it or not, the majority of us are going to have to rely more heavily on private sector pensions - or Lisas (lifetime individual savings accounts) - under the government's newest rubric.

Twenty-five years ago the then Labour government was moving in precisely the opposite direction. The postwar scheme, based on Beveridge's blueprint, had been wholly flat-rate. It provided a universal minimum income which, while sufficient for the needs of the poorest, left workers accustomed to higher standards reliant on the private sector to supplement their retirement income.

Labour's 1975 legislation was intended to rectify this dangerous over-reliance on the private sector, as it was then perceived, by extending earnings-related pensions to those parts of the population that did not have access to an occupational scheme. The new state scheme, Serps, would provide secure, defined-benefit pensions, protected from market fluctuations and the ravages of inflation. As Richard Crossman described the policy, the new scheme would transfer "the privileges of the minority into the rights of the majority".

Darling's green paper proposal to turn Serps into a flat-rate State Second Pension scheme brings policy full circle. While not explicitly stated, it is clear that the government believes the state's role should be confined to ensuring a minimum income standard. If Darling's proposals are followed through, in the future earnings-related insurance will once again be a private affair. The job of the state will be confined to ensuring everyone receives flat-rate benefits at the minimum level. People who want to retire on an income above this minimum will decide for themselves how much they want to pay into a pension and which private provider offers them the best deal. The government will be responsible for regulation, rather than provision or finance.

There is, however, a fly in the ointment. The pensions mis-selling scandal, a legacy of the Conservatives' reforms of 1986, has soured the relationship between private pension providers and the public. As is now well-known, the introduction of personal pensions led to hundreds of thousands of people being sold a new product when they would have been better off staying with their existing pension arrangements. This mis-selling mostly affected people who could have joined or stayed with an occupational scheme and who forfeited employers' contributions by choosing to opt out, a fact that commission-hungry sales staff conveniently ignored. But it also showed up the very high costs and charges attached to personal pensions, with up to a quarter of an individual's savings being lost through management and administration fees. Low and moderate earners in particular do badly, because of the high front-end, flat-rate charges that are often made. Forcing people to rely on existing personal pensions would be bad economics and worse politics.

So far there have been two general types of proposals for dealing with the problems of private pensions. The first argues that the problem is excessive regulation, which, it is claimed, drives up compliance costs and drives down the number of providers. The second suggests that the problem is not enough regulation, and that the government should go actively into the business of setting appropriate fees for pension provision.

Both of these arguments are, in serious ways, flawed. First, the argument for less regulation does not take into account the problem of what economists call "asymmetric information". That is, the providers of a product have much more information about its quality than consumers, a problem often faced in health care, for example. In such a case, consumers can either spend a substantial amount of time attempting to close the gap between what they know and what the providers know, or they can choose randomly, basing their decisions upon advertisements. This leads to a market where providers compete more on marketing than on reasonable charges, which is exactly what happened with personal pensions.

The second argument is equally flawed. The government does not have the information to determine what price is fair or reasonable for financial products, nor does it have any reason to prefer certain providers over others. Such a decision would require not only that it have comprehensive knowledge of the market as it exists today, but also of the adaptations that will occur in the future. Even if it is sold as part of a "partnership between government and business", detailed regulation of charges and providers would put the government in the untenable position of setting prices and closing out competitors. In other words, it would be back to "old Labour" command and control standards.

The government's proposals for stakeholder pensions do, to some extent, finesse the problem of whether to regulate more or less. In essence the government's idea is that only schemes meeting particular "benchmark" standards will be able to call themselves stakeholder schemes. According to the green paper these standards will include allowing individuals to transfer funds between schemes without penalty; sending out regular information about the value of pension entitlements that members have accrued; and, most importantly, ending flat-rate charges. In return the government will lighten the regulatory conditions attached to taking on new clients, relying instead on an annual administrative audit to ensure that the provider is still up to scratch.

While this is an improvement on the personal pensions regime, such a strategy is still fraught with problems. In particular there is a danger that private firms and their paid lobbyists will twist the government's ear about the impossibility of providing a product more cheaply or better. Weak consensual regulation could all too easily result, ensuring that the benchmark tests will leave most providers able to carry on their business as normal.

We think that there is a better option available, based not on theory but on existing practice in the United States: the US government's own plan for civil servants, the Thrift Savings Plan (TSP). Suitably adapted for a different purpose, it would admirably deal with all the considerations the government finds so nettlesome.

The TSP is remarkably simple in its basic structure. The US government contracts with an outside provider to set up and manage, at arm's length (and off the government's accounts) three indexed accounts, one for stocks, another for bonds, and a third for short-term government securities. All are managed passively - they do nothing more than mechanically purchase a standard basket of financial assets, such as the S&P 500 or the Lehman Brothers Long Bond Index. Overhead costs are therefore kept very low, with administrative expenses being covered by an annual deduction of approximately one-tenth of 1 per cent of members' accounts. In comparison, most personal pension providers currently charge around ten times this level.

The advantages of having a single provider, with very narrow investment choices, all managed passively, are enormous. First, a single provider can attain remarkable economies of scale, spreading basic management costs over a large contributor base. Second, narrow choices reduce transaction costs for those who either don't know or don't want to learn the ins and outs of financial products. This all but eliminates the need for outside (and expensive) financial advisers. Finally, a simple, centralised system can accommodate a wide range of contribution levels, in the TSP as low as ten dollars every two weeks.

The most important advantage, however, is that active managers cannot, on average and over any reasonable period of time, beat passive investing, for reasons that are quite obvious but usually overlooked. An index simply measures the average of what all stocks are doing. By definition, all investors collectively cannot beat an average, since taken together they are the average. Once you subtract the costs of investment research, trading and managers' payments, active managers will always under-perform the index. In fact, according to a study by Barclays Global Investors, approximately 80 per cent of active managers trail the index. They are attempting, collectively, the impossible: it should be no surprise that they usually fail, or that they fail more dramatically the harder (and more expensively) they try.

For all these reasons, the ideal stakeholder pension would incorporate all of the major components of the US government's Thrift Savings Plan. But it would be a mistake to have the government monopolise or otherwise limit providers. The better option is for the government to provide the "default option", but to allow any pension company that provides a comparable product (no front-end load, charges assessed on an annual basis, and so on) to enter the market as well. This is desirable in part for political reasons: completely shutting out the pension companies would be a huge obstacle for a centrist government. But there are principled reasons as well. Most of what our knowledge tells us is that an indexed, centrally run system will out-perform most private options. Even so, governments work better when they recognise their own fallibility, and that circumstances may change over time.

A monolithic system would tend to discourage innovation; when financial service companies have to compete to survive, though, they promote the development of new and better products. The very low charges of the state system will inevitably drive down costs in the private sector, squeezing out many low-quality providers, and forcing the rest to focus on simplicity and value for money, rather than marketing. In this way the stakeholder pensions system could act as a catalyst for a revolution in the way pensions are managed and sold.

Our Thrift Pensions proposal cuts through the Gordian knot of regulation, achieving all the government's objectives without reducing competition, but by actually expanding choice. Instead of a messy scheme that introduces unnecessary and possibly damaging cosiness between the government and the financial system, our scheme allows the government and markets each to operate within the sphere of their own competence.

In sum, the scheme is based on a tested and well-liked model which deals well with all the political and economic problems of pensions provision for the low-paid. Increasing competition through expanding choice represents the best route forward for stakeholding.

Steven M Teles is research assistant professor at Boston University and is completing a book on the politics of pensions privatisation in the US and UK. Phil Agulnik is a research student in the ESRC Centre for Analysis of Social Exclusion at the London School of Economics

This article first appeared in the 12 February 1999 issue of the New Statesman, Kick out the image-makers

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Why the elites always rule

Since an Italian sociologist coined the word “elite” in 1902, it has become a term of abuse. But history is the story of one elite replacing another – as the votes for Trump and Brexit have shown.

Donald Trump’s successful presidential campaign was based on the rejection of the “establishment”. Theresa May condemned the rootless “international elites” in her leader’s speech at last October’s Conservative party conference. On the European continent, increasingly popular right-wing parties such as Marine Le Pen’s Front National and the German Alternative für Deutschland, as well as Poland’s ruling Law and Justice party, delight in denouncing the “Eurocratic” elites. But where does the term “elite” come from, and what does it mean?

It was Vilfredo Pareto who, in 1902, gave the term the meaning that it has today. We mostly think of Pareto as the economist who came up with ideas such as “Pareto efficiency” and the “Pareto principle”. The latter – sometimes known as the “power law”, or the “80/20 rule” – stipulates that 80 per cent of the land always ends up belonging to 20 per cent of the population. Pareto deduced this by studying land distribution in Italy at the turn of the 20th century. He also found that 20 per cent of the pea pods in his garden produced 80 per cent of the peas. Pareto, however, was not only an economist. In later life, he turned his hand to sociology, and it was in this field that he developed his theory of the “circulation of elites”.

The term élite, used in its current socio­logical sense, first appeared in his 1902 book Les systèmes socialistes (“socialist systems”). Its aim was to analyse Marxism as a new form of “secular” religion. And it was the French word élite that he used: naturally, one might say, for a book written in French. Pareto, who was bilingual, wrote in French and Italian. He was born in Paris in 1848 to a French mother and an Italian father; his father was a Genoese marquis who had accompanied the political activist Giuseppe Mazzini into exile. In honour of the revolution that was taking place in Germany at the time, Pareto was at first named Fritz Wilfried. This was latinised into Vilfredo Federico on the family’s return to Italy in 1858.

When Pareto wrote his masterpiece – the 3,000-page Trattato di sociologia ­generale (“treatise on general sociology”) – in 1916, he retained the French word élite even though the work was in Italian. Previously, he had used “aristocracy”, but that didn’t seem to fit the democratic regime that had come into existence after Italian unification. Nor did he want to use his rival Gaetano Mosca’s term “ruling class”; the two had bitter arguments about who first came up with the idea of a ruling minority.

Pareto wanted to capture the idea that a minority will always rule without recourse to outdated notions of heredity or Marxist concepts of class. So he settled on élite, an old French word that has its origins in the Latin eligere, meaning “to select” (the best).

In the Trattato, he offered his definition of an elite. His idea was to rank everyone on a scale of one to ten and that those with the highest marks in their field would be considered the elite. Pareto was willing to judge lawyers, politicians, swindlers, courtesans or chess players. This ranking was to be morally neutral: beyond “good and evil”, to use the language of the time. So one could identify the best thief, whether that was considered a worthy profession or not.

Napoleon was his prime example: whether he was a good or a bad man was irrelevant, as were the policies he might have pursued. Napoleon had undeniable political qualities that, according to Pareto, marked him out as one of the elite. Napoleon is important
because Pareto made a distinction within the elite – everyone with the highest indices within their branch of activity was a member of an elite – separating out the governing from the non-governing elite. The former was what interested him most.

This is not to suggest that the non-governing elite and the non-elite were of no interest to him, but they had a specific and limited role to play, which was the replenishment of the governing elite. For Pareto, this group was the key to understanding society as a whole – for whatever values this elite incarnated would be reflected in society. But he believed that there was an inevitable “physiological” law that stipulated the continuous decline of the elite, thereby making way for a new elite. As he put it in one of his most memorable phrases, “History is the graveyard of elites.”

***

Pareto’s thesis was that elites always rule. There is always the domination of the minority over the majority. And history is just the story of one elite replacing another. This is what he called the “circulation of elites”. When the current elite starts to decline, it is challenged and makes way for another. Pareto thought that this came about in two ways: either through assimilation, the new elite merging with elements of the old, or through revolution, the new elite wiping out the old. He used the metaphor of a river to make his point. Most of the time, the river flows continuously, smoothly incorporating its tributaries, but sometimes, after a storm, it floods and breaks its banks.

Drawing on his Italian predecessor Machiavelli, Pareto identified two types of elite rulers. The first, whom he called the “foxes”, are those who dominate mainly through combinazioni (“combination”): deceit, cunning, manipulation and co-optation. Their rule is characterised by decentralisation, plurality and scepticism, and they are uneasy with the use of force. “Lions”, on the other hand, are more conservative. They emphasise unity, homogeneity, established ways, the established faith, and rule through small, centralised and hierarchical bureaucracies, and they are far more at ease with the use of force than the devious foxes. History is the slow swing of the pendulum from one type of elite to the other, from foxes to lions and back again.

The relevance of Pareto’s theories to the world today is clear. After a period of foxes in power, the lions are back with renewed vigour. Donald Trump, as his behaviour during the US presidential campaign confirmed, is perfectly at ease with the use of intimidation and violence. He claimed that he wants to have a wall built between the United States and Mexico. His mooted economic policies are largely based on protectionism and tariffs. Regardless of his dubious personal ethics – a classic separation between the elite and the people – he stands for the traditional (white) American way of life and religion.

This is in stark contrast to the Obama administration and the Cameron government, both of which, compared to what has come since the votes for Trump and Brexit, were relatively open and liberal. Pareto’s schema goes beyond the left/right divide; the whole point of his Systèmes socialistes was to demonstrate that Marxism, as a secular religion, signalled a return to faith, and thus the return of the lions in politics.

In today’s context, the foxes are the forces of globalisation and liberalism – in the positive sense of developing an open, inter­connected and tolerant world; and in the negative sense of neoliberalism and the dehumanising extension of an economic calculus to all aspects of human life. The lions represent the reaction, centring themselves in the community, to which they may be more attentive, but bringing increased xenophobia, intolerance and conservatism. For Pareto, the lions and foxes are two different types of rule, both with strengths and weaknesses. Yet the elite is always composed of the two elements. The question is: which one dominates at any given time?

What we know of Theresa May’s government suggests that she runs a tight ship. She has a close – and closed – group of confidants, and she keeps a firm grip on the people under her. She is willing to dispense with parliament in her negotiation of Brexit, deeming it within the royal prerogative. Nobody yet knows her plan.

The European Union is a quintessentially foxlike project, based on negotiation, compromise and combination. Its rejection is a victory of the lions over the foxes. The lions are gaining prominence across the Western world, not just in Trumpland and Brexit Britain. Far-right movements have risen by rejecting the EU. It should come as no surprise that many of these movements (including Trump in the US) admire Vladimir Putin, at least for his strongman style.

Asia hasn’t been spared this movement, either. After years of tentative openness in China, at least with the economy, Xi Jinping has declared himself the “core” leader, in the mould of the previous strongmen Mao Zedong and Deng Xiaoping. Japan’s prime minister, Shinzo Abe, has also hardened his stance, and he was the first world leader to meet with President-Elect Donald Trump. Narendra Modi in India and Rodrigo Duterte in the Philippines are in the same mould, the latter coming to power on the back of promising to kill criminals and drug dealers. After the failed coup against him in July, Recep Tayyip Erdogan has also been cracking down on Turkey.

***


In Les systèmes socialistes, Pareto elaborated on how a new elite replaces the old. A, the old elite, would be challenged by B, the new, in alliance with C, the people. B would win the support of C by making promises that, once in power, it wouldn’t keep. If that sounds like the behaviour of most politicians, that is because it probably is. But what Pareto was pointing out was how, in its struggle for power, the new elite politicised groups that were not political before.

What we know of Trump supporters and Brexiteers is that many feel disenfranchised: the turnout in the EU referendum could not have been greater than in the 2015 general election otherwise, and significant numbers of those who voted for Trump had never voted before. There is no reason to think that they, too, won’t be betrayed by the new leaders they helped to bring to power.

In the last years of his life, Pareto offered a commentary on Italy in the 1920s. He denounced the state’s inability to enforce its decisions and the way that Italians spent their time flaunting their ability to break the law and get away with it. He coined the phrase “demagogic plutocracy” to characterise the period, in which the rich ruled behind a façade of democratic politics. He thought this particularly insidious for two reasons: those in power were more interested in siphoning off wealth for their personal ends than encouraging the production of new wealth, and consequently undermined national prosperity (remember Pareto’s training as an economist); and, as the demagogic elites govern through deceit and cunning, they are able to mask their rule for longer periods.

Much has been made of Trump’s “populism”, but the term “demagogic plutocrat” seems particularly apt for him, too: he is a wealthy man who will advance the interests of his small clique to the detriment of the well-being of the nation, all behind the smokescreen of democratic politics.

There are other ways in which Pareto can help us understand our predicament. After all, he coined the 80/20 rule, of which we hear an intensified echo in the idea of “the One Per Cent”. Trump is a fully paid-up member of the One Per Cent, a group that he claims to be defending the 99 Per Cent from (or, perhaps, he is an unpaid-up member, given that what unites the One Per Cent is its reluctance to pay taxes). When we perceive the natural inequality of the distribution of resources as expressed through Pareto’s “power law”, we are intellectually empowered to try to do something about it.

Those writings on 1920s Italy landed Pareto in trouble, as his theory of the circulation of elites predicted that a “demagogic plutocracy”, dominated by foxes, would necessarily make way for a “military plutocracy”, this time led by lions willing to restore the power of the state. In this, he was often considered a defender of Mussolini, and Il Duce certainly tried to make the best of that possibility by making Pareto a senator. Yet there is a difference between prediction and endorsement, and Pareto, who died in 1923, had already been living as a recluse in Céligny in Switzerland for some time – earning him the nickname “the hermit of Céligny” – with only his cats for company, far removed from day-to-day Italian politics. He remained a liberal to his death, content to stay above the fray.

Like all good liberals, Pareto admired Britain above all. As an economist, he had vehemently defended its system of free trade in the face of outraged opposition in Italy. He also advocated British pluralism and tolerance. Liberalism is important here: in proposing to set up new trade barriers and restrict freedom of movement, exacerbated by their more or less blatant xenophobia, Trump and Brexit challenge the values at the heart of the liberal world.

***


What was crucial for Pareto was that new elites would rise and challenge the old. It was through the “circulation of elites” that history moved. Yet the fear today is that history has come to a standstill, that elites have ­become fossilised. Electors are fed up with choosing between the same old candidates, who seem to be proposing the same old thing. No wonder people are willing to try something new.

This fear of the immobility of elites has been expressed before. In 1956, the American sociologist C Wright Mills published The Power Elite. The book has not been out of print since. It is thanks to him that the term was anglicised and took on the pejorative sense it has today. For Mills, Cold War America had come to be dominated by a unified political, commercial and military elite. With the 20th century came the growth of nationwide US corporations, replacing the older, more self-sufficient farmers of the 19th century.

This made it increasingly difficult to ­distinguish between the interests of large US companies and those of the nation as a whole. “What’s good for General Motors,” as the phrase went, “is good for America.” As a result, political and commercial interests were becoming ever more intertwined. One had only to add the Cold War to the mix to see how the military would join such a nexus.

Mills theorised what President Dwight D Eisenhower denounced in his January 1961 farewell speech as the “military-industrial complex” (Eisenhower had wanted to add the word “congressional”, but that was thought to be too risky and was struck out of the speech). For Mills, the circulation of elites – a new elite rising to challenge the old – had come to an end. If there was any circulation at all, it was the ease with which this new power elite moved from one part of the elite to the other: the “revolving door”.

The Cold War is over but there is a similar sense of immobility at present concerning the political elite. Must one be the child or wife of a past US president to run for that office? After Hillary Clinton, will Chelsea run, too? Must one have gone to Eton, or at least Oxford or Cambridge, to reach the cabinet? In France is it Sciences Po and Éna?

The vote for Brexit, Trump and the rise of the far right are, beyond doubt, reactions to this sentiment. And they bear out Pareto’s theses: the new elites have aligned themselves with the people to challenge the old elites. The lions are challenging the foxes. Needless to say, the lions, too, are prototypically elites. Trump is a plutocrat. Boris Johnson, the co-leader of the Leave campaign, is as “establishment” as they come (he is an Old Etonian and an Oxford graduate). Nigel Farage is a public-school-educated, multimillionaire ex-stockbroker. Marine Le Pen is the daughter of Jean-Marie Le Pen. Putin is ex-KGB.

Pareto placed his hopes for the continuing circulation of elites in technological, economic and social developments. He believed that these transformations would give rise to new elites that would challenge the old political ruling class.

We are now living through one of the biggest ever technological revolutions, brought about by the internet. Some have argued that social media tipped the vote in favour of Brexit. Arron Banks’s Leave.EU website relentlessly targeted disgruntled blue-collar workers through social media, using simple, sometimes grotesque anti-immigration messages (as a recent profile of Banks in the New Statesman made clear) that mimicked the strategies of the US hard right.

Trump’s most vocal supporters include the conspiracy theorist Alex Jones, who has found the internet a valuable tool for propagating his ideas. In Poland, Jarosław Kaczynski, the leader of the Law and Justice party, claims that the Russian plane crash in 2010 that killed his twin brother (then the country’s president) was a political assassination, and has accused the Polish prime minister of the time, Donald Tusk, now the president of the European Council, of being “at least morally” responsible. (The official explanation is that the poorly trained pilots crashed the plane in heavy fog.)

It need not be like this. Silicon Valley is a world unto itself, but when some of its members – a new technological elite – start to play a more active role in politics, that might become a catalyst for change. In the UK, it has been the legal, financial and technological sectors that so far have led the pushback against a “hard” Brexit. And we should not forget how the social movements that grew out of Occupy have already been changing the nature of politics in many southern European countries.

The pendulum is swinging back to the lions. In some respects, this might be welcome, because globalisation has left too many behind and they need to be helped. However, Pareto’s lesson was one of moderation. Both lions and foxes have their strengths and weaknesses, and political elites are a combination of the two, with one element dominating temporarily. Pareto, as he did in Italy in the 1920s, would have predicted a return of the lions. But as a liberal, he would have cautioned against xenophobia, protectionism and violence.

If the lions can serve as correctives to the excesses of globalisation, their return is salutary. Yet the circulation of elites is a process more often of amalgamation than replacement. The challenge to liberal politics is to articulate a balance between the values of an open, welcoming society and of one that takes care of its most vulnerable members. Now, as ever, the task is to find the balance between the lions and the foxes. l

Hugo Drochon is the author of “Nietzsche’s Great Politics” (Princeton University Press)

This article first appeared in the 12 January 2017 issue of the New Statesman, Putin's revenge