Mr Micawber and the application of Endogenous Growth Theory

Brian Spence

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I am not sure who Gordon “we’re listening” Brown, our beleaguered prime minister and former chancellor, turns to for guidance in matters economic, but he could do worse than have regard, not to Keynes or Galbraith, but to Charles Dickens. Whether you are responsible for a household, corporate or national budget, we can all understand and relate to the conclusions of Mr Micawber on the happiness engendered by a budget surplus, the misery caused by a budget deficit and the fine line between the two.

The already huge and rising level of public borrowing and Mr Brown’s chronic inability while chancellor to produce anything approaching a balanced budget, would go a long way to explaining his apparently permanent miserable state. The turmoil in the financial markets means his demeanour is unlikely to change any time soon. But while governments around the world intervene in the “free” markets to an extent which would have brought a tear to Stalin’s eye, and Joe Public’s hard-earned tax revenues are used to bail out the arch enemies of state intervention, there is another elephant in the Cabinet Office which poses a further threat to the Government’s finances.

New Labour came to power wanting to think the unthinkable and say the unsayable. So here goes. Sooner or later the Government, of whatever hue, is going to have to cut public sector pensions. And ideally sooner.

The cracks are beginning to appear. Scottish police forces have been faced with implementing a recruitment freeze as a result of the level of the black hole in their pension fund, currently in excess of £50m. Money needed to be found from somewhere as the Scottish forces did not centralise their budgets with England and Wales in 2005 and the Government is refusing to commit additional resources.

But how surprised should we be by this? At the start of 2007, Sir Willie Rae, head of Scotland’s biggest police force, Strathclyde, suggested that the force was becoming more like a pensions agency than a law enforcement body as its pensions bill could soon rise above staff wages. Early in 2008, we saw £600,000 which had been allocated to help pay for extra security reallocated by Lothian & Borders police to fund its £3m pension deficit and Grampian Joint Police Board confirm that it had to fund its shortfall through the annual police authority budget.

The Scottish government has now pledged £32m to provide for some form of parity for police and firefighters with their colleagues in England and Wales but you have to ask the question if this will solve the issue completely and indeed if it does, for how long. Kenny MacAskill, Scotlands justice secretary, has admitted that the Scottish government is “also addressing the longer-term pension issues.”

These issues help to highlight the time bomb that is public sector pensions, which for many years have been living way above their means without any action having been taken. The public sector schemes have not responded to reduced investment returns and increasing longevity to the same extent as the private sector and, should they not do so, the position will continue to deteriorate and more stories of this nature will continue to emerge.

It is important to note that this is not just an issue faced by the major public sector bodies but also by much smaller organisations, such as charities and not-for-profit organisations, which participate in major public sector schemes. There is a significant lack of awareness among them of the issues faced.

The Government has rightly identified that the growth in the number of workers in the public sector, the level of salary inflation and, probably most significantly, the impact of improved longevity all threaten to push public spending on pensions above the stated objective of costing no more than 2.1% of GDP. The Government also wishes to move towards a system where private provision accounts for 60% of the total, rather than the current 40%.

Ultimately, paying out pensions for more people for longer will put a significant additional strain on the public purse. This will necessitate government action to try to control sponsor cost.

Changes to be implemented in public sector pensions go nowhere near far enough in addressing the issues faced. Within the private sector, final salary pension provision continues to decline with NAPF statistics suggesting that already 70% of existing schemes are closed to new entrants with around 10% closed for all further accruals. This trend is only likely to continue. It seems likely that most private sector workers would probably welcome such limited change with open arms.

An argument put forward against change is that salary levels in the public sector are below those of comparable jobs in the private sector. However, recent statistical evidence suggests that not only are benefits comparable but in some areas considerably higher. The biggest differences are in Northern Ireland and the north-east, where private sector graduates average £12 an hour compared with £15 in the public sector. This differential falls to £1 an hour in the West Midlands, the north-west and the south-west. Only public sector employees in London and the south-east are worse off than their private sector counterparts in pure salary terms. This, however, does not include the improved level of pension benefits available, which Pensions Policy Institute (PPI) research suggests – even after the changes proposed – represents an improvement over equivalent benefits in the private sector anywhere between 3% and 18%.

It is welcome news that, on average, we are living longer. As such, the proposals to move provision of full retirement benefits from 60 to 65 seems rational, given the improvements in life expectancy – improvements which all within the UK must come to terms with. Benefits would still be available from 60, but would be discounted to reflect early payment. The argument here is that we would not expect a policeman to be patrolling the beat or a fireman to be entering a burning building when they were 64.

This, however, is not a phenomenon unique to the public sector. Private sector schemes, for example those providing benefits for deep sea divers, must come to terms with this issue. It also seems a bit patronising to suggest that, just because an individual cannot do his current job, he ceases to be a productive member of society. Recent information suggests that, with declining birth rates in the UK, the economy needs people to continue to work beyond 60 and 65 if it is to continue to grow.

It is not just a problem with those retiring at 60 but, based upon startling statistics produced by the PPI in March 2005, it is also about those who require pension provision before the age of 60. The PPI figures show that, between 1995 and 2000, 68% of all fire service retirals were ill-health early retirements. This figure was 49% for the police; 39% for local government; 25% for teachers; 23% for the NHS; and 22% for the civil service. These figures compare with a level of well below 20% in the private sector. This is a very significant additional cost to the public purse.

At least these issues are now being drawn to public attention. This is a debate the Government, acting on behalf of taxpayers, cannot afford to lose and we should all be watching developments with interest.

On reflection, perhaps the more mainstream economists do have a contribution to make on this matter. J K Galbraith, in a 1962 letter to President Kennedy, made the following telling observation: “Politics is not the art of the possible. It consists of choosing between the disastrous and the unpalatable.”

Are you really listening, Mr Brown?

Brian Spence

Post by Brian Spence

Fellow of the Institute and Faculty of Actuaries and Society of Actuaries in Ireland, scheme actuary, professional pension trustee