Duelling Pension Manifestos

Critics agree that when Marx and Engel finished penning their Communist Manifesto in January of 1848, they had written one of the greatest masterpieces of sociopolitico- economic writing of all time. The authors’ success was based on carefully following a four-part formula for writing a good manifesto. First, they addressed a burning issue (the dreadful mid 19th-century working conditions of the proletariat). Second, they employed a highly dramatic writing style (starting line: “A spectre is haunting Europe—the spectre of communism”… ending lines: “The proletariat have nothing to lose but their chains. Workers of the world unite!”). Third, they kept it short (only 40 pages); and fourth, they avoided empiricism (no statistics!).

Isla Carmichael’s new Pension Power: Unions, Pension Funds and Social Investment in Canada is also a manifesto. Its burning issue is that pensions are deferred wages and, hence, the financial assets backing these deferred wages should be controlled by workers. This control should not be used to increase pension fund returns, but, in Carmichael’s words, should be used “to rebuild neglected communities and increase productivity for the benefit of workers, communities, and our governments.” How is this takeover to occur? Chapter 12, titled “Two Models for Union Control of Pension Funds,” provides the answer:

However, these four steps cannot just come out of thin air, but will require an explicit social action strategy.

So Carmichael’s book does indeed pass the first successful manifesto rule in the sense that it identifies a burning issue and offers a plan as to what should be done about it.

Unfortunately, the book scores less well against the other three manifesto rules. The book’s prose is uninspiring, it is far too long at 225 pages and, by indulging in a little empiricism, Carmichael inadvertently shows the whole union takeover plan for Canada’s pension funds to be an unambiguously bad idea.

Carmichael notes that we have had some experience with social investing in Canada and that, on the whole, it has been a good thing. Specifically, she writes: “These forms of investment are productive, socially useful, and far less speculative than much pension fund investment practice to date.” Here is a listing of the major examples she provides:

How have things worked out for these poster children of the union-led pension revolution that Carmichael advocates in her book? Predictably poorly. Why so predictably? Because there is a hard-wired “one-policy goal–one-policy instrument” rule in economics. Applied to pensions, the rule means that, at best, a pension plan can do only one thing well: produce a predictable stream of pension payments at a reasonable cost. If it tries to achieve other goals as well (for example, rebuild neglected communities, create jobs for union members), its primary goal will inevitably be compromised. All of Carmichael’s poster children are cases in point:

Amidst a long, glowing story on the founding and growth of Concert Properties, Carmichael slips in the rather innocuous observation that “figures are not available for complete returns on investment in Concert.” Finding it hard to believe that a $450 million real estate company would not have the return it earned for its shareholders readily available, I visited the Concert website. There indeed was no return on investment information to be found. The next step was to email Concert senior management with a request for the information. The curt response was that this was proprietary information available only to shareholders.What should we make of this story? Should we infer that building rental housing with union labour is more important than earning a competitive return on pension assets?

The CWPP story has turned into an unmitigated disaster. As the real estate investments in the B.C. carpenters’ pension fund soured at the turn of the decade, liabilities ballooned at the same time because of falling interest rates and generous early retirement packages offered to older union members. Fiscal sanity had returned by 2003, but not without a major organizational shakeup and cuts in pension benefits as high as 45 percent. Carmichael observes that “these reductions were higher than anticipated and devastating to the membership of the CWPP.”

What are we to make of Carmichael’s empiricism? Are these five stories meant to convince us that, in her own words, union-directed social investing is “productive, socially useful, and far less speculative than much pension fund investment practice to date”? Surely not. Is the message, instead, that investment return does not matter in her framework? That pension assets are put on this earth for a higher purpose? And that she knows what that higher purpose is? On the face of it, this would seem to be the case.

All this raises interesting questions. For example, if I were to write a pension manifesto, what would its message be? What arguments would I use to underpin my message? How would my manifesto differ from Carmichael’s? Let me try to answer these questions.

Rather than plot a takeover of Canada’s workplace-based pension system to achieve some greater good, my pension manifesto would focus on the interests of the people the pension system was created to serve. So it would start from a premise that rational individuals want to maximize happiness and personal satisfaction from a lifetime income stream. For most people this means acquiring an education early in life (that is, building intellectual capital), accumulating a pool of financial capital during the mid-life working years and converting that pool of financial capital into a stream of pension payments during the retirement years. Unfortunately, there are three practical flies in this theoretical pension ointment.

First, people exhibit only bounded rationality, rather than full rationality, in their decision processes. In other words, people are generally quite rational in making decisions within the bounds of the familiar. However, when circumstances take them into uncharted territory, people stop being rational. Unfortunately, for most, making a series of complex savings and investment decisions over three or four decades is decidedly uncharted territory. So now people exhibit tendencies to construct inappropriate decision rules, to act impulsively or, more often, to avoid making any decisions at all.

The second fly in the ointment is that agencyrelated costs can create a serious wedge between investors and their money. Such costs arise in markets where sellers know more about what they are selling than buyers know about what they are buying. In the financial services marketplace this means that if the sellers of these services (such as financial advice, money management) have the opportunity to turn their informational advantage into profits, they will. In her manifesto, Carmichael—to the detriment of her own argument— makes the important point that for-profit financial services sellers are not the only constituency that can impose agency costs on retirement savers. Her five examples show that, given the opportunity, people with “greater good” aims can also impose material costs on people attempting to accumulate retirement savings.

The third fly is that individuals all face a serious risk of outliving their money.While an actuarial table might show that the life expectancy of a 65-year-old is 20 years, that doesn’t mean all 65- year-olds are going to live until age 85 and then obediently die. Some will die sooner, others later, a few much later. This reality creates a serious conundrum for people. How much of a retirement nest egg should we plan for? To last 20 years? 25 years? Longer? A serious conundrum indeed!

In the spirit of Marx and Engels, these three flies also deserve a ringing “workers of the world
unite!” response. However, the goal of our pension revolution would not be to get control of pension assets to achieve some greater good. Instead, it would be to increase the efficiency and
reliability with which streams of retirement savings are converted into streams of pension payments. To achieve this, I propose the following four-step pension program for Canada:

We conclude with arguments why such a program would shower material benefits on practically all Canadians.

An important test of any proposition in welfare economics is the Pareto optimality rule, which requires that an unambiguously good policy makes at least some people better off and no one
worse off. The policies set out in Carmichael’s manifesto fail this test. While parties deemed worthy in Carmichael’s eyes win through wealth transfers, parties that end up with the short end
of the wealth-transfer stick lose. In contrast, the only people who would lose under the pension policies proposed in my manifesto are the financial services providers who are currently being paid too much for too little. Adam Smith would be pleased.

Meanwhile, under my manifesto, workplacebased pension coverage would more than double,
from under 50 percent of the workforce today to 100 percent. The minimum 10 percent contribution rate would ensure that the workplace pension system would eventually produce material pension cash flows on top of promised payments to the Canada and Quebec pension plans. At the same time, it would take considerable pressure off future taxpayers to underwrite future burgeoning payments to the Old Age Security and Guaranteed Income Supplements owed to Canada’s aging baby boomers.

Furthermore, my manifesto places the control of the resulting very large accumulations of Canadian retirement savings in the hands of well-governed, arm’s-length pension co-ops charged with the sole task of turning retirement savings into pensions in a cost-effective, transparent, reliable manner. Thus, this approach keeps control of this money out of the hands of all power groups—not just organized labour, but organized business and government as well. This is the pension socialism that Peter Drucker hoped would evolve from the time he wrote his 1976 book The Unseen Revolution: How Pension Fund Socialism Came to America.

Carmichael and I do agree on one thing. Canada’s workplace-based pension system could use a good revolution. Where we differ is on what the means and ends of that revolution should be.