The stock market's recent turbulence has again raised doubts about the economy's growth potential. The immediate concern is that rising interest rates around the world will undermine economic growth. But there's a more insidious problem, one that is restraining growth and that could get worse still if the stock market stumbles again. Pension paranoia threatens to become self-fulfilling by holding back corporate investment.
The demographics of the looming pension problem have been known for years. As the UK population ages, the burden of paying pensions is set to grow. But it was not until the stock markets took a dive earlier in the decade that this problem hit the headlines. Pension funds that enjoyed the stock market boom times of the 1990s suddenly found themselves in deficit. Coupled with corporate fears for long-term growth, this raised concerns about how pension liabilities would be met.
Lots of solutions to this problem are being hotly debated. They include reducing pensions, raising retirement ages, increasing labour force participation or offering incentives to encourage savings. Each pose substantial practical and political difficulties.
However, one factor that tends to be overlooked in the pension debate is that the prospective shortfall in accumulated savings can be addressed through stronger economic growth. This would both add to the pool of savings and increase the rate of return on those savings.
Achieving stronger economic growth is easier said than done. But it remains the single biggest factor that will determine whether or not we can fund the pensions of our ageing population.
This should turn our attention to the flipside of savings: investment. Investment is crucial to long-term growth. Faster economic growth allows income, and therefore savings, to grow faster too. Thus a short-term investment shortage will surely create a long-term growth, and hence savings, problem.
The danger is that worries about a potential savings shortage may become self-fulfilling if they discourage investment. Sadly, it is clear that concerns about prospective pension liabilities have indeed been boosting saving in the corporate sector.
Across the developed world, the revival in the growth in corporate sector capital spending has fallen well short of the growth in profitability. As a result, savings of this sector have recently exceeded its investment for the first time in more than 20 years.
This has been especially true in the UK. Non-financial corporations have more than doubled their net savings from less than £30bn in 2001, to around £68bn last year, equivalent to 5.6 per cent of GDP. It appears that the bulk of this has been devoted to shoring up company pension schemes. Although there is no official data for 2005 yet, employers' contributions to private pension schemes took off in 2002, reaching £48bn in 2004.
There can be little doubt that the stock market collapse at the start of the decade, coupled with the corporate scandals that followed, are the prime reasons for this investment shortfall. Since then, under pressure from the markets, companies have been determined to deliver genuine, sustained profits growth, while adopting a cautious approach to new investment.
Although some of the reluctance to invest in the UK could be attributed to the attractions of investing in the emerging world, even there, investment has fallen short of domestic savings. The corporate sector's reluctance to invest in the developed world, coupled with the flood of Asian savings, has tended to keep interest rates low in recent years. This, in turn, has fuelled a global boom in residential investment.
However, this is not the basis on which future growth can be built. With central banks now raising interest rates in order to head off inflation, the challenge of generating the necessary investment to fuel growth and fund future pensions will become all the greater.
Mark Cliffe is chief economist, ING Financial MarketsReuse content