Jeremy Warner's Outlook: The debt overhang is a real problem for the British economy. Is there any way out?

...and another thing about pension reform
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The Independent Online

The Australians started it, Britain followed suit, and now the Americans are going the same way. Throughout the English-speaking world, central bankers have been attempting to quell excessive, debt-fuelled consumption and soaraway house prices with tighter monetary policy. Policymakers won't admit they've been deliberately targeting the housing market - for their brief is only to regulate inflation and growth - but in all three jurisdictions this has been the sub-text.

Rising housing wealth, easy credit conditions and low unemployment have given consumers the confidence to borrow and spend. This has given a welcome boost to economic activity in the post-bubble period, but it was always likely to be a temporary respite.

The longer it went on, the greater the danger of a nasty demand shock to the economy when eventually the music came to an end. The object of policy has thus become to engineer a slowdown in consumption and a parallel soft landing for the housing market, the latter to ensure that spending doesn't fall off a cliff. The Australians tried it first and it seemed to work. Interest rates were raised and the effect was to slow the housing market without producing a corresponding collapse in economic activity. The Bank of England seems to be achieving broadly the same effect in Britain. House price inflation has slowed to virtually zero, consumption growth has abated too, but the economy as a whole is still growing - just about - and there has been no significant rise in unemployment.

As for America, it seems to be a bit behind the curve. US house price inflation has yet to slow, despite 13 consecutive interest rate hikes, yet presumably much the same effect will eventually kick in. However, to produce the desired outcome of a soft landing for the economy as a whole, the ingredients of growth need to rebalance.

It's all very well removing the boost to consumption delivered by rising house prices, but if the economy is to keep growing, the consumption has to be replaced with something. High government spending helps, but eventually there needs to be an uplift in both exports and business investment to restore economic growth to a reasonably balanced diet.

Australia has been lucky in this regard, for it's got the Asian boom and the related spike in commodity prices to help sustain it. It is much harder to see where the counterweight is going to come from for Britain and the US. There's little sign so far of an uplift in business investment in Britain, while our manufacturing base is now so small that producing decent export growth isn't going to be easy either. Productively growth meanwhile refuses, stubbornly, to move above trend.

More worrying still, the fall off in consumption may yet have further to go. Strip away housing investment - in purchases and improvements - and Britons aren't saving at all. To the contrary, they are still running a deficit. The same is true in the US, only worse.

The time has come, says Christopher Smallwood in Lombard Street Research's latest Monthly Economic Review, for a new economic policy. Consumers and the public sector are both over-borrowed, so in the absence of a pick up in business investment and exports, which the Government cannot rely on to occur of their own accord, growth is likely to remain subdued for possibly years to come.

The solution, he argues, lies in fiscal consolidation. If taxes were raised and spending cut, it would produce an immediate reduction in demand, allowing the Bank of England to cut interest rates without triggering a second leg to the consumer boom. This would eventually stimulate investment.

Mervyn King, Governor of the Bank of England, probably has some sympathy with this view. In so far as central bankers ever criticise their sponsoring governments, Mr King has expressed concern over the growing size of the public sector deficit. Is the Chancellor likely to listen? Don't hold your breath.

...and another thing about pension reform

Ministerial reaction to the recommendations of Adair Turner's Pensions Commission has ranged from lukewarm to outright hostile. There's little appetite to implement the Turner proposals in their present form, and the chances of anything serious being done about pensions this parliament are virtually zero.

Yet this has not been an entirely wasted three years for Lord Turner, for his proposals do at least provide a useful framework for debate and eventual action in some shape or form. Reform of the state pension system need not concern us too much here. Hell might freeze over before there's a resolution to the debate over means tested benefit versus a decent, citizen's pension.

It is in any case the proposed National Pension Savings Scheme (NPSS) which is exercising people in the savings industry most. This is the idea of compulsion-lite, where employees are automatically enrolled into a state sponsored savings scheme, with 4 per cent contributions from employees' post tax pay and 3 per cent from matching compulsory employer contributions - but subject to an opt out.

Employees wouldn't have to participate if they didn't want to, either because their personal financial situation made it inappropriate or because their employer offered superior, alternative pension arrangements. By administering the scheme and collecting the payments nationally, say through the existing Pay-As-You-Earn system, Lord Turner also expects to be able to reduce the annual management charge to 0.3 per cent or less, thus countering one of the criticisms of saving for the low paid - that the amounts are so small that they all get gobbled up in fees.

Who could quarrel with such an eminently sensible approach? There are two main criticisms.

The most obvious is the possibility that the NPSS becomes seen by employers as an inexpensive default option for pension provision. Why provide better, more costly arrangements when there is a Government sponsored alternative? Paradoxically, the new scheme might in time result in less being saved in aggregate than occurs at the moment.

It might also lull employees into a false sense of security about their pensions. The NPSS would in fact provide only a bare minimum, equal to a pension of about 15 per cent of earnings. Most people need to save much more to achieve the standard of living in retirement they aspire to.

The other criticism concerns the mechanics of the scheme itself. The idea that costs could be kept to a minimum by having a nationally administered scheme is naive. A vast new bureaucracy and IT system would be required to keep track of the millions of separate accounts involved, ensure the timely investment of the monies collected, and report on a regular basis to members. There's not much doubt who ultimately would pick up the tab for all that - the taxpayer.

As it happens, a perfectly adequate infrastructure of this type already exists. This is the systems the insurance industry put in place to service the Government's doomed, stakeholder pensions initiative.

Nobody expected to make any money out of it initially, but the industry went along with the idea partly as a gesture of goodwill after previous savings scandals, and partly because it believed stakeholder arrangements would eventually be made profitably when the Government moved to the sort of compulsion-lite regime suggested by Lord Turner.

Yet he now proposes to bypass this infrastructure completely and set up a separate national scheme. The insurance industry believes it could achieve the same management fees as those envisaged for the NPSS provided it is able to dispense with the present requirement for point-of-sale advice. The system would also need to be made administratively more simple.

If there is a private sector solution to the auto-enrolment arrangements suggested, ministers would be wise to take it. The creation of a vast new bureaucracy is needless and wasteful.

j.warner@independent.co.uk

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