Speech delivered on pensions

- Saturday, 20th February 1999

 

I accepted with enthusiasm the invitation to give the keynote speech to this conference for three reasons.

First, because Sir Michael Partridge was my Permanent Secretary for four of the five years I was Secretary of State at the DSS. I enjoyed working with him enormously. Not just because he was extremely talented and helpful - all the Permanent Secretaries with whom I worked were talented and helpful.

But Michael was exceptionally creative, original and enthusiastic. And he was hugely experienced. He had personally written almost every plan for reforming our pension system over the last thirty years. So he knew where the bodies were buried! Together we carried out a massive programme of reform which he described at his leaving party as ?the biggest revolution in social security since Beveridge?.

Fans of ?Yes Minister? might be rather surprised that we get on so well.

One of my Ministerial colleagues used to say - "You think ?Yes Minister? is a comedy; we know it?s a documentary". Well it probably does describe accurately what happens for Ministers who are weak or vacillating. The Civil Service steps in to fill the vacuum. And thank heavens for that.

But where Ministers know what they want, our Civil Service is absolutely superb in helping them identify and iron out the problems in their path. In my experience, we have the best Civil Service in the world.

My second reason for accepting today was that Michael has characteristically assembled to help prepare his report a panel which is a roll call of honour in the field of social security reform.

And my third reason for accepting this invitation was that I believe reform of social security is the central issue facing developed countries. And within social security, pensions are by far the largest component and set to grow strongly.

Finally, I must express my thanks to the Action Centre for Europe for inviting me to give this address even though my vision of Europe is different from that normally advocated in ACE publications. But I did notice that you published one entitled ?Gilding the Lily? which sounds rather hopeful.

The Partridge Report

However, I do find myself in agreement with the main thesis of the Partridge Report. I agree with you that ?except where free movement is concerned, decision making about social security should remain in the hands of member states?. I agree with the inquiry that: "it is neither feasible nor desirable for there to be EU legislative powers on social policy. Each society should remain free to adopt social policies best suited to its circumstances"

Although all countries in Europe and the developed world face common social trends, our different national histories have led us to develop widely different institutional and policy responses to those problems. The fact that a common European social policy is neither possible nor desirable is not a cause for disappointment, still less a reason for ignoring each other. We should try to learn from each other?s experience. We can do so only because different countries are pursuing different policies. And it is only because member states remain independent in these matters that they can display the initiative, originality and diversity from which others can learn.

I am pleased to say that on the rare occasions that all Social Security Ministers met during my period of office, we reached a similar conclusion - that we should learn from each other, not try to impose a common European solution in our differing national circumstances.

Nonetheless, the fact that this panel and Social Security Ministers display good sense, should not blind us to the fact that there is a strongly held view, particularly prevalent on the continent, that we should seek to develop a ?Social Europe? with common social policies. The German Chancellor said only last month that "It is certain that the times of individual national efforts regarding......social.....policies are definitely over". I recently attended a conference in Germany at which this view was taken as almost axiomatic.

Two reasons were given for the supposed necessity of common European social policies. First, it was argued that if Europe is seen primarily in terms of the Single Market imposing the rigours of capitalist competition on member countries, then ordinary people will not be willing to give their allegiance to European institutions. So the European institutions themselves must also become the source of social benefits which would ameliorate the rigours of the market. The transfer of responsibility for social policy from national to supranational level was seen as a necessary pre-condition for transferring allegiance from the lower to the higher level.

That is not a view I have ever heard expressed in public in this country. Our centuries old tradition of belief in free trade makes us see the removal of barriers to trade as essentially benign. We instinctively expect the Single Market, which was very much a British initiative, to create benefits in the form of wealth, opportunities and jobs which far exceed any costs of breaking down protectionist policies.

The second argument adduced for a ?Social Europe? is the alleged need to stop social dumping. The whole concept of social dumping is economically illiterate and it is important that we spell out why. Everyone accepts that different wage levels can co-exist within the Single Market so long as they reflect different levels of productivity in different parts of Europe. Social benefits have been usefully described as the social wage. Countries may choose to allocate some of the value of what their people produce to social benefits financed by taxation, leaving the remainder as take home pay. As long as the combined value of the social wage and take home pay in any country does not exceed the value of what its people produce, that country will still be competitive within the Single Market.

So social benefits can be higher in some countries than in others which have lower productivity or which allocate less of their national output to social benefits.

[Of course, problems of adjustment can arise if the terms of trade between one country and another alter. The country whose terms of trade have declined may have to alter the real value of either its wages, or its social benefits, or both. Such adjustments could be made automatically by exchange rate movements, but those will no longer be available within the Eurozone. So the problem will be more acute in Euroland, but that is their problem and another story!]

What should be clear is that there is no need for uniform or minimum levels of social benefits to be prescribed throughout the European Community to prevent unfair competition.

The third argument for centralising social security policies in Europe is that this will be essential to make the Euro work. Countries of Euroland will no longer be able to adjust to changes in their terms of trade by movements in their interest rates or exchange rates. The same problem exists within any large state with a single currency - the USA for example. But the USA has federally financed programmes which help make up for the lack of currency flexibility. Thus if the Californian economy is depressed, it receives more federal welfare dollars and pays less in federal taxes. Sot it is argued that Euroland needs to centralise social spending to provide similar fiscal transfers to parts of Europe which may be depressed in future.

That is a logically coherent argument though it reinforces the case for Britain keeping its own currency. Just imagine what harmonising European social security systems would involve. It would be bound to involve a massive upward pressure on social security entitlements and spending. As harmonisation of employment law and Health and Safety rules has shown, the EU always operates by setting minima, never by setting maxima.

Even though most countries spend a fairly similar share of their national income on social security, they spend it in vastly different ways. Some spend more on pensions, others more on helping those out of work. Some countries have high levels of benefit for short periods of entitlement, others lower benefits for an indefinite period.

Is any politician in a country with high pensions going to propose reducing them to the European average? But there will be plenty of politicians in low pension countries calling for an increase. Harmonisation will almost inevitably mean harmonising towards the most generous level of every element of the benefit system. So that every country will find itself raising its least generous benefit levels, periods and conditions of entitlement. Yet few countries will be persuaded to cut their more generous provisions.

The process will be most harmful for the UK because the EU tends to consider only state provision and Britain has a far more extensive reliance on private provision, especially in pensions, than other countries.

A recent report by Lombard Street Research showed that Britain spends 6 per cent of GDP less than the EU average on social security - largely because of our different system of pension provision.

[This results in lower payroll taxes and partly explains Britain?s success in generating jobs. It would be sad to throw away such a relative advantage.]

Which brings me to the central issue of pensions.

Pensions in Europe

The biggest single social cost faced by every country in Europe is financing an aging population.

Throughout Europe we are living longer and having fewer children to support us in old age. As the report shows, between 1995 and 2025, the number of people aged 60 years or over will increase by 37 million. But there will be 13 million fewer people aged between 20 and 59. The United Kingdom is rather better placed than most countries. Our ratio of people of working age to retired people is set to decline by less than in most countries. And by 2020 only four countries (Ireland, Portugal, Spain and Greece) will have a higher ratio of workers to pensioners than the UK. We are also fortunate in having a higher proportion of older workers in employment than many other countries in Europe.

An aging population brings increased expenditure not just on pensions but on health, residential and nursing care and support for disabled people. That makes it all the more necessary to ensure that the main item - pensions - is affordable and properly financed. There are great differences between different countries in the level of pensions, the ages at which they become payable, the extent of means testing, the relationship with earnings and so on.

However, there are only two ways to finance pensions. The first is to tax those in work to pay for the pensions of those already retired. The second is to encourage people in work to save and invest for their own retirement. Most European countries rely largely on the first method. Almost all their pensions are financed on a pay-as-you-go basis. This year?s taxes are used to pay the pensions of people already retired. Nothing is saved or invested for the future.

So as the number of pensioners rises and the number of workers falls they face an increasingly crippling burden of tax. That is the nightmare facing most finance ministers in Europe and elsewhere.

By contrast the UK has relied on the second approach to financing pensions.

We have persuaded the bulk of people to save and invest in pension funds for retirement. We allow and encourage them to opt out of the State Earnings Related Pension Scheme into company or personal funds. Around 60 per cent of those eligible do opt out. Over eight million people are in occupational funds.

And over 5 million (ten times the number expected when such funds were introduced) have personal pensions.

Those who opt out of the state system receive a rebate from their payroll tax sufficient to finance a private pension at least equivalent to that which they would have been entitled to in the State Earnings Related system. That rebate is paid directly into their private pension fund. So their money is genuinely saved. It is invested. It goes into industry to earn the profits which will pay their pensions when they retire - without imposing a burden of tax on the economy and meanwhile strengthening it through a massive build up of investment.

Significantly, the total value of British owned pensions funds is now some ?830billion. That is not just more than any other country in Europe. It is more than all the other countries in Europe put together have saved and invested for their own pension needs.

As a result, the IMF calculated that if countries maintain their present systems - by 2050 France and Germany would have accumulated government debts in excess of their national income. By contrast the UK would have paid off its entire national debt and accumulated a surplus. The Partridge Report comes down in favour of funded pension provision and believes it should be encouraged. Before looking at the rest of the EU - is there scope for Britain to increased further the extent of private funded provision. I strongly believe there is. We should build on our success. Hence Basic Pension Plus. It would lead to full funding over a generation and the widest extension of personal ownership since home ownership

Labour?s Green Paper

Will this government move in the direction of more funding? The Labour Party has always ideologically tended to favour state pension provision on a pay as you go basis financed from taxes and national insurance contributions. But in practice both Old and New Labour has always tempered that belief in the light of British traditions of private provision. National traditions are stronger even than ideology. Beveridge deliberately made the state pension a flat rate basic pension so that people could supplement it with private pensions. When Barbara Castle introduced a State Earnings Related pension, she, albeit grudgingly, allowed company schemes to opt out.

The Labour Party, when in Opposition attacked us - as Oppositions are inclined to do - when we extended the right to opt out of the state scheme to individuals taking out personal pensions. Labour spokesmen used the subsequent misselling and Maxwell scandals to attack private provision. But widespread public support for private personal and occupational pensions coupled with the obvious benefits to long-term public finances, forced the Labour Opposition to change their tune. Even before the General Election, they began to adopt our rhetoric.

Now they are in power, they have even abandoned their pledge to keep SERPS and say their plans are intended to increase the extent of privately funded provision for retirement. I entirely welcome that objective. There is always more joy in heaven over one sinner that repents than 99 just men who need no repentance. Unfortunately so far their conversion applies more to their rhetoric and intentions than their practice.

There are only three ways to increase funded pension provision. The first is compulsion. Over the last couple of years, I have heard the most amazing nonsense talked by intelligent commentators who should know better, about the need to introduce compulsory second pensions in this country. The fact is that we already have a compulsory second pension for all employees in this country.

Everyone is required to put nearly 5 per cent of their earnings either into the State Earnings Relating Pension Scheme to provide a second, earnings related, pension, or into a private personal or occupation fund to provide an equivalent pension or better.

The only people not covered by this scheme are employees earning below the lower earnings level and the self-employed. The lower earnings level is set at the same level as the basic state pension. It would be odd to compel people earning less than the state pension to save and therefore spend less than the pension level now, in order to be able to spend more than the state pension when they retire. The government has therefore sensibly abandoned this idea.

The self-employed have always been excluded from SERPS for two reasons: their true earnings are difficult to measure and they are often building up their business as a capital asset which they will sell to finance their pension.

Like so much else, the Green Paper does not make clear whether the self-employed are to be included in future second pension schemes. Rumour has it that the government were intending to increase the element of compulsory funded second pension until just days before the Green Paper came out.

That explains the reference to compulsion on page 105 of the paper which appears to have survived from earlier drafts. More compulsion must mean either increasing the percentage of earnings compulsorily saved in SERPS or private schemes, or compelling people to opt out of SERPS into private funded provision.

Plans outlined in the Green Paper fall short of this and talk merely of an ?expectation? that most people above a certain income level will take part in such a scheme once it is bedded in in five years time.

Simplification and Cost Cutting

Failing more compulsion, the best way to persuade more people to save more in private schemes is to make them simpler and less costly. My priority was to drive down costs by a threefold strategy. By making costs more transparent and requiring companies to express their overall costs on a comparable basis, we hoped competition would drive down costs. Then I sought to reduce marketing costs, one of the main elements of costs, by encouraging Group Personal Pensions. Where employers or affinity groups arrange such schemes, they can negotiate reduced charges for their employees or members by cutting out a lot of the providers? selling costs.

Finally, we sought to reduce the regulatory costs. The Evolution Project developed by the Personal Investment Authority in consultation with its members sought to define a simple standardised product which would require the minimum investigation by the provider to establish that the product was suitable for the client.

As I understood it, the government Stakeholder Pension had essentially the same objectives. It was intended to be available on a group, company or industry basis. It would be standardised to reduce costs. And charges would be capped.

Unfortunately, according to expert observers, the actual scheme produced in the Green Paper is unlikely to fulfill its own objectives. A very lucid and sympathetic analysis by Watson Wyatt concludes, I quote, "Even the most efficient Stakeholder Schemes are likely to find problems in operating at a cost below the charging limits and this could severely limit the market in providers. There will also be a more complex legislative and regulatory structure compared with personal pensions which will tend to reinforce this point."

Incentives

The only other way to encourage increased provision of funded pensions is to improve the incentives available to savers. Unfortunately, the government has moved sharply in the opposite direction. First it imposed its ?5 billion a year pensions tax through abolishing tax credits on dividends payable into pension funds. Robert Maxwell would have been proud of them. Then they restricted the tax relief previously available on PEPs and TESSAs to the lesser reliefs available on ISAs.

Now they propose different limits on the tax free contributions which can be made for Stakeholder Pensions to those available for personal pensions. For many people the personal pensions limits will be more attractive. Finally, the LISA tax envelope has been announced without any apparent co-ordination with either Stakeholder Pensions or ISAs.

Most of us are still wrestling with what the LISA will mean. But independent experts conclude that "the administration of individual envelopes each containing a range of different funds is likely to be complex and expensive".

I am obviously not the most sympathetic admirer of this government, but I applauded their rhetoric when they began to praise funded pensions. I welcomed their proclaimed strategy of simplifying and reducing costs to encourage increased take up. So I am simply amazed that they should have instead produced a plan which objective practitioners find so bewilderingly complex they cannot understand it which threatens to increase the complexities and costs of running such schemes and which is so insultingly devoid of numbers as to make it impossible to quantify the full implications of the scheme.

Conclusions

Although we have criticisms of the government?s proposals, there is a consensus within the UK that the British system allowing people to opt out of unfunded state provision into funded private schemes is successful and should be carried further.

But how far is the UK model exportable? The UK model was made possible because of our long established tradition dating back almost two centuries of self-reliance, voluntary co-operation and commercial provision for old age.

Comprehensive state provision came later than in many countries and was deliberately introduced at a flat rate to allow people to build up private savings on top of it. And our earnings related scheme, when introduced, had an opt out.

Similar traditions exist in other Anglo-Saxon countries. Notably in Australia and New Zealand with whom there is a continuous exchange of ideas. The United States of America is also interested in these ideas and earlier this month I gave evidence to the House of Representatives? Way and Means Committee on the British experience as they consider whether to move towards a funded element as part of their Social Security scheme.

By contrast Continental countries - particularly those with a long Bismarkian tradition of comprehensive state earnings related provision - would find it more difficult to move towards the Anglo-Saxon model.

As so often, the channel is wider than the Atlantic. Auckland is nearer than Antwerp. Singapore is closer than Strasbourg.

So I have reservations about the conclusion of the Partridge Committee that the European Union should encourage the development of funded pensions. It is not really for the European Commission to tell member states what is good for them in these matters. They are perfectly capable of working it out themselves.

And what may be right for some, may not be appropriate for others.

Above all we in this country should no more wish to impose our systems on our Continental neighbours than we would be willing to see them impose their systems on us.

 

 

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