Economics – We Know Zero

Bring Two Brains’ Hammer Inside the Tent

13. March 2018 · Write a comment · Categories: Cartoons, Economics, Pensions

While the NHS has been asked to find £22 billion in savings by 2020, the latest figures from the Student Loans Company show that over £13 billion has been found to fund student loans for 2016/17 alone, without increasing the Government’s deficit and without appearing in the Public Sector Borrowing Requirement until some time in the 2040s. How is this possible?

The key difference is that the money the Government provides in student loans are seen as just that: loans. However, unlike any other kind of loan (and the reason that commercial banks declined to join the SLC – which was the original plan and the reason it was set up with a company structure), only between 40 and 45% is expected ever to be repaid, the repayment term is limited to a maximum of 30 years and the payments limited to a percentage of earnings above a minimum earnings threshold (which is about to increase to £25,000 pa). It is in reality a graduate tax masquerading as a loan, with the “sticker price” of £9,250 pa (which is of course a real price for overseas students) just used to ensure students don’t feel like they are paying this tax on someone else’s behalf. However the payments made by the Government since 2011 as “loans” have not led to any outcry about uncosted commitments, or passing the bill onto future generations which you might expect. Which is surprising, as it has meant that Higher Education has effectively been allowed to sidestep the austerity policies applied to just about every other Government department completely.

One might think that the architect of such a scheme would be quite popular within the Higher Education space. Far from it. Since the announcement of his appointment as the new Chancellor at the University of Leicester, the Leicester branch of the UCU has widened the campaign it is already running against the Joint Negotiating Council’s decision to close the USS pension scheme to further defined benefit accrual to embrace a #WillettsOut position. The students who occupied the corridor outside the Leicester VC’s office for two days similarly had Willetts’ removal on their list.

Apart from elements of his voting record (he was strongly in favour of an elected House of Lords and was strongly against the ban on fox-hunting. TheyWorkForYou additionally records that, amongst other things, he was strongly in favour of the Iraq War, strongly in favour of an investigation into it, moderately against equal gay rights, and very strongly for replacing Trident), the main charges against him seemed to date from an article about him in the Guardian from 2011.

Now without minimising the differences of opinion which I and many of my colleagues will clearly have with David Willetts on a wide range of issues, I do think we are in danger of surrounding ourselves with the comfortable cushions of like-minded individuals all equally in the dark about the regulatory changes in store for us and at risk of all the worst consequences of Group Think. I would therefore like to put forward an alternative view.

The University of Leicester is facing, along with the rest of the Higher Education sector, serious challenges over the coming decades in response to an expansion of the proportion of young people going to university which no political party is going to want to reverse (and which I, for one, would not want them to). David Willetts was the chief driver of much of these reforms and has a clear vision of what they are trying to achieve, set out in his book A University Education. He is currently a visiting professor at King’s College London where he works with the Policy Institute at King’s, a visiting professor at the Cass Business School, Chair of the British Science Association, a member of the Council of the Institute for Fiscal Studies and an Honorary Fellow at Nuffield College, Oxford. However his real passion is around social mobility, something which I believe is important to many of us here at Leicester, and which has led him to a role as Executive Chair of the Resolution Foundation. As a former cabinet minister and shadow cabinet minister from 1996 until 2014, Willetts is very well connected, a formidable debater and would make a fierce friend of the University, fighting Leicester’s corner in what is likely to be an increasingly challenging period.

David Willetts would undoubtedly bring significant challenge with him. Arguing with him (I watched him in debate with Stefan Collini and a variably outraged university audience at the Senate House last year) can sometimes feel like doing battle with a hammer. But it may be that this is what we need to respond successfully to the new world which is coming rather than yet another comfortable cushion to make us feel better. Let’s welcome him inside the tent.

We are paying too much attention to the wrong actuaries’ index

03. September 2017 · Write a comment · Categories: Actuarial, Climate Change, Economics, Prediction, Risk

The FTSE All-Share Index, originally known as the FTSE Actuaries All Share Index, along with the FTSE 100, represent nearly all of the market capitalisation and the top 100 companies by size listed on the London Stock Exchange respectively. They are mentioned in all BBC news bulletins. When they go up, we all feel better. When they go down, they are seen as portents of doom.

Let me show you a different actuaries’ index instead:

Figure 1 shows the ACI and each of the components. The composite ACI represents the average of the six components (with sign of change in cool/cold temperatures reversed). The ACI is increased by reduction in cold extremes, consistent with increased melting of permafrost and increased propagation of diseases, pests, and insects previously less likely to survive in lower temperatures. A positive value in the ACI represents an increase in climate-related extremes relative to the reference period.

The threat of climate change is real, independent of speculative trading and the news media cycle, and increasing with each degree of warming we are unable to stop. Alongside this are the increasing risks of extreme weather events, which is most neatly described for North America currently by the Actuaries Climate Index. This focuses on six components in particular which have the most impact on human societies:

Frequency of temperatures above the 90th percentile (T90);
Frequency of temperatures below the 10th percentile (T10);
Maximum rainfall per month in five consecutive days (P);
Annual maximum consecutive dry days (D);
Frequency of wind speed above the 90th percentile (W); and
Sea level changes (S).

It then tracks them all over time, as shown in the graph above.

It seems clear to me that we should be reacting much less to the booms and busts of economic cycles and much more to climate-related threats. This is for two main reasons:

1. More people are at threat of death or injury as a result of climate change than even the 2008 crash in our financial systems. The World Health Organisation (WHO) predicts that, between 2030 and 2050, climate change is expected to cause approximately 250,000 additional deaths per year, from malnutrition, malaria, diarrhoea and heat stress. However, the additional deaths are already here. Taking just two examples from the WHO:

In the heat wave of summer 2003 in Europe for example, more than 70,000 excess deaths were recorded, with the frequency of such events steadily increasing.
Globally, the number of reported weather-related natural disasters has more than tripled since the 1960s. Every year, these disasters result in over 60,000 deaths, mainly in developing countries, which means that 40,000 of those deaths pa can already be directly attributed to climate change.

On the other hand, the 500,000 additional cancer deaths and 10,000 additional suicide deaths since 2008 cannot be attributed directly to the 2008 crash, as the analysis shows. These are more a result of the austerity policies which have been applied since 2008. Unnecessarily.

Climate change on the other hand does not care whether we react to it or not. It will relentlessly change the chemistry and biology of everything around us as the Earth and the inhabitants of the Earth adapt. We may survive it, in reduced numbers, or we may not. The Earth does not care. Responding to the threat will not make more climate-related events happen unless our response is to, by and large, ignore it.

2. One depends on the other. We cannot base our economies on a FTSE-led GDP-growth-at-all-costs model because it is not physically possible to maintain it without losing the environment from which our growth originates. As Finbarr Livesey points out in his excellent From Global to Local, the circular economy which the overwhelming consensus of studies show would increase employment and contribute to economic growth is taking a long time to arrive. In Europe, where we consume around 16 tonnes of stuff each per year, figures from Siemens in 2016 suggest that 95% of it and its energy value is lost through the life cycle of the products themselves. As Kate Raworth and others have pointed out, we need to focus on different measures of success if we are going to direct our economies in a more sustainable, less volatile and doom-laden direction.

There are plans to extend the Actuaries Climate Index to Europe (including the UK in this instance!), with a recent feasibility study concluding “that the prospects for constructing an analogue to the Canada-US ACI over the European region are promising”. I hope we see such an index soon, because, as Randall Munroe illustrates here, we have not been here before.

I look forward to the day when a new global actuaries’ climate index is on every news bulletin, making us feel better when it goes down and seeing any rise as a portent of doom. Because this time it really would be.

Pensions and the Zombie Apocalypse

12. March 2017 · Write a comment · Categories: Actuarial, Demographics, Economics, Pensions

If the models are correct we are heading for a Zombie Apocalypse

Let’s forget the strapline of this blog for a moment and assume that the models are correct. The Pension Protection Fund (PPF) is targeting “self-sufficiency” by 2030, ie no more levies from sponsors of pension schemes required for it to independently fund all the future benefits of every scheme member whether they are already in the PPF or going to end up in it with only the insufficient assets their former employers allocated to their former pension schemes for company. BHS has concluded a very high profile deal in the last couple of weeks to set up a new self-sufficient scheme for its former employees. The Universities Superannuation Scheme (USS) has proposed a funding plan which targets self-sufficiency less a “covenant” (ie amount of money feasible to get out of the university sector in the future) by 2031. John Ralfe mentioned a few other examples in his article from 2015.
These are schemes which have been dubbed “zombie” schemes on the basis that they are basically dead, with no new money or new members coming in, but nevertheless dragging themselves along the floor year after year until all of their members have stopped twitching.
What does the UK pensions world look like in 2030? Well according to various sources:
• UK population will have increased to 70.6 million (assuming Scotland and Northern Ireland are still in it) with 21.4% of them over the age of 65 (S&P)
• Credit rating of UK will have fallen to A, with a further fall to BBB by 2035 assuming no change in economic policy (also S&P)
• Average life expectancies at birth in UK would be over 85 for women and 82.5 for men (Imperial College and WHO)
• Benefit outgo from defined benefit pension schemes is £100 billion more than contribution income pa (Hymans Robertson)

This does not sound like a happy place for our zombies to be negotiating with the occasional limb getting torn off as multiple doors are slammed in their faces. Although the self-sufficiency route is now a common approach amongst large schemes, it is largely untested. No scheme as far as I am aware has actually managed to run in a self-sufficient manner for any appreciable length of time, whereas the more expensive buy out route (where the benefits for members are purchased in the form of contracts with an insurer) is by comparison well established.

So off into this volatile landscape our zombies will be let loose, trying to run themselves like little insurance companies, but without the scale or diversification or experience which makes insurers (mostly) survive for long periods. However that better track record comes at a price which schemes are currently reluctant to pay. There is a good chance that this experiment will not end well.

My guess for 2030? That the volatile landscape will have claimed some casualties amongst the self-sufficient zombies and put them into the PPF with much bigger deficits than if they had gone there straight away. And then all the other zombies will T-U-R-N A-R-O-U-N-D V-E-R-Y S-L-O-W-L-Y and follow them there. At which point the PPF will realise that they are undead no longer.

RSA ANIMATE: Economics is for Everyone!

02. August 2016 · Write a comment · Categories: Cartoons, Economics

Ha-Joon Chang invites you to get involved in economic debate and not leave it to the experts in the latest RSA Animate of his Economics: The User’s Guide.

Well worth 12 minutes of your time!

Vote for Me!

22. May 2016 · Write a comment · Categories: Actuarial, Cartoons, Economics, Regulation

It is election time for the UK Actuarial Profession. The annual Council election is our chance to have our voices heard and to help in setting the strategic direction of the Institute and Faculty of Actuaries (IFoA). And this year I am running!

I think the next 10 years could be one of the most formative periods the profession has seen – with politics and economics at something of a turning point globally, and the place for actuaries and the finance industry more generally within that open to question as never before. I feel, as a former pensions actuary who now works with the actuaries of the future every day, that I have something to contribute to the process of actuaries finding their place in this new world.

So if you are a member of the IFoA please watch my video below and, if you share my priorities for the profession, I would greatly appreciate your vote.

Thinking in groups

26. February 2016 · Write a comment · Categories: Actuarial, Cartoons, Economics, Risk

Two women were fighting on my train the other morning. It was a packed train, with people standing the length of the carriage, so I didn’t see it so much as hear it. The first woman felt she had been pushed by the other one and complained very loudly and with much swearing. The second woman made some comment about the first woman’s mother and it escalated from there, getting louder and louder. Neither was prepared to let the other have the last word and, seeing the impact the mother comment had had, the second woman used it again. At which point the first woman hit her. The other passengers had been sitting and standing grim-faced up until this point, but now one or two intervened. One, who had the bearing of a lay preacher, attempted to assume sufficient authority to stop the argument. He was ignored. Another one stood and put the second woman in his seat and stood between them.

The second woman continued to make comments, but as much to herself as to the first woman. She kept stamping her feet in frustration. She was clearly in unbearable discomfort, but not from any physical pain. Finally she called the police and, as we pulled into New Street Station, started to give a physical description of her assailant. “Everyone on the train saw it” she said several times, while the passengers around her stared in any direction but hers.

I don’t know what happened next in the lives of these two women, although an announcement was made a couple of days later on the same service that police were working their way through the train for witness statements about the incident. They never appeared in my carriage, and I am not sure what I would have said if they had. And I don’t know what your reaction to my story is – whether that the other passengers, including me, should have acted differently or some commentary on the behaviour of the two women. I am, however, reasonably confident that you will have a reaction, perhaps quite a strong one, despite my limitations as a narrator. The reason I am confident about this is that I found myself, involuntarily, completely absorbed in the dispute, upset when one of the women expressed upset, constructing back stories for each of them, questioning their strategic wisdom at various points and, by the time we arrived at New Street Station and I dispersed with all the other witnesses, emotionally drained. And a look at the faces around the carriage suggested to me that most of my fellow passengers reacted similarly.

Why am I telling you this? Because it is a clear example of our domesticated brains in action. The almost physical pain this argument caused me and most of my fellow passengers is the reason we can travel from Sutton Coldfield to Birmingham every day with rarely an incident. It is often referred to these days, in pejorative terms, as Group Think. The shared assumptions and behaviours which allow us to live alongside each other in peace. I then get on a second train each day from Birmingham to Leicester, which I tell everyone is a great train to work on. But this is only because I can trust the 80 or so other passengers not to start an argument. The police could not cope if everyone behaved like the two women in my story. When the police do make an appeal for witnesses, they do so secure in the knowledge that nothing they say or do will encourage more than a handful to come forward, so strong is our group instinct to stay out of each other’s lives if we can. It is not indifference but survival. You need very strong structures to counteract the very strong instinct for Group Think.

However the reason Group Think is used pejoratively is that we have had vivid demonstrations of its power to make large groups of people behave stupidly. For example, herding behaviour in financial markets often causing the very problems people are trying to protect themselves from by going with the crowd. Or regulatory regimes which seem to encourage monocultures to develop, whether in finance, health, education, politics or academia, based on shared assumptions rather than encouraging diversity, because monocultures are easier to regulate. Many professions, including the actuarial profession, have introduced specific professional guidance to encourage whistle-blowing where appropriate, ie standing up to the policies and practices of their own organisations in most cases, which often means doing battle with Group Think. How successful such initiatives prove to be remains to be seen.

Encouraging challenges to Group Think is hard. It normally means going out of your way to allow views to be expressed you don’t agree with. It makes getting your own way harder to achieve. It can seem to us like the opposite of strong leadership and decisiveness when we seek out opinions that will make decision-making more complex. But we have made our society so complex and organisationaly fragile that this is what we are going to need to do more of in the future to stop it all from crashing down around us.

Simplicity, transparency and personal responsibility

31. August 2015 · Write a comment · Categories: Actuarial, Defined Ambition, Demographics, Economics, Pensions, Prediction, Regulation, Risk

The Treasury is consulting on the tax relief that should be available in future for pension schemes and their members. The principles for any reform that it has set out are:

it should be simple and transparent;
it should allow individuals to take personal responsibility;
it should build on the success of automatic enrolment; and
it should be sustainable.

Simplicity, transparency, personal responsibility and sustainability mean different things to different people, which means that the precise meaning of these principles will depend on the politics of the people proposing them. However the words themselves are difficult to argue with, which is presumably why they have been chosen.

It has then set out 8 questions that it would like answered in response to its consultation. The consultation ends on 30 September. I have set out my responses below. I hope that they will sufficiently incense one or two more people into making their views heard, before the chance disappears.

1. To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension?

On this question I think I agree with Henry Tapper at the Pension PlayPen. He says the following:

In summary, millions of pounds of tax relief is wasted by the Treasury helping wealthy people avoid tax…Incentives are available to those on low earnings who pay no tax, but this message is not getting through, we need a system that resonates with all workers, not just those with the means to take tax advice.

I then think I agree with the following:

The incentive should be linked to the payment of contributions and not be dependent on the tax or NI status of the contributor – if people are in – they get incentivised.

That would certainly make the incentive to the pension scheme member clearer and potentially easier to understand. The other simplification I would support would be the merging of income tax and national insurance contributions – many of the sources I have referenced below are trying to solve problems caused by the different ways these two taxes are collected. This simplification would be an essential part of any pension reforms in my view.

2. Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save into a pension?

This is the invitation to support TEE (ie taxed-taxed-exempt, the same tax treatment as for ISAs). I have up until now been persuaded by Andrew Dilnot and Paul Johnson’s paper from over 20 years ago that this was not a good idea. This pointed out that the current EET system:

Avoids problems with working out what level of contributions are attributable to individuals in a DB system
Does not discourage consumption in the future relative to consumption now

I have changed my mind. The first point has already been addressed in order to assess people against the annual allowance, although this may need to be further refined. The second point is more interesting. As Paul Mason has pointed out in Postcapitalism, the OECD 2010 report on policy challenges, coupled with S&P’s report from the same year on the global economic impacts of ageing populations point to the scenario pensions actuaries tend to refer to when challenged on the safety of Government bonds, ie if they fail then the least of your problems will be your pension scheme. The projections from S&P (see bar chart above) are that 60% of government bonds across all countries will have a credit rating below what is currently called investment grade – in other words they will be junk bonds. In this scenario private defined benefit schemes become meaningless and the returns from defined contribution schemes very uncertain indeed. A taxation system which seeks to extract tax on the way in rather than on the way out then looks increasingly sensible.

I think that both the popularity of ISAs and the consistently high take up of the tax free cash option by pensioners, however poor the conversion terms are in terms of pension given up, suggest that tax exemptions on the way out rather than on the way in would be massively popular.
3 Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions?

Based on my comments above, I think the whole idea of personal responsibility for saving adding up to more than a hill of beans for people currently in their 20s may be illusory. People do take responsibility for things they can have some control over. Pension savings in the late twenty-first century are unlikely to be in that category.
4 Would an alternative system allow individuals to plan better for how they use their savings in retirement?

As I have said I favour a TEE system like ISAs. I think some form of incentive will be required to replace tax exemption, such as “for every two pounds you put in a pension, the Government will put in one” with tight upper limits. The previous pensions minister Steve Webb appears to broadly support this idea. Exemption from tax on the way out (including abolition of the tax charges for exceeding the Lifetime Allowance) would also aid planning.
5 Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated?

I think this is inevitable due to the fact that defined contribution (DC) schemes receive cash whereas defined benefit (DB) schemes accrue promises with often a fairly indirect link to the contributions paid in a given year. In my view taxation will need to be based on the current Annual Allowance methodology, perhaps refined as suggested by David Robbins and Dave Roberts at Towers Watson. The problem with just taxing contributions in DB is that you end up taxing deficit contributions which would effectively amount to retrospective taxation.

A further option discussed in Robbins and Roberts is making all contributions into DB schemes into employee contributions. I would go further and apply this to both DC and DB schemes – a sort of “reverse salary sacrifice” which could be encouraged by making the incentives on contributions only available on employee contributions, which would then be paid out of net pay. Any remaining accrual contributions made by employers in a DB scheme would be taxed by an adjustment to the following year’s tax code.
6 What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome?

I think everything points to the need for the retirement of DB for all but the very largest schemes. It would be better to do this gradually starting soon through an accelerated Pension Protection Fund (PPF) process rather than having it forced upon us in a hurry later in the century when PPF deficits may well be considerably higher than the current £292.1 billion.
7 How should employer pension contributions be treated under any reform of pensions tax relief?

As I have said, I think they should be converted into employee contributions based on higher employee salaries. This would make it clearer to people how much was being invested on their behalf into pension schemes.
8 How can the government make sure that any reform of pensions tax relief is sustainable for the future.

They can’t, and any change now will almost certainly be revisited several times over the next 50 years. However, systems where people feel they can see what is going on and which are tax free at the end are currently very popular and I would expect them to remain so for the foreseeable future. That takes care of political sustainability in the short term. What about longer-term economic sustainability? Faced by an uncertain and turbulent next 50 years where I have argued that personal responsibility (rather than communal responsibility) for pensions will seem increasingly irrelevant, I think what I have proposed will allow us to transition to a system which can be sustained to a greater degree.

We are entering what may prove to be a traumatic time for the world economy if Postcapitalism is even half right. Pensions taxation seems a good place to try and start to move our financial institutions in a more sustainable direction.

Nick Foster is a former pensions actuary who now lectures at the University of Leicester

Debt: one actuary’s view

11. July 2015 · Write a comment · Categories: Actuarial, Economics, Pensions

I was a pensions actuary for some years, and spent most of that time advising trustees of defined benefit (DB) pension schemes about what to do with their funding debts (we called them deficits or shortfalls, but so as not to confuse them with what the UK Government means by a deficit, ie spending greater than receipts in any given year, I will stick with the term debt here). It seems to me that there are many parallels between this kind of debt and the kind that governments run:

The debt has built up over many years, and the reasons it was built up are often no longer a priority for the sponsor trying to pay off the debt (whether this is former employees for companies, or bailed out banks for governments)
It is very sensitive to things which are not under the control of the sponsor (whether this is gilt yields or pensions legislation for companies, or the state of the world economy for governments)
The debt position can change very quickly
The sponsor usually has more attractive options for investing money than paying off the debt

Pension scheme debts fall broadly into three categories:

Small debts, where the company sponsoring the pension scheme can easily afford to service the debt and is relatively large financially compared to the debt. Think Norway, with their massive sovereign fund, or South Korea on the graph above. There are a wide range of ways of dealing with a debt like this: if the funding target was not to buy out the benefits with an insurance company at this point, I would generally try and encourage the trustees and sponsor in that direction because of point 3. However there are many other completely reasonable approaches here and the point is that, whichever is chosen, it is unlikely to seriously affect the ability of the company to implement its business plans.
Large but manageable debts. The company does need to put in place a proper funding plan here. How quickly it would be asked to pay off the debt would depend on what is called the employer covenant, which is the willingness and ability of the company (or sometimes group of connected companies, which is where the willingness comes in) to pay. Strong companies are allowed more options and longer repayment periods if they want them, although in some cases they may just want to fully fund and remove the ongoing costs of meeting the regulatory and administrative requirements of running a DB pension scheme. Think of the UK in this category. The paper from which the graph above is taken is concerned with the green zone cases like the UK, for which it concludes that reducing debt in the current circumstances of very low real interest rates (the same problem making pension debts so large) and demand shortfalls in the economies in question (the rather more important debt) is likely to be undesirable as the costs will outweigh the benefits.
Large and unmanageable debts. The company cannot afford a funding plan. In most cases the scheme does not have access to sufficient assets to buy policies to pay full pensions to its members with an insurer. An organisation called the Pension Protection Fund (PPF) then gets involved, which guarantees to pay full pensions to pensioners and 90% to non-pensioners, in exchange for all the assets it can get from the defaulting scheme and its sponsor. The sponsor usually needs to be insolvent for its scheme to enter the PPF, although sometimes it is allowed to return phoenix-like without the pension scheme but with the PPF as a stakeholder receiving a share of company profits over an agreed period.

I saw my role as to help trustees negotiate hard for a funding settlement with the sponsor, on the understanding that the sponsor would also negotiate hard. It was always clear to me that the sponsor’s responsibility was to grow its business and it would look to direct most of its profits to that end. The trustees were there to ensure that the (in the main) employees of the past who had been made a pension promise were not forgotten by the employees of the present and future and their employer when resources were being directed.

Imagine what the trustees’ role might be if this whole basis of funding was turned on its head: companies directing ever more of their profits into debt repayment at the expense of any sort of investment in the future of their businesses. To the extent that this threatened the future income stream to the scheme as the business fell apart, trustees and their actuaries might find themselves making very different arguments (perhaps along the lines of the flexibility the regulator promotes and the importance it stresses of trustees having a good understanding of the employer’s position and plans, including how any plans for sustainable growth enhance the employer covenant). But we would then be in a situation where what the company was expert in, ie running its business, had been subordinated to funding a pension scheme, while what the trustees and their advisers were expert in, ie funding the pension scheme, had become less important than protecting the long term health of the company. This would appear to be sub-optimal.

But it is not that different from having a government that makes its highest priority to reduce a debt which it does not fully understand and certainly cannot fully control, while cutting back on all the things that governments do which support the economic health of a country, from investing in infrastructure and housing to promoting real social security for the economic units, ie us, within it.

And imagine what would happen if we treated schemes with large unmanageable debts like Greece. The current deal which looks like it might be agreed tomorrow involves asset sales, spending cuts, tax increases and reform of both its tax and pensions system in return for three year loans and debt restructuring and reprofiling. This would be the equivalent of not only putting the sponsor into administration and selling off all its assets but also immediately demanding pension contributions from the workers who had been kept on into a scheme which would never give them any benefits just before firing them with no pensions (pensioners left without pensions was a scenario which occasionally happened in the UK before the PPF and sometimes led to naked pensioners demonstrating on the beach). The sell off would, as it always does (and certainly has in the case of Greece) pay off the banks first before moving on to the unsecured creditors. Insolvency practitioners know that they can get more for a company by selling it as a going concern rather than as just a bunch of assets. The PPF similarly understand that a proportion of future profits can be in their best long term interests as a creditor rather than dancing around the flames of a fire sale. The Troika, the IMF and their enforcer, the ECB, appear to have lost sight of this.

The current austerity fixation is not bringing good private sector practice into the public sector. On the contrary it is removing the public sector foundation required for the private sector to flourish. And that is just bad business.

We know zero about 2015

10. January 2015 · Write a comment · Categories: Antifragility, Economics, Prediction

There have been a lot of predictions already for 2015. The Chartered Institute for Personnel and Development predicts employment in the UK increasing by half a million, GDP growth of 2.4% and earnings growth of between 1% and 2%, ie keeping its predictions reasonably close to what happened in 2014 and/or what the OBR, OECD and IMF are predicting. The annual FT economists’ survey resulted in an average conclusion amongst 90 economists that GDP growth would increase from 2.4% pa to 2.5% pa around election time and then on to 2.6% pa soon after. I could go on but I think you get the general idea – small changes around current economic statistics with a remarkable level of agreement amongst the experts. It’s enough to make you want to use these predictions to populate your models with, which is of course the general idea.

But before you get any idea that these people know more about 2015 than you do, consider what was being said about the oil price only 6 months ago in the Office for Budget Responsibility’s Fiscal sustainability report. Here is the graph:

Once again, there was a trend of projecting a price rather similar to the current one and a remarkable level of agreement amongst the experts. Here is what has actually happened subsequently:

Now I don’t want to pick on these forecasters in particular, after all the futures prices indicated that these views were the overwhelming consensus. But the oil price is a fundamental indicator in most economic models – Gavyn Davies details how the latest fall in oil prices has changed his economic forecasts here – with implications for inflation and GDP growth, and dependent upon predictions about many other areas of the political economy of the world which impact supply (eg OPEC activity, war in oil-producing areas) and demand (eg global economic activity). So an ability to see a big move in oil prices coming would seem to be a clear prerequisite for being able to make accurate economic forecasts. It seems equally clear that that ability does not exist.

Economic forecasts generally tell us that things are not going to change very much, which is fine as long as things are not changing very much but catastrophic over the short periods when they are. Despite the sensitivity testing that goes on in the background, most economic and business decisions are taken on the basis that things are not going to change very much. This puts most business leaders in the individualist camp described here, ie a philosophical position which encourages risk taking. Indeed even if some of the people advising business leaders are in the hierarchist camp, ie believing that the world is not predictable but manageable, to anyone with little mathematical education this is indistinguishable from an individualist position.

The early shots of the election campaign have so far been dominated by the Conservative Party branding Labour’s spending plans (which to the extent they are known appear to involve quite severe fiscal tightening, although not as drastically severe as Conservative ones) as likely to cause “chaos”, while the Labour Party wants to wrap itself in the supposed respectability of OBR endorsement of their economic policies. Neither of them has a plan for another economic crisis, which concerns me.

What are desperately needed are policies which are aimed at reducing our vulnerability to the sudden movements in economic variables which we never see coming. We should stop trying to predict them because we can’t. We should stop employing our brightest and best in positions which implicitly endorse the assumption that things won’t change very much because they will.

What sort of an economy would it have to be for us not to care about the oil price? That’s what we need to start thinking about.

Do pensions make inequality better or worse?

22. August 2014 · Write a comment · Categories: Actuarial, Demographics, Economics, Pensions, Regulation

I ask this question because:

I have just read The Spirit Level by Richard Wilkinson and Kate Pickett, and am convinced by their arguments and evidence that inequality lies at the root of most of the social problems we have in the UK; and
As a scheme actuary, I persuaded myself that I was facilitating a common good, namely the provision of good pensions to people who might not otherwise have them to as high a level and for as long as possible given the economic conditions of the sponsors. The introduction of the Pension Protection Fund reduced the importance of the scheme actuary role, by mitigating the impact of sponsors not meeting their obligations, but still left a job I felt was worth doing. However, it now seems to me that, if pensions are not tackling inequality or even exacerbating it, they might be doing more harm than good.

First of all, I strongly recommend the Equality Trust website, which has a number of graphs showing the links between inequality and various social ills. One example, showing the relationship between inequality and mental illness, is set out below.

So what is the evidence on inequality and pensions? Certainly inequality, as measured by the Gini coefficient, in this case after a reduction for housing costs, has increased markedly in the UK since the 1960s.

While the proportion of private pension provision since 1997 as a percentage of the workforce has fallen (courtesy of the Office for National Statistics).

But is there much of a correlation between them? Well there is a weak negative correlation between the Gini coefficient and the percentage in workplace pensions as a whole.

And a rather stronger one when we just look at defined benefit (DB) pension scheme membership.

Neither of these are particularly strong correlations. Any impact by workplace pensions on inequality is likely to be limited of course, because they are in general structured (via final salary formulae in the case of DB, and employer and employee contributions as a percentage of salary in the case of defined contribution (DC)) to preserve relative incomes in retirement, even if not absolute differentials. However, moving now to the OECD statistics website, we can look at the retirement age community as a whole and compare their relative inequality with that of the working age population.

Turning to the working age population first, we can see below that the UK is a very unequal society compared to a range of rich countries, although less so than the US.

data extracted on 15 Aug 2014 15:52 UTC (GMT) from OECD.Stat

On the other hand, we get a very different picture if we consider the UK’s over 65 population, where the level of inequality is well below that of the US, and broadly comparable with the other major EU states.

data extracted on 15 Aug 2014 15:52 UTC (GMT) from OECD.Stat

Clearly this is not primarily down to private pension provision, but the more redistributive state pension and other benefits. However, at least the weak correlations we saw previously suggest that private pensions have not made inequality any worse and possibly slightly mitigated against it.

I think we can do better than this: after all we had inequality levels equivalent to current Norwegian levels back in the early 60s (which is why I included them in the international comparisons above). So the news that pensions tax relief is likely to be provided at a 30% rate for all after the election rather than reflecting the current tax bands is not, in my view, the cause for gnashing of teeth as the Telegraph and others believe but actually a good thing. After all, the Pensions Policy Institute have shown that 2/3rds of all tax relief is going to those earning over £45,000 pa.

One of the clear conclusions of the research carried out in The Spirit Level and elsewhere is that reducing inequality in society benefits every group in it, including those who are redistributed away from. Pension provision has its part to play in this.

And 30% tax relief does not seem like too high a price to me.

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