British ¡Afuera! is a new series of pieces applying the principles of the IEA’s ‘Sharper Axes, Lower Taxes’ and Argentinian ¡Afuera! to Britain today.
Read Kristian Niemietz’s introductory piece explaining the project here. Read part 1, on the NHS and national pay scales, here, and part 2 on higher education here.
Paid Insider subscribers receive exclusive early access to this: part three, on pensions.
The British state spends 7.5% of GDP on old-age benefits, including non-cash ones. The Australian state only spends 4.5% of GDP on equivalent benefits, a difference of three percentage points. That is despite the fact that the average life expectancy in Australia is more than two years higher than here (just over 84 years vs just under 82). The difference in public spending levels is primarily due to differences in the way the two countries organise their pension systems. If we could move to a pension system similar to theirs, we could also cut public spending on old-age benefits to a level similar to theirs.
The main difference between the two systems is that the Australian one is largely based on private savings, not state-organised intergenerational transfers. What we pay into our state pension system, they pay into private pension funds.
Their main vehicle for this is and statutory employer contribution. That is not the way I would do it, because it is not an entirely honest way: in the longer run, there is really no such thing as an ‘employer contribution’. It is really, in effect, a mandatory minimum savings rate, so why not openly label it that?
On the positive side, though, Australians have a lot of choice over how they want to invest those savings. They can use a conventional pension fund, but larger employers can also set up their own schemes, and individuals can even manage their investments themselves.
Not everybody is in a position to save for their own retirement, and there is a safety net for those who cannot, in the form of a means-tested guaranteed minimum pension – that’s one reason why public spending in this area is still 4.5% of GDP rather than 0%. But most people can save for their own retirement, and in Australia, most people do.
About four fifths of the working-age population have a pension fund or equivalent savings vehicle, compared to just over half in the UK. If we wanted to match their level, we would have to enrol more than 11m additional people in pension funds.
The total amount of wealth earmarked for retirement which Australians have accumulated is worth 135% of their GDP. The equivalent figure for Britain is less than 80%. If, again, we wanted to match their level, we would have to build up assets worth more than half of the British economy.
What that means is that we cannot just ‘switch’ to their system, in the way we could switch from, say, one electoral system to another. If we want a system like theirs, we have to build it up through long-term savings.
But it is worth it, and we should do it. This article series is about reducing public spending, which is why I have highlighted the three percentage points of GDP we could permanently ¡Afuera! if we adopted a system like theirs, but it has advantages well beyond the fiscal ones.
For a start, savings-based pension systems typically offer better rates of return. IEA authors (myself included) have often criticised the triple-lock as excessively generous, which is true in the sense that it has made the fiscal cost of the state pension grow faster than the economy as a whole. But at the same time, the state pension is also, in a different sense, excessively stingy, even with the triple lock.
Since the introduction of the triple lock in 2011, the state pension has grown by an average of 3.7% per annum in nominal terms. If that were the rate of return of a pension fund, you would not consider that fund a star performer.
The uprating of the state pension has been very generous given the performance of the British economy since 2011. It’s just that that’s an extremely low bar. Because the performance of the British economy since 2011 has been a joke, for reasons we have talked about many times here.
The generosity of pay-as-you-go pension systems is ultimately tied to the performance of the domestic economy. The triple lock loosens that tie, but it cannot entirely undo it. It is hard to finance an ever-more generous pension out of a barely-growing economy.
Our savings, however, are more mobile than we are. They can go wherever they can find the highest returns. The domestic economy may be nearly stagnant, but other economies are not, and if we had an investment-based pension system, we would still be able to benefit somewhat from the growth that happens elsewhere.
There might also be less tangible benefits for the climate of ideas. Old-school Thatcherites used to believe in what they called ‘Popular Capitalism’, a market economy with widespread asset ownership, in part because they thought owning some capital would immunise people against socialism. We could do with some of that immunisation today, given the immense popularity of anti-capitalist populists like Zack Polanski and Zarah Sultana on social media. Imagine 80% of the working-age population had a pension fund, and knew that their future pension will be provided by the market, not the state. Would they still be so keen on, for example, Zarah Sultana’s plan to ‘nationalise the entire economy’?
People love anti-capitalist rhetoric if they think ‘the capitalists’ are someone else, some remote group that has nothing to do with them. But in a prefunded pension system, almost everyone is a small-scale capitalist.
The old-school Thatcherites were not entirely correct on this. Their idea of how capital ownership supposedly changes mentalities was too materialist, oddly enough: they wanted to use Marxist logic to de-Marxify the population. It does not quite work that way. Chile has a prefunded pension system as well, but that has not stopped 42% of the electorate from voting for a candidate of the Communist Party at the last presidential election. Capital ownership does not automatically turn people into capitalists. But then, who knows – maybe if Chile didn’t have that pension system, the hammer-and-sickle flag would now be flying from the presidential palace.
Either way, a politically beneficial effect of a prefunded system is that it depoliticises a major area of life, at least to some extent.
On an anecdotal note: I sometimes travel through France, via the Eurostar, when I visit my family in Southwest Germany. When I do that, I check beforehand what’s going on in French politics. If it’s anything to do with the retirement age – I don’t book that trip. Because I know that there will be mass protests, and that the probability of train cancellations will shoot up because of it.
Some put that down to French protest culture, which, I am sure, explains some of it, but there is also the fact that hardly anyone in France has a private pension fund. They rely entirely on the public system, and so, there is a lot more at stake for them when such political decisions are made.
This would not happen in Australia. Australia does not even have ‘a retirement age’ as such. They have a minimum age for access to the means-tested state pension, and another, much lower one for access to one’s own private pension fund, but by and large, Australians simply retire when they think they have saved enough money to retire. That is an individual choice, not a political one.
Britain is somewhere in between these two examples: pensions are not as hyperpolitical as in France, but not as apolitical as in Australia either. We should go full Australian.
But how do you do that? How do you get to a prefunded pension system?
Unfortunately, in that regard, Australia does not offer many lessons. They never had a particularly comprehensive state pension system to begin with, so they did not have a lot of Afuera-ing to do. Their current system was officially introduced in the early 1990s, but this was really a formalisation of something that was already happening. The transition to that system was therefore not particularly difficult.
The Chilean example is more insightful in that regard, because they had a fully state-run pay-as-you-go pension system until 1981, which they then successfully Afuera’d step by step. The Chilean transition is a fascinating story in its own right, which I will cover in more detail in a future article, but for now, let’s keep it basic. Here’s how they did it:
For people who had already retired, nothing changed. They simply kept receiving the benefits to which they were entitled under the old rules, paid out of general taxation and government borrowing.
But the system no longer accepted new entrants. Everyone who joined the labour force from May 1981 on had to join the new savings-based pension system.
Everyone in between, that is, the entire active labour force as it was in May 1981, was given a choice. They could remain in the old system, in which case they would continue to build up entitlements under the old rules, and eventually retire on that basis. Or they could switch to the new system, in which case the contributions they had already paid into the old system were, in a sense, ‘refunded’. More precisely, they were given government bonds worth roughly the net present value of the pension entitlements they had already built up under the old system, and those bonds were deposited in their pension funds.
In 1990, the Chilean state still spent about 8% of GDP on old-age benefits. Today, that figure is down to 3.7%. That’s not quite an ¡Afuera!, but it’s a decent attempt.
I should add that they, too, have an old-age safety net, which has become a lot more generous over time. A private system is very easily compatible with a safety net. But the vast majority of the population are quite capable to provide for their own retirement, and if they weren’t forced to prop up an ailing state system, they would do it. Old-age provision should be largely a private matter, with the state playing no more than a subsidiary role. I wouldn’t ¡Afuera! the state entirely from this area, but I would certainly eject it from the main stage, and re-hire it as a security guard.
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