Funded pensions a mad idea whose time has come

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If the ideas Tony Blair outlined in Singapore about the "stakeholder economy" are insufficiently radical for you, consider this proposition: what would be the implications were the Singapore model of a state-run funded pension system to become the norm for the industrial world? Or, to put the point from the perspective of participants in financial markets: could the rise of state-sponsored investment funds become as important an influence on world finance in the next quarter century as the rise of institutional investors have been in the past one?

A mad idea? Far from it. Indeed, growth in state-sponsored investment funds seems inevitable as countries find this is the only way they can fund the demands of an ageing population. The present pay-as-you-go pension systems, which just about work if there are four or five people of working age to every pensioner, cannot work if there are only two-and-a-half workers for each pensioner. Encouraging people to save more for their old age via established occupational pension schemes is one way of squaring this circle, but there will always be people left out of such schemes.

In much of continental Europe funded pension schemes hardly exist, while even in the UK only about half the population is a member of one. Some kind of funded scheme offered by the state and backed by compulsory saving seems the obvious way of making adequate provision for people.

Thoughtful politicians are well aware of this. Tony Blair praised the Singapore Central Provident Fund, though he was careful to explain that such an idea was not necessarily directly transferable to another country. But Labour MP Frank Field has developed his own model, a state-run funded pension, and Tony Blair is known to be interested in this idea.

In one sense this is not a British problem: we are almost unique in that our social security fund is close to actuarial balance. Thus there is not the grinding financial imperative that faces many other countries. But one key reason we do not have large unfunded pension liabilities is that our basic state pension is very low. So there is a powerful social case in that a compulsory savings scheme linked to a supplementary pension would mean that more people had a decent standard of living in their retirement.

So Britain is an ideal country in which to launch such a scheme. Elsewhere, forcing people to save money for pensions, in addition to paying into a social security fund, smacks of deceit. In Britain it could come in as a top-up scheme.

To say all this is not to suggest that in 25 years all developed countries will have something on the lines of the Singapore system. Singapore has pounds 28bn in its Central Provident Fund; gross that up by population and a British scheme would have more than pounds 500bn. That is an almost unthinkably big number: the total market capitalisation of the all the companies on the London Stock Exchange is pounds 900bn, so the state would be owning, on our behalf, more than half of the shares of all quoted companies.

That would be a real stakeholder economy. But the numbers point to the difficulty. One can do things in a small country like Singapore which one cannot do in a large one. That is why the growth of the "tiger" economies of East Asia, depending on exporting a large proportion of output to Western markets, cannot be replicated in mainland China.

Let's assume, though, that we were to bring in a compulsory savings scheme based on 5 per cent of wages and salaries. That would bring in roughly pounds 25bn a year. Let it run for 10 years, add in compound interest, and if the markets performed reasonably the capital value could indeed be about pounds 500bn.

True, after 10 years the total market capitalisation would be larger, and arguably one might have to build up to the full 5 per cent levy over a period of years, but you see the point. A compulsory savings scheme, even at a quite modest level, would build large sums of money quite quickly - large sums in relation to GDP (at present pounds 750bn) and large in relation to present market capitalisation. Not all the money would need to be invested in equities, for some could go into fixed-interest securities and perhaps into property; some could be invested abroad. But suppose other countries also started similar schemes.

Were that to happen, some of their funds would seek a home in UK securities. Instead of being dominated by private sector institutional investors, markets would come to be, if not dominated, certainly heavily influenced by new state-sponsored retirement funds.

This possibility raises a string of questions. Could the markets absorb such a flow of capital? There would certainly be much less talk of a global capital shortage, and real interest rates would come down. How would these funds be managed? Would they be under the same performance criteria as their private sector cousins? If they performed significantly worse, would the savers have grounds to complain or seek a change in management? Or perhaps all fund management would be contracted out to professionals from day one, creating a vast new business opportunity, akin to that created by privatisation, but affecting the fund managers rather than the corporate finance people.

Thinking about it, it would almost certainly be wise for governments to distance themselves from the fund, partly to increase confidence in the apolitical nature of the scheme, for politicians have no comparative advantage as fund managers, partly to avoid being directly responsible for investment policy. So there would certainly be opportunities for the financial services industry.

Could this happen? Why not? It is logical and rational. There are functioning models already. It is no more radical in concept than mass-privatisation and less radical than the creation of the post-war welfare states. And once one established Western democracy launches such a scheme, expect others to follow. It is an idea that could sweep the world.