14. The Private Pensions Casino

The idea of pensions in a barter system, i.e. without money, may seem quite bizarre. We have gotten so accustomed to the modern, money-based concept of pensions that we assume that without money pensions could not exist. But actually money-based pensions are historically the exception, not the rule. Interestingly, though, throughout the past millennia pensions worked just fine in a completely different way.

Pensions throughout history

Let’s just take a moment to think about what a pension is and why we need them. We all realise that when we reach old age we can no longer work as efficiently in the production of goods and services, either to consume ourselves or to exchange with other people for whatever we need to get by. The standard way this situation has been dealt with throughout history is via the family. As long as you were fortunate enough to have a loving family, your children would look after you in your later years. They would give you some of their food, shelter etc. There was no need for any legal contract; it was just “the done thing”. Note that neither parents nor children were aware of any “savings” going on in this process. The system was completely stable and could work for generation after generation without any “warehouse” being filled up with any goods for later use. Looking at the society as a whole you could simply observe that at all times there were some younger working people donating a fraction of their produce to older retired people.

Now let’s consider the introduction of money into this system. Presumably the same scenario could be arranged: You could have a continuous flow of money from younger working people to older retired people. Systems could be devised to enable this to take place. But bizarrely it has not happened. Instead we seem to have evolved a model in the west which involves a kind of “storing things in a warehouse” model of savings.

Now, many people may try to defend our modern pensions system. They may claim that the money saved by people during their working lives needs to be used for “investments”. They may claim that alternative systems are too “socialist” and deny us our freedoms. We have objections to both those arguments on several grounds. But first of all let’s consider the effects of our modern “money and savings” based pensions system with a story:

Mr Lucky and Mr Unlucky

Consider two people born five years apart. Let’s call them Mr Lucky (the older man) and Mr Unlucky. Let us imagine that they are equally conscientious, equally hard working, equally intelligent, equally everything.

Now Mr Lucky starts his working life and starts saving towards his pension. Just by chance this is at the end of a recession when stock prices are low. He’s already off to a good start because his early pension’s investments are likely to rise nicely.

Five years later Mr Unlucky starts his working life. He does a similar job and saves the same fraction of his income toward his pension. Unfortunately now is the peak of a stock bubble. His early pension’s investments will turn out to be a disaster.

For several decades to come both men have investments in the stock market at the same time. Unfortunately Mr Unlucky’s fund manager is not as financially savvy as Mr Lucky’s. This is not really Mr Unlucky’s fault – neither men are financial experts. How can anyone possibly expect your average man in the street to determine the different skill levels of two different fund managers? They can’t. Mr Unlucky’s fund gradually drifts even further behind Mr Lucky’s. But it doesn’t stop there...

The fund managers make their choices based on their knowledge of the markets and the economic “fundamentals”, i.e. the balance of trade between countries, rates of unemployment, tax laws, political changes, levels of natural resources etc. etc. However, a sizeable component of the variability of stock prices is things that no fund manager could be expected to prepare for, like earthquakes, floods, political assassinations, industrial accidents etc. And you’ve guessed it – the floods and earthquakes just happen to be to the benefit of Mr Lucky’s stocks and Mr Unlucky’s fund manager’s stock selections get badly hit, so his pension fund falls even further behind. But it doesn’t stop there...

Now we come to retirement time and would you believe it, Mr Lucky retires at the peak of another bubble and so has a boosted pension pot just when he buys his annuity. And oh dear, Mr Unlucky retires at the depths of a recession so his pension pot is additionally suppressed at the time of purchasing his.

So there you have it – two similar guys doing similar jobs, saving similar fractions of their wages towards their retirements and yet their retirement incomes could be hugely different based entirely on luck. Is that fair? Is that how we want the system to work? Some people find it extremely stressful worrying about their pensions – are they going to be lucky or unlucky? What should they do? Should they just save way more than they really need just in case they’re unlucky? Or should they scrimp on their pension contributions hoping they get lucky and then simply carry on working longer if they’re unlucky?

Note that there two types of random variability between pensioners. One type is between pensioners of the same age. Let’s call this stock selection variability. Another type is concerned with the start and end times of pensioners’ saving period. Call this bubble timing variability. Now bubble timing variability will affect entire age groups of pensioners, some of them having miserable retirements and others having good ones.

Just imagine if you applied the same pensions system in your own home. Imagine you have your old grandma and grandpa living with you. They’ve both worked hard all their lives. Now at dinnertime you serve Grandma a feast of the finest foods and champagne while you give Grandpa a slice of bread and a glass of water. They say, “What did we do to deserve this?” and you have to remind them that Grandma thought eBay was a great idea and Grandpa liked the Betamax video cassette system (for younger readers – you should know that Betamax was a commercial disaster despite its technical superiority over it’s rival VHS).

Now you may say that this is simply how life is – if you get lucky then you do better in life, if you’re unlucky then you do worse. But that’s not true in all aspects of our lives, and people can usually select the degree of risk they want to take. If you want to be a professional stock broker then you may get rich or you may go bust; it goes with the territory. People choose to be stockbrokers. Nobody who loses on the stock market ever says, “Gee, nobody told me there was any risk involved.” But we can choose to take a less risky career. Say you become employed as a plumber. There’s not much risk in that. If business gets bad then you can always retrain as something else. There’s little chance of ever suddenly having your life savings wiped out as a plumber. So you see there are some choices in our working lives which are inherently risky and some inherently less so. Now when it comes to designing a pension system, is it so obvious that we should select a mechanism so full of risk? We think not. It is possible to design an inherently safer mechanism.

A fairer pensions system

Now the first characteristic we want for a pensions system is that people who save more in their working lives should get more – and roughly speaking if you save twice as much as the average guy in your working life then you should get twice as much in your retirement.

The second characteristic of the system is that people must be forced to save for at least a minimum standard of living in retirement. Now some people may say, “How dare you take away our freedom! It’s up to us to individually decide what we save for retirement.” But not saving throughout your life puts a blatantly unfair burden on the rest of society when you retire. We can’t just stand by and watch you become homeless and starve. We’ll be forced to give you a certain minimum standard of living for free. We would also add that the amount we are forced to save for retirement will be very small. Just enough so that you could have a bare minimum quality of life.

A system to achieve all these things is the following:

The government invent a new type of tax (but of course we don’t want to call it a tax!), call this compulsory elderly-support. Say its X%. This is the minimum. People can optionally also put whatever extra they want into the elderly-support system. The continuous flow of elderly-support money that comes in from workers is used to pay money to the retired. Note that this is all happening at one instant – there is no pretence that some investment is being put in storage for future use. It’s plain and simply workers-now-support-retired-people-now.

So the next question is how to apportion the money – this is where we need to do a little mathematical jiggery pokery. The money is not distributed evenly among retired people, instead it is (roughly speaking) distributed in proportion to the amount of money those retired people fed into the elderly-support system during their working lives. The maths required to achieve this is not trivial, but it is certainly doable.

So what are the advantages of this system?

• Nobody is being forced to predict the stock market. People who save similar amounts will be similarly comfortable in their retirements.

• If a country develops well and has a boom then the retired population will automatically benefit from the boom.

• If the country has a recession then retired people will take their share of the burden rather than requiring an unbearably large fraction of the now-poorer nations’ GDP.

• The whole system will be far more predictable for pensioners, workers and government.

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