Stephen Poloz is special adviser at Osler, Hoskin and Harcourt, and author of The Next Age of Uncertainty. He is a former Bank of Canada governor and sits on the boards of Enbridge Inc. and CGI Inc.
Canadians are less prepared for retirement than they think. They don’t know how long they will live, what cumulative income they will earn, or what investment returns might be. Rising volatility is making these guesses harder – fostering a growing sense of insecurity that is likely to drive a renaissance of defined benefit, or DB, pension plans.
The volatility will only continue to rise as multiple tectonic forces rock the global economy. An aging global workforce will lead to slower trend economic growth and persistent worker shortages. The Fourth Industrial Revolution – the digitization of our economy, use of robotics, and artificial intelligence – will disrupt a wide range of occupations and further worsen income inequality.
The growing cohort being left behind by technology will continue to foster rising populist, nationalist or isolationist policies and a drift toward a multipolar world, opening the door to even more geopolitical shocks. Meanwhile, high and rising indebtedness will amplify and propagate the aftershocks of every new disturbance. We must also transition to net-zero carbon emissions, a complex and highly disruptive undertaking. Taken together, we face a highly unusual confluence of forces.
Canadians may believe that governments will protect them from rising volatility and risk, but the global pandemic has left a historic debt burden. In a world where interest rates will not return to crisis-lows, where an evaporating peace dividend means more spending on defence, and where caring for an aging population will cost more, governments will find it hard to take on new risks. Besides, one way that people will adapt to rising uncertainty will be to carry larger financial buffers. Spending less while working and during retirement will mean lower economic growth and weaker government tax revenues, worsening the fiscal outlook further.
That leaves employers as the most likely source of solution. The baby boomers gave us 50 years of above-normal work force growth. This boosted economic activity while shifting market power to employers. But the boomers’ retirement wave represents a transition to a new normal of persistent worker shortages. Immigration can help only so much, as other countries face the same issues and will soon begin to compete much harder to attract skilled migrants.
These tectonic forces are shifting market power from employers back to employees. We are seeing evidence of this already: Companies paying starting wages above the legal minimum, employer flexibility around working from home and rampant strike activity. In the end, inflation-adjusted employee compensation will rise, halting the long-term decline in the share of total income that has been going to workers. Behind the scenes, companies will digitize their operations, and deploy robotics and artificial intelligence, thereby boosting productivity to make this compensation realignment sustainable.
All of this paves the path for a rise in DB pension plans. An extra dollar dedicated to one is a far more effective means of assuaging rising life insecurity for employees than an extra dollar in income.
The downside of a DB plan is that transferring lifetime risks from employees to employers is too risky for smaller companies, which is why such plans have been in decline. But shifting those pension obligations instead into large, professionally managed pension pools can transform them into a simple cost stream for a sponsoring company.
From the point of view of the employee, a large independent pension pool effectively eliminates longevity risk, minimizes fund management costs, and permits maximum investment diversification. It allows households to spend their income freely, during both work and retirement, thereby helping to stabilize the economy automatically, raising average economic growth while boosting government tax revenues.
In these conditions, Canada’s pension system ought to transition back toward broader DB pension coverage all by itself. Surveys show that employees are willing to contribute more for greater lifetime financial security, and this will only increase in a riskier future. Companies will likewise want to deploy more compensation tools in the face of persistent worker shortages.
Consider the current emphasis by companies on environmental, social and governance, or ESG, matters. Shareholders, lenders, customers, and employees often penalize a company by selling its stock or hurting its brand in social media for failing to meet the “E” or the “G” of ESG. Moving forward, a focus on the “S,” which includes the livelihood of employees in the form of pensions, is likely to grow.
Governments can and should help shift the pension pendulum back toward DB plans.
First, they can actively encourage the creation and growth of large pension pools and employers’ participation in them. This can include enhanced tax incentives for both individuals and companies to join pension pools, because greater lifetime security will mean a stronger and more stable economy and increased government tax revenues.
Second, the combination of elevated government debt and increasingly polarized politics has heighted global inflation risks, a major challenge for pension managers. Governments can help address this risk by reinforcing central bank independence, committing to ensuring that fiscal policy is countercyclical rather than pro-cyclical, and by maintaining active real return government bond programs.
These proposals could catalyze a significant improvement in Canadians’ income security – at minimal fiscal cost.