Thursday, 27 September 2012

Is pensions auto-enrolment good for the economy?

Rock superstars no longer ‘just fade away’. Rather like monarchs and popes they nowadays keep going until called to the great hall of fame in the sky. With improvements in health aiding ‘active ageing’ it’s becoming increasingly common for people from all sorts of occupational backgrounds to put off retirement too. But while for some this is a matter of lifestyle choice, a growing band of older people are finding it financially difficult to slow down in later life and need to stay in employment simply to keep the wolf from the door.

One reason is the paucity of decent pension provision against the backdrop of increasing longevity. Last week the Office for National Statistics (ONS) told us that only around 8 million people in the UK are contributing to workplace pension schemes, the number of savers working for private sector firms having more than halved to just 2.9 million in the past two decades. With the state pension never likely to offer more than a meagre ration, the stark choice facing the remaining millions if they are to avoid poverty in later life is thus that between saving more while young and/or working well beyond their mid-sixties.

Policy makers have for more than a decade been wrestling with how to deliver the necessary wake-up call on this issue, especially with regard to pensions. Most of us don’t like to think about getting old and would rather spend today than save for tomorrow. But next week sees the start of a major effort to nudge us toward saving much more with the introduction of auto-enrolment to workplace pensions.

Employers will have to enrol employees aged over 22 not in a pension scheme and earning more than £8,105 a year onto a workplace pension scheme to which both employers and employees will make at least a minimum contribution alongside a taxpayer contribution.  At first only large businesses will have to comply, with employers and employees required to contribute no more than the equivalent of 1% of the employee’s basic pre-tax pay. But by 2018 employers of all sizes will be covered, with employer and employee contributions gradually rising to 3% and 4% respectively.

The policy amounts only to a nudge because participation isn’t compulsory for employees. Those eligible can choose to opt out if saving a chunk of their pay cheque doesn’t appeal, though this means losing out on the employer and taxpayer contributions. Nonetheless, the expectation is that around two-thirds of those automatically enrolled will decide to contribute – around 8 million people by 2018 – which will give a massive boost to overall pension saving.     

However, despite the broad political consensus in favour of auto-enrolment some business groups have warned of potential adverse impacts on cash strapped small employers who may find the cost and red tape associated with providing employee pensions difficult to bear. This it is argued will harm economic growth and cost jobs. But relatively little attention has been paid to the possibility that encouraging more people to save in what remain very tough times will slow the pace of economic recovery by curbing consumer spending.  

As the ONS confirmed this morning, the economy contracted by 0.4% in the second quarter of the year and has been contracting since last autumn. Even if this marks the trough of the double dip recession few economists expect an early return to strong economic growth. So what might be the effect of auto-enrolment in this context?

Given that the policy is a slow burn, with only around 600,000 employees expected to be enrolled by the start of 2013 and minimum contributions initially set very low, the immediate impact on overall consumer spending should be small. But with the likelihood of several years of relatively slow economic growth, and the prospect of little if any improvement in real take home pay for most workers, the dampening impact of auto-enrolment could well become significant.

Not only will more workers be drawn into pension saving but as time goes on those enrolled will start to bear a bigger financial burden since labour market economics suggests that employers will gradually shift the additional costs they incur onto employees by way of curbing pay rises. Eventually, therefore, the effect of auto-enrolment will be to shift at least 7% of the pre-tax  earnings of participating employee into savings. If the real value of those earnings is static or only growing very slowly it’s difficult to avoid the conclusion that this will hit consumer spending.

However, while this will be painful for our ‘live for today, forget about tomorrow’ culture it isn’t necessarily bad news for the long-term health of the economy. We need as a society to be saving more to meet the cost of an ageing population and we also need to rebalance the economy away from over-reliance on consumption and toward productive capital investment. Auto-enrolment can help in both respects, with the possibility that even the short-run impact on economic growth might be limited if we get better at channelling pension savings to financing investment projects. As those classic ageing rockers The Rolling Stones might put it, when it comes to the choice between saving or spending more today ‘you can’t always get what you want, but you get what you need.’  

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