The pensions myth – part two

Last week’s public sector workers strike in Britain against the reductions in the value of their pensions exposed the pensions myth – namely that decent pensions for those who retire after a lifetime’s work are ‘unaffordable’ without extending the years at work, increasing contributions while at work and cutting the real value of pensions over time.  In the first part of my posts on the pensions myth (see The pensions myth – part one, 3 December 2011), I argued that it was perfectly possible to deliver a decent state pension for all at the existing retirement age – as long as average real GDP growth in the major capitalist economies rose significantly and governments adjusted their taxation and spending policies towards people’s needs and not towards support for the rich elite controlling capitalist production and distribution.

The UK spends just 5.7% of GDP on pensions (state, public and private) compared with 7.2% average in the OECD.  Yet, in the UK, we have 27% of our working population aged over 65 compared to 24% in the OECD.  So Britain’s pensioners have the fourth-highest level of poverty in Europe, worse off even than Romanian and Polish pensioners in relative poverty terms.  Nearly one in three British pensioners are ‘at risk of poverty’ compared with just 19% for the EU average.

The solution of the mainstream would not even begin to reduce the relative gap with the OECD average or even increase pensions in real terms.  On the contrary, measures to cut the real value of pensions by indexing for a lower rate of inflation would take 15% off the real value of pensions over the lifetime of an average pensioner, while delaying the retirement age and increasing contributions at work would make it even more costly to obtain. Former right-wing Labour minister Lord Hutton was commissioned to produce a report on public sector pension schemes in the UK.  As the Hutton report itself says: “this change in the indexation measure may have reduced the value of benefits to scheme members by around 15 per cent on average. When this change is combined with other reforms to date across the major schemes the value to current members of reformed schemes with CPI indexation is, on average, around 25 per cent less than the pre-reform schemes with RPI indexation.”  A nurse who retired at 60 in Hutton’s planned new career average scheme would have a pension 40% lower than a counterpart with an equivalent career but retiring at 60 in the final-salary scheme.  And working another five years to 65 would still leave them 20% worse off.  The increased pension contributions that public sector employees are being asked to make in the next few years would amount to some staff paying 50% more each year.

The reforms that the mainstream plans throughout the OECD are based on the fact that the mature capitalist economies are getting older.  It assumes that decent pensions are ‘unaffordable’ under present arrangements.  But then they always were!  There are no decent pensions for the average retiring employee, whether working in the public or private sector.  Under the current system, the tax-financed state pension in all rich capitalist countries is not enough for comfortable retirement.  So workers in the public sector can contribute towards government-run pension schemes, while some employees in the private sector can make contributions to a company scheme.  Employers make contributions alongside workers in both schemes.  And this is supposed to provide an additional pension to the state pension to fund retirement.

The most efficient way of delivering a decent pension for all would be to fund all pensions totally from taxation and other government revenues and administer it through a government pension agency.  It would be the most equitable, cheapest to run and simple to understand.  Even the Turner report on UK pensions, commissioned by the then government in 2009. which otherwise prescribed all the usual ‘reforms’ that the pensions myth demands, admitted that the cheapest, most equitable and effective pension scheme would be a universal taxation-funded state pension for all without means testing and doing away with costly private pension fund managers (

But no, we must have private sector company schemes, public sector contributory schemes and personal pension or retirement funds.  These are run by private insurance agencies and controlled by private pension funds and investment managers.  They are expensive to run, difficult to understand and, above all, fail to produce a decent pension for all.

The big debate in the UK is now between public sector and private sector pensions.  The government, in its attempt to save money in its fiscal austerity drive (see my post, The best laid plans of mice and George Osborne, 29 November 2011) argues that public sector pensions are too generous compared with private sector pensions and so must be reduced to be fair to all.  Fairness, as usual, means that everybody should be reduced to the lowest level and not raised to the highest.

The tabloid newspapers proclaim that public sector pensions are ‘gold plated’.  First, they are defined benefit pensions, meaning that the pensions depend on the final salary earned at retirement age and the length of service and not on how much contributions have gone into the pension pot.  Many private sector pension schemes were similarly ‘defined benefit’, but they have been gradually phased out to be replaced by ‘defined contribution’ schemes, where the pension is based solely on how much has been contributed and then invested in financial assets like stocks and bonds.  Indeed, in the UK, only 18% of private schemes are now ‘defined benefit’.

Second, public pension schemes are ‘unfunded’.  That means that, after paying out pensions and receiving contributions from workers and the various public sector employers, any deficit is topped up by taxpayers money.  No funds are invested in the stock market or in bonds; it is ‘pay as you go’.  Frankly, this is excellent, because it means that the pension funds are not subject to the vagaries of rise and fall of the stock market, as are most company pension schemes.  It makes for stability and avoids huge deficits, as I explain below.

But are public sector pensions in the UK ‘gold-plated’ and over generous?  Yes, we know about the huge salaries and pension pots that the top chief executives in local government, various quangos and some NHS managers, school head teachers and civil servants receive.   But the same grotesque pension schemes exist for top executives in large companies and in the banks.  Indeed, these huge public sector pension payouts only started when successive governments started to bring in ‘experts’ from the private sector to run government agencies because they were so ‘talented’ and ‘business-oriented’.  Of course, they expected private sector-type top executive pension pots.

The big economic experts who say these public sector schemes are too generous, based on final salary, early retirement and low contributions, don’t seem too concerned about ‘reforming’ their own pension schemes.  Take the International Monetary Fund (IMF) that produces regular reports calling for ‘pension reform’. The IMF’s Staff Retirement Plan (SRP) is a contributory defined benefit plan, provides a lifetime pension annuity, payable at age 50 with a minimum of three years of service.  The normal retirement age is 62.  Generous indeed!  In the UK, there are 12,082 public sector employees who retired last year on pensions worth over £50,000 a year, or twice the average wage.  And there were 100 who retired on over £100,000 a year.  Interestingly, 72% of these were NHS doctors, presumably consultants.  The others would have been chief executives of government agencies and top civil servants.

But this does not reflect the reality for the vast majority of public sector workers.  Public sector pensions in the UK are the lowest relative to earnings in the OECD!  The replacement rate (value of pension payout to income) is just 31% in Britain compared 39% in the US and 59% for the OECD as a whole.  The median average pension payment in local government is just £4000 a year, in the civil service it is £6000 a year and in the NHS £7000 a year.   And the average public sector pensioner receives only slightly more than the minimum income standard in retirement, according to the Joseph Rowntree Foundation.   The median average salary-linked public sector pension that is currently being paid out to a pensioner, is worth £5,600 a year.  That compares with £5,860 in the private sector, according to the National Association of Pension Funds (NAPF).  Using a mean average, some £7,800 a year is being paid in a public sector pension compared with £7,467 for a private sector salary-linked pension.  So there is not much difference.

Ah! Say the tabloids, public sector workers get to earn more when they are working as well.  So they need to have their wages curbed to be fair in the current crisis.  Well, for most of the last decade in the UK, average private sector wages rose faster than in the public sector until the Great Recession.  Then private sector wages contracted drastically.  In 2010, public sector wages stood some 24% above average wages in the private sector.  But this is misleading because many more public sector workers have higher education qualifications and are generally older and so would expect to earn more than a young shop worker in Tesco.  The Institute of Fiscal Studies (IFS) did a study that showed, after taking into account, education and experience, the mean average wage in the public sector was 7.5% higher than in the private sector in 2010.  But that was after the Great Recession hit private sector earnings.  With the current freeze on public sector pay and further curbs on wage rises to 1% a year until 2015, public sector wage rates will end up the same as the private sector on average, after taking into account different skills.  What is also interesting is that, in the south-east of England, the IFS found that private sector pay is higher than in the public sector even excluding educational qualifications and experience, but 9% lower in Scotland, Wales and the south-west.  The former region has all the banking, professional and business jobs while the latter regions are where the capitalist sector has just not delivered any decently paid jobs.  Without the public sector, incomes and employment in these regions would permanently depressed.

Basically, what the government and the mainstream experts want to do is destroy the better features of the public sector schemes and reduce them to the level and vagaries of the private sector schemes.  Some 87% of public sector employees are currently paying into a salary-linked pension scheme, compared with 12% of private sector employees.  Many of the salary-linked pension schemes in the private sector have been shut by employers.  Instead, 32% of the private sector workforce, including the self-employed, contribute to personal pensions and other schemes where there is no promise of a particular level of retirement income.

The Hutton report claimed that the current public pension schemes were unaffordable as the cost would rise from around 2% of GDP a year to 2.3% by 2020 if there are no changes.  This does not seem such a large increase.  And here is the real fakery.  This ‘cost’ is BEFORE any contributions made by employees and employers into the public sector schemes.  The total contributions in public pension schemes from employees is about 21% of pensionable pay, the same as in the private sector.  Indeed, contributions are much higher in the fire, police and armed forces. Once these contributions are added in, the cost to the taxpayer of topping up the ‘unfunded’ scheme to meet payouts is just 0.4% of GDP, rising to 0.8% by 2020, assuming the pathetic rate of average growth in the UK.  So 80% of public pension scheme costs are funded by public sector workers and their employers and not by the taxpayer.

Indeed, the main reason for the growing deficit on public sector schemes is not because public sector pensioners are paid too much or public sector workers contribute too little.  It is because 3m employees have left the public sector since 1991 due to privatisation and cuts in services, a fall of 45%.  Indeed, with the coalition’s pay freeze and planned further reductions in the public sector workforce (700,000 to leave by 2017), pension contributions will fall even further behind the growth in the cost of the pension payouts (something admitted by Hutton this week – of course his answer was even more reductions in the value of the schemes).  In contrast, just a 15% increase in the number of public sector workers (rather than a reduction) contributing to the schemes would close the gap.

The financial crisis is the main cause of the growing deficits in public (and private) pension schemes. The financial collapse has led to losses or lower returns in private sector ‘funded’ schemes that are invested heavily in the stock market.  Of Britain’s ‘funded’ schemes, 60% are invested in the stock market compared with only 36% in the OECD average.  This is what ruins funded schemes: their returns depend on the vagaries of the stock and bond markets. By 2011, according to the Pension Protection Fund, private sector pension fund assets covered only 83% of the potential payouts because of the falls in global stock markets.  Funded pension schemes just can’t do the job.  Moreover, unfunded schemes are much cheaper to administer than funded schemes, public or private.  In the private sector, it costs £41-47 per member per year to administer the scheme (ie pay fees to managers). In unfunded public schemes, it is as low as £7 a member.

Some 23 million are employed in the UK private sector. But only 3.2 million contribute to a workplace pension scheme that also includes a contribution from their employer.  The number of people actively saving in company pension schemes in the private sector has almost halved since 1991.  The Workplace Retirement Income Commission, which was commissioned to investigate the state of the sector by the National Association of Pension Funds (NAPF), recently reported that millions of private sector workers faced a “bleak old age” because they fell through the cracks of pension provision.  There are also 6.4 million people paying into personal pensions, which have no contribution from their employer. This is the only option for the self-employed.

And yet governments and ‘experts’ like the IMF everywhere want public sector pensions to be converted into ‘funded’ schemes that depend on high contributions from workers, longer working periods and volatile returns from the stock market.  Also pensions should be based on average earnings and not final salaries (except the IMF scheme!), again reducing their value.  If this were to happen and more workers opt out of schemes because they were too expensive relative to their wages (and that is what has happened across the board already), then the schemes would never pay enough on retirement.  So we end up with a deficit anyway and eventually, companies or the state would have to put more funds into them.

The pensions myth is just that.  Decent pensions for all is not impossible or unaffordable, even as populations get older in the make-up of the mature capitalist economies.  If economies grew faster, even at a rate at half that of China now, sufficient new value would be created to pay for the older generation to live comfortably when they stop work without squeezing the next generation’s incomes.  A taxpayer funded state pension for all at 60 years at a sufficiently high replacement ratio to average earnings could be introduced by governments dedicated to people’s needs and not to sustaining the profitability of the capitalist sector and relying on it and the movement of the prices of the stock market to fund pensions.  It would be more efficient, cheaper to run and much more equitable.  Instead, the majority, whether in the public or private sector, face paying way too much for their pensions, working longer for them and receiving less value when they do retire.  That means poverty if they retire, at worst, or a struggle to make ends meet, at best.


Have a look at this column from Tim Harford at the UK’s FT.  An interesting dialogue on who creates wealth in an economy.

Labour power creates use-values or wealth in a society, but capitalism appropriates that to create exchange value.  Public sector workers deliver use-values to society just as much as private sector workers.  But public sector workers are a cost to capital and exchange-value under capitalism.  In the view of capital, only capitalist production creates ‘wealth’.


It’s getting worse – Consultancy firm Mercer reports that the funding deficits of UK pension schemes rose 33% to £80 billion at the end of November, hitting their highest level this year as both corporate bond yields and stock markets fell.   This is equivalent to a funding ratio of 86% compared with a deficit of £60 billion with a funding ratio of 89% at end-October.


A recent survey by the UK’s Confederation of British Industry found that 71% fo employers though their compnay pension schemes were ‘under water’.  Indeed, if the European Union pension authority has its way, compnay pension funds may need to find up to £600bn so that retiring staff had an adequate pension.   And Shell UK has announced that it is ending its final slary defined benefit scheme to new entrants, the last FTSE 100 company to do so.  Now only 19% of company schemes were defined benefit and open to new entrants.

3 thoughts on “The pensions myth – part two

  1. Hi Michael, I have read both your blogs on the “The Pension Myths” with great interest and have learnt a lot from them. I was wondering whether you were considering doing one about the “Frozen Pension Myths” that refers to the more than 500,000 UK expat pensioners whose pension is frozen because of where they have chosen to live in retirement? I would be happy to provide some sources of information if you were.

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