Economics and similar, for the sleep-deprived

A subtle change has been made to the comments links, so they no longer pop up. Does this in any way help with the problem about comments not appearing on permalinked posts, readers?

Update: seemingly not

Update: Oh yeah!

Monday, December 16, 2002

Pensions (too tight to mentions)

Well ... some call it hypocrisy, others call it "balance", me, I'm a neutral arbiter. But despite yesterday's pissy little rant about "deafening silences", there are a few issues where I am always personally unable to believe that nobody cares about the same things as me. The issue which is disturbing my digestion at the moment is that of defined benefit pensions ...

[Do you know, the moment I typed that sentence, I suddenly realised why it was that nobody cared? It is part of the folklore of direct mail advertising that the three words which are most likely to attract readers' attention are "free", "sex" and "chocolate". It is a hunch of mine that the three words most likely to turn off any incipient interest are "tax", "regulation" and "pensions"]

Nonetheless, for all that people don't care about pensions, they ought to care about pensions. I mean the word "ought" here in a normative but non-moral sense; the mass of the world are not bad people for not caring about pensions, but their lives would be better for them if they cared about pensions. Because, with the possible exception of war in Iraq, the current phenomenon which has most potential to effect the aggregate welfare of the developed English-speaking world, is the "reform" of pensions. Another lexicographical note; when I use the word "reform" here, I mean it in its normal sense, the sense in which advocates of reform throughout the ages have used it. In other words, I am using "reform" as shorthand for "a disgraceful attack on the common man by those better off than himself, which is made to look less disgraceful by lying about it".

I'll use scare-quotes to make it clear that by "reform", I mean nothing of the sort.

The "reform" in question is the ongoing replacement of final salary pension schemes by money purchase schemes in the private sectors of the USA and UK. If you've read my mug's guide to the subject (not many people did, possibly because I was a bit patronising to people who hadn't heard of the subject), then you'll know that, whatever the whys and wherefores of your personal beliefs about what you'd like to do in saving toward your retirement, it is impossible to deny that a shift from final salary (also referred to as "defined benefit") pension schemes to money purchase (or "defined contribution") schemes, represents a transfer of risk from the employer to the employees. I'm using "impossible to deny" here in its strict sense; there is a mathematical proof of this proposition.

Now, transfers of risk aren't always one way transactions; when you insure your car (or for that matter, your life), you transfer risk to the insurance company, but in general this is a transaction which benefits both parties. On the other hand, it's also a transaction which is noncoercive and typically takes place in a competitive market between relatively well-informed parties. Changes to pension schemes often lack any or all of these crucial factors. I'm not saying that all (or any particular) instance of pensions "reform" is a hell of a rip-off for the employees. I'm not saying that the fact that employers are mad keen for pension "reform" should probably be considered pretty good evidence that there's something in it for them. I'm not saying any of these things. I am, as they say, just sayin'.

Let's start off with an analogy. Say your cousin Kevin borrows ten pounds from you on Monday, telling you he's going to put it on a horse running on Sunday at ten to one. Then you see him on Wednesday, and he tells you he's made a decision. Instead of paying you back the tenner, he's going to give you half his winnings on the horse if he wins, and nothing if he loses. What would you do?

Yes, right, wring his fucking neck.

Quite. And it is my contention that this is exactly the sort of thing that is being carried out under the name of �pension reform�. I�d hesitate to say at this point that pension law and economics are extremely complicated, and that it is certainly far beyond my ability to pass definitive judgement on any particular actions of any particular pension fund, its sponsor or its trustees. It�s often the case in this field that seemingly innocuous measures can actually be quite deviously awful, while actions which appear prima facie to be unconscionable confiscations are actually perfectly legitimate risk-sharing transfers. I don�t want to get into any specifics. But as to the question of whether the general shape of what is happening to pension provision in the Anglo-Saxon economies passes the ISDTTMIWHFN test (if someone did that to me, I�d wring his fucking neck), my personal assessment is that it doesn�t.

It clarifies matters considerably to think about the question in the following manner. In general, we say that there are two types of funding used by companies; debt and equity. However, Marx and Ricardo, among others, noted that there is a third kind of finance, which is both far less well-defined under common law, and often quite material to a company�s financing, and that is deferred wages. If debt finance is the proportion of a company�s capital assets which are bought out of money advanced by creditors in exchange for a promise of repayment, and equity finance is the proportion of a company�s capital bought out of money advanced by investors in return for a fractional title to those assets, then deferred wages is that proportion of a company�s capital assets which are effectively bought out of the sale proceeds of goods produced by workers who have not yet been paid for producing them, in return for which, those workers get ... what?

Deferred wages finance, like bank loans, comes in short-term and long-term varieties. The short term, �working capital� kind of deferred wages finance is simply generated by the system of paying wages partially in arrears, and having paydays once a month rather than paying workers immediately they produce a piece of work. Although this is often ignored in classical theories of the financing of an enterprise, economic analysis has no real problem in dealing with this; it is simply a short term, working capital loan advanced by the worker to the employer. In some cases (I am thinking particularly of commission salesmen working on annual bonus payments), the sums can be really quite substantial, and ever since Marx and Ricardo�s day, the employees of bankrupt firms have been surprised to discover that without realising it, they have effectively been acting as creditors.

However, once we have carried out this piece of fairly obvious analysis, the conclusion seems inescapable that the pension fund obligations of a company also represent financing claims on it. Although this fact is obscured by the thickets of legal wrangling which surround the ownership and trusteeship of pension fund obligations, the truth of the matter (since about the 1980s) has been evident on the face of the balance sheet of most companies; the pension fund obligations are recorded as a long term liability; a claim on the cashflow and assets of the company which is not debt, not equity, but which nonetheless represents a binding obligation on the firm, one which was provided by someone in anticipation of a future benefit and one for which some present benefit (presumably, a higher cash wage rate) was sacrificed.

Right now, we can see that an important and politically significant truth is concealed by the very language of pensions-speak. Pensions are not �employee benefits� any more than dividends are �shareholder benefits� or coupon payments and principal redemptions are �creditor benefits�. Pension fund members are suppliers of investment capital to the firm, not vassals or serfs of it, and the payments made to retirees are not tokens of gratitude for long service, but the redemption of investments made over time. I only hesitate to publicise this fact more as I fear that it would make the retired persons� associations of the self-titled �Greatest Generation� even more insufferably self-righteous than they already are.

But the analysis I want to make right now is a comparative one of the legal rights and protections afforded to the three classes of investors. Debt investors are, of course, protected by the full apparatus of the common law; though it be ever so complicated in its development and specifics, the law relating to debt investments stems from the tort of breach of contract, and most of its judgements can be reasonably predicted by the consideration of the nature of that tort. The law relating to equity investors is somewhat more modern as it only came into being with the creation of the joint stock corporation in the eighteenth century, but by the Companies Act 1824, it was quite recognisable in its modern form; the protection of equity investors stems from a fiduciary duty of the directors and officers.

The law relating to investors through deferred wages, however, is much less clear; much of it is implicit rather than explicit and all of it is much more recent and less settled. For short term wage creditors, things are reasonably clear; unpaid salaries rank (under UK law; yours may vary, but not too much) just above floating charge-holders; behind mortgagors, bankruptcy practitioners� fees, excise duties and PAYE, but ahead of corporation tax and outside unsecured creditors. Things become much more murky when one gets into the matter of bonuses and deferred commissions, but this murk is as the sparkling waters of Lake Treviso when compared to the law relating to pension funds.

The trouble with pension funds is that for too long, they have been treated as if they were benefits provided by a benevolent employer, rather than as a long-dated financial claim. Pension fund claimants have few rights; they have the right that the employer keep sufficient financial asset holdings to reassure an actuary that the claims can be paid, and that these asset holdings be held in a trust legally separate from the company. They have the right to appoint a minority of the trustees of that trust. And that is about it.

Which brings us back to the ISDTTMIWHFN issue above. Although there is no contract between us, I had provided �10 sterling of finance to my cousin Kevin on the understanding that we had a debt-like contract in which he was bearing the risk that the underlying investment (the horse) would fail to produce its expected returns. When he chooses to take advantage of the ambiguity of the contractual relationship between us to unilaterally alter our contract to an equity-like one, in which I share the risks and rewards of being a bettor on the 3.30 at Kempton Park, then, whatever my personal beliefs regarding the likely investment performance of Lucky Boy, I would consider myself to be in a WHFN situation.

Add on top of this the fact that according to the last survey, the shift from final salary to money purchase pension schemes in the UK has resulted in, on average, a halving of the cost of provision to the companies who run the schemes (which however way you cut it up, has to be considered equivalent to a c5% cut in wages!), and the fact that nobody seems to care about this becomes even more curious. All in all, it�s a shame that pension fund economics isn�t as interesting as horse racing.

0 comments this item posted by the management 12/16/2002 11:33:00 AM

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