What’s the Point of Pension Funds?

WARNING: Political philosophy thought experiment ahead.

John and Jane are stranded on (snore) a desert island together. John’s getting old, and knows that one day he won’t be able to hunt, gather, fish, etc. He says to Jane: ‘If I help you out now, will you promise to look after me when I’m too old to help myself?’ Jane replies, ‘Yes’.

Congratulations, John and Jane. You’ve solved a problem that seems to have bamboozled the entire political class: the problem of pensions.

Alternative scenario. John says to Jane: ‘One day I’ll be too old to work. Hunt and gather food for me and store it in a silo. When I’m old, I’ll eat the food from the silo.’ Jane then works to fill up the silo. In addition to producing the surplus of food, she has to expend extra effort maintaining the silo. How pointless. Whatever surplus she can produce today, she could just as easily have produced later. The extra storage costs are unnecessary.

Boo, John and Jane. You’ve screwed it up, just the way the political classes do today.

John and Jane’s mistake, in the second scenario, was to start a pension fund. We’ll be just as able to produce extra output tomorrow as we are today, indeed more so if we spend now on things that increase productivity – education in particular – instead of saving for the future. Why not focus today on providing what we need today? We can focus tomorrow on providing what we need tomorrow.

What screws up people’s reasoning on this, as usual, is money. Imagine that there’s a third person on the island, Frank the Fund Manager, and that Jane can somehow convert the extra food she produces into money. She produces a surplus, converts it into money, and then stores the money in a silo. She then gets Frank to ‘manage’ the money in the silo. When John retires, the money will be converted back into food for him. But in the meantime Frank needs to eat, so Jane and John also need to produce extra food to feed him. Why? Frank could be helping to produce food. Jane may as well wait to produce the extra food until John is ready for it. No need to produce it now.

Likewise, I have no idea how storing up money in pension funds is meant to make the future economy more productive. I guess it comes down to the old-fashioned, pre-Keynesian belief that investment requires savings: we need to build up a stock of capital to finance new production. That was true when money was tied to some real resource like gold. It’s not true now. If a bank (or a pension fund) wants to make a loan, it doesn’t go into its vault and scoop up gold coins first. It finances the loan from the borrower’s future income stream. In some countries, it needs to maintain legal reserve requirements, but that’s all.

The current pensions system reminds me of those factories that were built tall and thin to accommodate the steam-pistons – even though the machines already ran on electricity. When it doesn’t run on steam power, there’s no point building a factory tall and thin; in fact it’s a massive inconvenience. When money is just an accounting record, there’s no point in beavering it away like Long John Silver. It serves nothing but a misplaced sense of nostalgia.

If your fund manager is clever about trading with other fund managers, you might end up with more in your silo than others. But it’s a zero-sum game. It has to be, since when we retire the actual stuff we’ll all be able to buy will just be whatever is being produced at that time.

Indeed, that will be less than it would have been if people had been able to consume their income instead of saving it. Investement is spurred by consumption. And, again, current spending on education or just better nutrition increases future productivity. And employing fund managers uses up labour that could have been used for real production (innovation, management, etc.).

The government should just promise to issue every retiree with enough money to maintain a decent standard of living, buying what they need out of future production. Since they can issue this money then, there’s no need for anyone to save it now. When productive firms need to borrow for capital development, lending agents can finance the loans from the future income stream. They don’t need to be sitting on piles of capital. Sitting on capital guards them against risk, but that’s just another way of saying it lets them slack off from doing their underwriting properly – i.e. make worse investments. Yes, they need to attract savings in order to maintain their cash buffers, but there’s no reason for the savings they attract not to come out of the proceeds of the investments they finance. You need investment to have saving, not the other way around.

Contributing to pension funds by saving out of current income is unnecessary, adds costs, and supports a financial sector whose human capital could have been used for real production. By restricting current consumption it reduces opportunities for investment. Pension funds aren’t a stock of capital. They’re a drain on capital. Or have I missed something?


5 thoughts on “What’s the Point of Pension Funds?

  1. NeilW

    Pension funds are a job guarantee for finance and insurance types, and a way of increasing the earnings related state pension via the back door (Gilt interest). It’s the only rational explanation.

    Pensions are always a current production issue. If you cut down on investment now then even if you have a billion currency units in the future you won’t be able to buy anything with them – because the producers at the time will be back on a subsistence existence.

    1. axdouglas Post author

      ‘Pension funds are a job guarantee for finance and insurance types’ – I almost want that on a t-shirt.

  2. Ralph Musgrave

    What you’re advocating is what’s called “pay as you go” pension schemes. They already exist: the UK’s state pension scheme is pay as you go, as are some private schemes.

    Re your last paragraph, pension scheme contributions (even in a pay as you go system) do have a point: first the money supports today’s pensioners. Second, total contributions during someone’s working life are normally related to what they get on retirement (both in the state and private schemes) and that makes some sort of sense.

    1. axdouglas Post author

      PAYG schemes still require somebody (current workers) to save out of their current income. That’s what I don’t see the point of. The government can support today’s pensioners by just issuing them money.

      Rewarding people for making contributions during their working life is just rewarding them for not spending all their income. That means less investment. The more people cut back on current spending, as Neil points out above, the less there’ll be for them to buy in the future, no matter how much currency they’re issued as a ‘reward’ for their contractionary efforts.

  3. Pingback: What My Students Taught Me About Capitalism | Origin of Specious

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