In a guest contribution, economist Jim Walker lays out the case against calls for a universal pension in HK, including the lessons from history of the European welfare state.

Universal pensions in HK: the case against
12 March 2011

By guest contributor Jim Walker

Recently there have been calls from some legislators which raise the issue of whether or not Hong Kong, like so many other countries, should introduce a universal pension scheme. After all, Hong Kong has an embarrassment of fiscal riches so why not make good use of them by taking good care of our old folk?

While I would agree that there is plenty that the government could be doing to better use Hong Kong's fiscal stockpile (who needs an even faster rail link to Shenzhen, for example?) adopting policies which are abject failures in other countries is not a sensible option. Admittedly, this seems to be lost on the Hong Kong government as it continues to introduce and propose Western-style policies - a minimum wage, Competition Law, maximum work hours - that have done nothing but reduce employment and entrepreneurship levels elsewhere. Albert Einstein once wrote, "The definition of insanity is doing the same thing over and over again and expecting a different outcome".  We need to guard against Hong Kong falling into the same traps as everyone else.

Old Age Pension: Historical backdrop

Neville Chamberlain introduced the Widows, Orphans and Old Age Contributory Pensions Act into the UK parliament in 1925. This act promised a pension to male citizens on reaching the age of 65 (60 for women). Despite the loss of life in the First World War the UK was then a relatively young, vibrant country with a low dependency ratio i.e., many more workers than dependents (under 15s plus over 65s) in the population.

The only problem with Chamberlain's proposal was that in 1925 the average life expectancy for a man in the UK was 56 and, for a woman, 60. In other words, the government of that day was promising something that it never intended to pay - hence the reason that no UK government since has ever actually pooled National Insurance (the original MPF-style form of contribution) into a pension fund for the future.

When the Welfare State was given the green light by the Labour Government in 1945 its commitments barely meant a thing either. By that time the life expectancy of a man in the UK was 64 while that for a woman was 68. At least the state pension would only need to feed half the population and that only for eight years. Of course, by 1999 the picture had changed somewhat. Male life expectancy in the UK had risen to 75 and female to 80. They have since increased further. Between 1925 and now the UK, along with nearly every other European country, has made no attempt to set aside funds explicitly for old age pensions. These have been non-contributory entitlement schemes.

This is all very well as long as the contributions to National Insurance and general taxation from workers and private businesses are greater than the demands from the growing old age pensioner cohort. The UK and Europe, because of the ageing population, is fast reaching a point where, between pensions and social welfare entitlement programmes, the Ponzi scheme is being laid open. (A Ponzi scheme is where payments to earlier members of a project or fund are funded from the contributions of new members. It comes to a crashing end when there are fewer and fewer new entrants and more and more existing members looking to take money out).

Politicians like to promise the electorate something for nothing. European governments have been doing so for decades. In most of Europe government spending is now over 50% of GDP. Fiscal deficits have been used for many years to prop-up this spending but government debt loads have now reached levels that cannot be tolerated. From here onwards the private sector in Europe is going to find out just how much the past promises of politicians are going to cost it. It cannot pay.

Government finances: Your money

It is worth stating a simple truth at this point: the government is entirely financed by the private sector. Only private sector workers and companies pay taxes. Public sector workers' net salaries (i.e., less the taxation which they pay) are entirely funded by private sector contributions (or, in some countries, borrowing). Public sector capital spending is also entirely funded by the private sector, either at home or abroad. Even government revenue from land sales - and who granted the government the right to own land in the first place? - is dependent on private sector purchase.

The distinction in people's minds (aided and abetted by bad economists, I freely admit) between the private and the public sectors is mythical. The public sector is entirely paid for by the private sector. That is why the terms 'public servant' or 'civil servant' came into use and are still appropriate - not that government employees act like they are.

With that in mind, the question should be asked of the Hong Kong Government, "Why do you have so much of our money in reserves and what are you going to do with it?".

Hong Kong is in something of an unique situation in that - for now - it runs a budget surplus and has accumulated vast wealth to the tune of 65% of current GDP (in the Budget Statement it is claimed that reserves amount to only 30% of GDP but that is purely fiscal reserves and omits many other capital funds in the overall public accounts, including the HKMA). There is absolutely no good reason for this to be the case. It is not government's role to 'save for a rainy day' nor are these surplus reserves necessary to support the Hong Kong dollar peg.

That aside, governments should run only balanced budgets at any time (or at least balanced through a normal economic cycle). Neither borrowers nor lenders should they be - unfortunately that is not the way of the world.

Hong Kong's Future

Here is a recent comment from someone described as a 'battle-scarred veteran of municipal finance boards': "During my time on two pension boards, the boards did less as the problems got worse. Board members tend to be town employees caught in the headlights. They are not financially trained, and they tend to believe rather unsophisticated consultants who all say the same thing: 'You can earn your way out in 15 years.' This is not true. Not even compounding can save you when benefits are rising faster than the return on assets. We have yet to begin to seriously attack this problem. The most we have done is 'tried' to initiate cuts of annual percentage increases in benefits."

Maybe Hong Kong public servants would be better than this but I doubt it.

The problem with European and US pension schemes is that they have never been fully costed nor have they ever been based on realistic assumptions about what pension scheme managers can be expected to produce as a return. The 8% per annum projected returns of most US state and private pension schemes is an artifact of the inflationary 1970s when pension plans were exploding in addition to state guaranteed benefits.

Here is what you have to consider before Hong Kong plunges headlong into the same hole:

At the moment, the government's finances would tell us that Hong Kong is a very rich place. That encourages politicians and pressure groups to be generous with the money. That is all well and good but it is very different from setting in place an unfunded entitlement programme. It is open-ended, unfunded entitlement programmes that are quickly becoming the rod for people's backs all over the developed world. It is not good enough to adopt schemes such as old age pensions just because everyone else has done so.

Bear in mind that, when all is said and done, "the road to hell is paved with good intentions".

Jim Walker is the Founder and Managing Director of Asianomics Ltd, an economic research and consultancy company servicing principally the fund management industry.

So, what would a universal pension cost and can we afford it? Read our other article today, The cost of a universal pension.

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