Reaction to Superannuation Scheme
Deutsche Bank
Friday, October 13th 2000, 12:00AM
On 10 October, the Government released further details of its proposed scheme to partially pre-fund New Zealand's estimated future retirement income needs. The key features, which broadly matched our expectation, were:
- contributions will be made from general taxation, paid for from the operating surplus, with the actual contribution rate set by the Government, based on advice from the Treasury on the required rate;
- the Government reserves the right to vary the actual contribution from that recommended by the Treasury, for example, if surpluses prove insufficient, although the Government would need to explain how it would make up for the shortfall in future years;
- the required contribution rate will be calculated annually by the Treasury based on a forty-year rolling horizon, so that the annual rate is 1/40th of the amount needed to fund 40 years of superannuation;
- the contribution rate in the Treasury's modelling assumes the transition path specified in the Budget is followed ($600m in 2001/02, $1,200m in 2002/03 and $1,800m in 2003/04). Between 2004/05 and 2009/10, the Treasury estimate that the required contribution rate will be 1.7 - 1.8% of GDP;
- the fund's assets are projected to peak at roughly 50% of GDP sometime between 2023 and 2029, although the actual size will depend on factors such as superannuation costs and the investment strategy pursued.
- a Crown entity Board called the Guardians of New Zealand Superannuation will be set up to invest the assets of the fund. The Board, which will be independent of the Government, will be responsible for determining the investment strategy of the fund, allocating portfolios to fund managers to invest, monitoring the performance of these portfolios and amending allocations if necessary;
- the Board will be required to invest the fund on a sound commercial basis. The fund will have investments that have risks associated with them, although it is envisaged that the Board would invest in a manner that is prudent; the fund will be established through a new Act, the New Zealand Superannuation Act, that will bring together the funding and entitlement aspects of superannuation. The Government intends to introduce the Bill later this year and it will be enacted in April 2001.
The Government appears to have the numbers to implement the scheme The proposal by the minority Labour/Alliance Government appears to have the support of other minor political parties (the Greens and New Zealand First). This suggests that the scheme will go ahead, subject perhaps only to minor amendment (eg the Greens are likely to demand some restrictions on the specific assets in which the Fund is able to invest). In any case, the Government had indicated an intention to begin to put aside surpluses even if additional support was not forthcoming, in anticipation of making superannuation an election issue.
It is important that the debate about the provision of retirement income continues Some commentators, including our Chief Economist, have been outspoken critics of the scheme. While this author also shares some of the same concerns raised by the critics, one has to now accept that the scheme will likely go ahead. However, this does not preclude continued debate about how one deals with the future pressures on the provision of retirement income and the maintenance of living standards more generally - in this author's view, the scheme fails to tackle the real issues.
The Government's current approach is focused too much on a static view of the economy - one grounded in the accounting problem of how one transfers financial claims from one sector of society to another - rather than on a dynamic view of the economics of superannuation and an aging population. Put simply, practical considerations mean that individuals do not have the option, over their lifetime, of putting aside physical goods and services sufficient to meet their expected future requirements. Many goods are perishable; those that aren't would require a huge amount of storage space. In addition, most services can not be stored eg electricity, telephone services and doctors appointments. Therefore, it is an inescapable fact that the future retired generation can only consume either (a) the non-consumption (i.e. savings) of the future working generation or (b) the non-consumption of foreigners on which they hold financial claims.
The usual approach to superannuation is, therefore, to build up financial assets that can be converted to claims on the output of future working generations, either domestic output or that of foreigners. But individuals can not eat bank notes or accounting book entries - the value of financial assets rests in their ability to be converted into real goods and services. If the retired generation demands more goods and services than the working generation is willing to forego, the result will be excess demand for goods and services - phenomenon that will occur across the Westerm world. The issue then becomes how is excess demand reconciled - through a temporary bout of higher inflation or though higher current account deficits? Inflation acts to reduce the real value of the retired generation's savings in particular, thus reducing the retired generations demand for goods and services. If foreigners, faced with similar demographic pressures, refuse to fund increased current account deficits at the prevailing exchange rate the currency may depreciate, again acting to reduce real incomes and spending power. Thus pre-funding superannuation may not even solve the income transfer problem.
In this author's view, the Government's pre-funded superannuation scheme may have a some role to play in helping to deliver future retirement incomes, but it should not be seen as the entire answer to the problem. To the extent that a rise in Government savings is translated into an increase in national savings - and the experience of recent years suggests there is considerable cause for doubt - it is conceivable that the scheme may be partially successful in transferring real resources from the present to the future. Whether or not it will raise investment in the economy and thus stimulate wealth creation requires a further leap of faith. By encouraging a lower current account deficit, the scheme may lead to a modest reduction in the premium New Zealand's pays to access the world's capital markets, thus encouraging investment. But to the extent that the existence of the scheme makes impossible other options, some of which are discussed below, the net impact of the scheme is less clear. Cabinet papers released by Dr Cullen devoted remarkably little space to the economics of the scheme. We have lodged a request under the Official Information Act to receive copies of any advice provided to Dr Cullen by the Treasury on the economics of the proposed superannuation scheme and on the economics of coping with an aging population.
In our view, the key economic issues are:
- how can a relatively smaller working generation produce sufficient real goods and services to meet the demands of the entire population?
- can one influence, through public policy, the dependency ratio ie the ratio of retired to working age persons?
Policies to encourage physical investment and R&D are needed: We are aware of no evidence to suggest that New Zealand's physical and intellectual capital stock lies above the optimal level. The Government needs to explore options for encouraging greater physical investment and R&D. In a world of open capital markets, inevitably this means looking again at corporate tax rates and other means by which Government policy impinges on investment and R&D decisions. The revenue consequences of such policy changes may, all else equal, reduce the surpluses available for investing in the Government superannuation scheme.
Disincentives to private saving also need to be identified and tackled. Greater emphasis needs to be given to equipping people with the skills the world demands: It should go without saying that in an increasingly knowledge-based economy, education is the key to sustaining rapid growth in incomes. Increasing focus needs to be given to providing people with the necessary skills to participate productively in the economy, rather than educating people for education's sake.
The economic reality is New Zealand can not afford an education system that fails its students. This means that consideration needs to be given to upgrading both the quantity and quality of spending. Of course, for a given tax burden (and we accept that a low tax burden is desirable for reasons of efficiency), more spending on education leaves less funds available for other forms of spending - including the Government's prefunded superannuation scheme. In our view, in a world of scarce resources, it is desirable that the Government is forced to balance and prioritise its spending.
The Government should encourage greater labour force participation: Undoubtedly part of the solution is to pursue policies that seek to encourage greater participation in the labour force. Clearly the interface between the tax and benefit system and the so-called replacement ratio have a major influence on work incentives. This needs to be borne in mind when forming social policy.
Consideration also needs to be given to the policies needed to attract people into the labour force who would like to participate, but currently find it difficult (eg people at home caring for children). A mere 2 percentage point increase in the average labour force participation rate could add a further 60,000 workers to the labour force by 2040, boosting the economy's productive capacity.
The age of eligibility should continue to rise: Advances in living standards and health care mean that people are able to work safely to a more advanced age than in the past. This trend is likely to continue and there seems little reason to assume otherwise. Raising the age of eligibility for superannuation gradually over time from 65 to 70 could add around a further 150,000 workers to the labour force by 2040 (based on Statistics New Zealand's demographic projections and current labour force participation rates for the 60-64 age group). Raising the age of eligibility is surely part of a sensible response to aging pressures and the Government's proposal to fix the age of eligibility at 65 should be dropped.
Immigration policy can also play a role: Increasing the intake of working age immigrants would help to partially offset the aging of the population structure.
By itself, immigration will never be sufficient. In order to maintain the same ratio of working age persons to those aged over 65 years as exists currently, approximately 3,750,000 working age immigrants would be required by 2040, i.e. a net inflow of 94,000 per year! Over 1,000,000 working age immigrants would be needed to maintain the same ratio of working age persons as a proportion of the total population. The reality is that such an inflow is unlikely to be sustainable in social and political terms and would itself pose considerable stresses on the economy.
However, a more modest net inflow of, say, 15-20,000 working age immigrants per year seems reasonable (equivalent, perhaps, to a net 30,000 migrants in total given accompanying dependents). Aside from the purely fiscal benefits, skilled migrants are also likely to bring qualities that help to raise productivity across the economy.
A more comprehensive solution is required
To conclude, in this author's view, a comprehensive solution to meeting New Zealand's future retirement income needs is necessary. Reliance on just one approach is unlikely to deliver optimal outcomes. A more comprehensive solution would include:
- a more limited form of pre-funding (which could be delivered by further reduction of gross debt rather than setting up a dedicated fund of assets);
- more and better targeted spending on education;
- policies to encourage increased labour force participation;
- a further gradual rise in the age of eligibility for superannuation;
- and an increase in net immigration of skilled working age migrants.
To the extent that a comprehensive approach is followed, the required contribution to the proposed superannuation fund will be somewhat smaller, and economy activity - and thus overall prosperity - somewhat greater.
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