The harsh truth about your pensions: None of them are sustainable

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John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).

We need to talk about pensions, where a problem may be brewing.

Broadly speaking, there are two ways to fund a pension plan: pay as you go (PAYG) and funded.

In a PAYG plan, contributors support pensioners with their payments. The U.S.’s Social Security system, which uses this model, is headed toward difficulties because the rising demands of an aging society will gradually erode the contributions of the labour force. The second type is called funded. In this model, members’ contributions are invested, and that’s what members live off when they retire.

Because Canada’s pension system tends toward a funded model, there isn’t the same anxiety about the future of pensions, since you can theoretically live off a plan’s investments even in the absence of new contributions.

In truth, though, the distinction is largely a bookkeeping fiction. All pensions are fundamentally contracts between economically active and economically inactive people, the agreement being what an individual will receive in return for what they gave.

The principal difference is temporal: PAYG systems rely on today’s workers to support today’s pensioners, while funded systems rely on tomorrow’s workers to support tomorrow’s pensioners. That’s because the future value of a fund’s investments will be determined by the future health of the economy.

At the base of that economy will, of course, be workers, enough to keep production going and revenues sufficient to justify those investments.

The big expansion in our pensions systems took place in the past century, a time when there were lots of workers, not many retirees, and rapid productivity growth, the result being an economy that looked set to bound to infinity.

It was reasonable to forecast future economic growth sufficient to sustain the generous pensions that today enable retirees to live their best lives, travelling the world or trying new hobbies.

But things have changed. With society aging and the birth rate declining, the ratio of workers to pensioners has dropped, slowing the growth of the economy. Were labour productivity still rising at the rates it did in the postwar period, each worker could support more inactive people. But productivity growth is also declining.

So, faced with the need to generate the income streams that retirees were promised – or promised themselves – in a more dynamic time, there are various ways to adapt.

You can inflate returns on the investments by squeezing more from workers. A related option is to inflate rents on fixed assets, such as real estate, and obtain more revenue from the working population that way. You can squeeze more from your capital by depleting its stock. You can import workers, or alternatively go find them abroad, investing the fund’s assets in developing countries where the returns are higher.

All these measures, in varying combinations, have been used to keep pension funds healthy amid their rising demands but diminished new supply. The neo-liberal policy regime of the past 30 years inflated profits relative to wages, yielding the sluggish real wage growth and booming asset values we have known. And pension funds have eagerly got into the property business, having been behind some of the renovictions that have inflated their rental returns.

As for running down capital, Britain’s privatized water utilities provide a textbook example of how to do this, since they’ve become a playground for pension funds (including Canadian ones) that have loaded them with debt, deferred maintenance and thereby paid themselves big dividends.

Meanwhile, all Western countries have boosted their immigration to supplement their labour forces, while many Western pension funds have equally started investing more abroad.

The problem is, all these adaptations are now running into political objections. The neo-liberal model now looks to have run out of road and, in future, the profit-wage ratio will compress.

At the same time, as we know all too well in Canada, the model of driving up rents has become both a political and economic headache. So too immigration is causing ructions, as Western electorates turn against the rise in newcomers.

And as for running down capital, British voters are up in arms because the depletion of infrastructure has created a situation in which raw sewage coats the beaches, putting heat on the utility owners.

Finally, Western governments are starting to put pressure on their funds to reduce offshoring, since they want them to invest at home to revive moribund economies.

These problems will likely intensify. What would be the options then? One obvious way to ensure the long-term health of funds is to reduce benefits. That would involve a reopening of the contract between pensioners and workers. Although that might seem unfair, a counterpoint would be today’s workers had no role in the negotiations that produced the contract now binding them.

And while nobody wants to start this conversation, sooner or later it may become unavoidable.