The Pension Commission's First Report reaches two key conclusions. First, our population is ageing. Second, we have no obvious plans to cope. Why do we have no plans? The simple answer is that, until recently, we haven't had to. The nation has simply muddled through: it's got lucky. But relying on luck is no way to plan for our collective futures.
The sources of luck? The first is fertility rates. From the late 1940s through to the early 1960s, the baby-boomer generation was born. Families got bigger, as parents chose to have their 2.3 children (and the dog, cat and goldfish). As those children grew up and entered the workforce, so the workforce grew rather more rapidly. That, in turn, meant that the state pay-as-you-go pension system was easy to finance: a growing number of taxable workers became available to support those people heading into retirement.
The second source is gains in asset prices. The 1980s and 1990s marked an extraordinary period of asset price gains, most obviously reflected in rising equity prices. This, in turn, meant that corporate pension schemes were relatively easy to finance because share-price gains reduced the need to make additional pension contributions from one year to the next. Some companies were able to take pension contribution "holidays", which in turn made their profits look even better and hence led to further gains in share prices - all part of a giant Ponzi scheme, one might say.
More recently, though, we've discovered that share prices can go down as well as up. Partly as a result, companies have realised that they can no longer afford the defined benefit pensions that formed the mainstay of company pension schemes in earlier years. The shift to defined contribution schemes simply means that the risk associated with pension "underfunding" has been passed on by companies to their employees. And, as any pension fund salesman knows through bitter experience, most individuals really have little interest in planning for their financial futures. Hence, the Pension Commission estimates that 9 million people may be "under-saving".
The commission argues that individuals and society as a whole are faced with four choices. Either pensioners will become poorer relative to the rest of society: or taxes/National Insurance contributions devoted to pensions must rise; or savings must rise; or average retirement ages must rise.
No wonder politicians like to sweep the pension debate under the carpet. They have been able to do so in part because the problems will not come through yet - the pension time bomb still has plenty of years on the clock. But no politician likes to be faced with a series of choices, any one of which is not particularly pleasant.
The fundamental reason for the growing pensions - and healthcare - crisis is simply stated but is too often ignored. Ageing populations give rise to possibly excessive claims over limited output. Let me give you a simple example. In the 1930s, males entering the US workforce could expect to live to 65 or so. It's no coincidence that this was also the standard age of retirement. Back then, you worked until you dropped. Nowadays, male US workers can reasonably expect to live to about 78, but, at least for the time being, are retiring at about 60. There's nothing necessarily wrong with having an elderly life of leisure. The tricky part, though, lies in working out who pays.
The difficulty stems from the degree to which pension promises have, over the years, been turned into pension "rights". People have come to believe in the sanctity of their pension entitlements because, up until recently, funding has been easy. The combination of rapid working population growth and rising asset prices was perfect for underwriting pension "rights" because the economic numbers made sense. When the baby boomers head into retirement, though, the economic numbers will no longer add up, implying that governments, companies and individuals will have to come to terms with the idea that pension "rights" are, in reality, not much more than pension "privileges".
Hence the commission's four difficult choices. Making pensioners relatively worse off might be in nobody's long-term interests but it hasn't stopped governments and companies going down exactly that route. The Conservatives indexed the state pension to inflation rather than average earnings, implying that pensioners would, over time, see their proportionate command on the nation's resources fade. Labour's tax raid on the pension fund industry gained tax revenues in the short term, but only at the expense of a weaker private pension system than otherwise would have been in place. The shift by companies towards defined contribution schemes is yet another example of a policy that might make pensioners worse off over time. So although the Pension Commission says that making pensioners relatively poorer is "unattractive", it's been happening nevertheless.
How about increased taxes or National Insurance contributions? I doubt that this is going to happen yet, but I think there's a very good chance of it happening later on. The baby boomers who, up until now, have been part of the working generation will, before long, be part of the retired generation. In 25 years, about 50 per cent of the voting population will be beyond today's retirement age. They might not have liked high taxes when they were working, but higher taxes on workers and companies will seem a lot more interesting to the baby boomers in retirement. And they may have the voting power to force through policies that, today, seem a million miles away.
What about higher savings? On their own, higher savings solve nothing. It all depends on what the higher savings are used for. Individual savers need to know that, in the future, their higher savings will guarantee them a greater command over scarce resources. Unfortunately, that guarantee is not so easy to deliver. For example, if everyone puts aside £100 a year for the next 10 years, there will be a nice pile of cash in 10 years' time. But unless that cash has been used to create more productive resources, the cash will simply fall in value when the time comes to spend it (in other words, inflation will rise). Alternatively, rather than holding our savings in cash, let's suppose that we put our money into equities. All fine, until we come to sell them to the younger generation. Unfortunately, there are fewer of them than of baby boomers, so the equities are likely to fall in value at the point of sale. Put more simply, an increase in the supply of savings, other things being equal, will simply depress interest rates and, hence, returns on capital: it's a simple story about supply (of savings) and demand (for savings).
So that leaves a higher retirement age. Fine, so long as people are happy to work for longer. And, to be fair, plenty of people probably are. Often, though, the incentive structure is so skewed that, financially, it's not worth people carrying on. This probably requires a major overhaul of the tax and benefit system, that will deal with retirement in much the same way that changes in the laws regarding unemployment - the New Deal, for example - have reduced the number of people within the working-age population who are out of work.
I haven't got the space to be able to write about them here, but there are other options which will doubtless need to be fleshed out. In particular, ageing is often seen only within a national context yet it is ultimately an international phenomenon which carries huge implications for global capital flows and international property rights. I'll return to these issues over the next few weeks.
Stephen King is managing director of economics at HSBCReuse content