Report Pages 16-17

Section 3 - On claims against the economy both public and private[1]

It is relatively easy to see that public pensions, like those paid to New Zealanders over age 65, are claims on the contemporary economy, especially if they are financed on a ‘pay-as-you-go’ (PAYG) basis. A government’s capacity to pay those pensions depends on its ability to collect tax and redistribute that to the qualifying old. Economic output is directly connected to a country’s capacity to support the old: the stronger the economy, the greater that capacity.

The connection is indirect but just as evident with private provision. Saving for retirement involves setting aside money during the accumulation period. That is invested in the economy and makes claims against the economy each year; returns are added and may again be set aside. At retirement, the collection of economic claims (savings) is converted to cash to support the retiree’s income needs. Selling those investments requires a buyer who will pay a price that is related to the perceived value of those claims. Again, there is a deep connection between that value and the strength of the economy at the time they are converted to pay for loaves of bread, milk and the other things that pensioners need.

There is no significant economic difference between public and private provision for retirement. For today’s retirees, both types entail claims against today’s economic output to support today’s consumption by today’s pensioners. The overall ‘affordability’ of any retirement income system is therefore directly related to the strength of the country’s economy at the point of payment. For today’s pensioners, that means now; for pensioners in 2060, it means the strength of the 2060 economy.

The total size of retirees’ entitlements, public and private, represents output that must be effectively delivered to them by workers and other producers of the day. Whether through redistribution (PAYG pension) or by converting financial savings, pensioners must get money into their bank accounts to meet their living expenses.

The economy has ways to adjust the real value of claims that taxpayers (public pensions) or citizens (‘private’ claims) expect to receive if those claims are deemed ‘excessive’. For example, the real value of ‘private’ claims can be adjusted downwards by unexpected inflation or structural falls in the value of investments. ‘Public’ claims can be reduced by changes to the pension rules. Again, those adjustments occur in the contemporary economy, regardless of the way the claims have been accumulated or are accounted for. In that regard, private claims are no more secure than public claims, even though some people might have a preference for one over the other.

Healthcare costs are also claims on the economy and both public and private costs are expected to increase with ageing populations.

A government must balance the competing, contemporaryclaims of the young, workers, the old and claims for all the other things governments do such as policing, defence, education, infrastructure-development etc. With a stronger economy, more is possible in all these areas.

It may seem that an individual saver can defer consumption (by saving) and so ‘store up’ claims against tomorrow’s economic output. But what actually happens is that the saver converts the possibility of consumption today into a different form of claim on today’s economy (a bank account, retirement saving account, a listed share or a bond). Whether that new claim can be realised to support the saver’s lifestyle in retirement depends on the strength of the economy in each year up to and in retirement (and standard supply/demand pressures).

Whole countries cannot defer consumption by ‘saving’ for their citizens’ future retirement[2]. What they can do is re-arrange economic claims in today’s economy. And the way those are re-arranged for retirement incomes doesn’t much matter at the ‘macro’ level: whether they are public or private, defined contribution or defined benefit, pension or lump sum, pre-funded or PAYG. However, what they are ‘re-arranged into’ matters greatly.

Questions New Zealand needs to discuss on public vs. private economic claims:

  1. Do more savings in accounts like KiwiSaver schemes and the New Zealand Superannuation Fund improve New Zealand’s (not individuals’) ability to finance the retirements of increasing numbers of older citizens?

  2. What is the international evidence on the economic impact of government-encouraged (or forced) private savings?

  3. How do the total claims (private and public) on the economy by older New Zealanders today compare with the equivalents in other developed countries?[3]

  4. What are the expected trends in total claims (private and public) in New Zealand over the coming, say, 40 years?

  5. How do New Zealand trends in total claims (private and public) compare with the equivalents in other developed countries?

  6. How have other countries adapted those total claims (private and public) to changing patterns of work and retirement? What lessons might New Zealand draw from those examples?

There was no mention in the Terms of Reference for the Retirement Commissioner’s 2019 Review of the issues associated with the future claims on our economy that will represent the effects of an ageing population. As we have said, public pensions and private retirement savings are both claims against the economy to support the old. Neither is more ‘secure’ than the other, as both depend on the strength of the contemporary economy. Countries cannot ‘save for retirement’.

[1]This section is based on a submission by Michael Littlewood for the Retirement Commissioner’s 2016 Review: Ageing populations, retirement incomes and public policy: the four ‘first principles’ of policy-making - A submission to the Commission for Financial Capability (accessible here).

[2]A concept proposed by Nicholas Barr in The Economics of the Welfare State, Stanford University Press, 1987.

[3]The case of Japan is interesting – Japan’s total population is falling with a 330,786 (0.3%) net loss of births over deaths in 2016. The pace of reduction over the previous eight years was increasing. The government estimates that Japan’s population will fall from 127.1 million in 2015 to 88.1 million in 2065 (see here). We should understand the economic implications for Japan of future pension claims (public and private). New Zealand, on the other hand, expects the current (2016) 4.69 million population to grow to 6.52 million by 2068 – StatsNZ National Population Projections 2016-2068, median estimate (accessible here). For retirement incomes, the population’s age mix is the significant issue.