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A new take on Cullen's speech

Michael Littlewood gives his views on a recent speech by Finance Minister Michael Cullen.

Wednesday, May 30th 2001, 2:32PM

I (like Good Returns' editor) am really concerned at the inadequate debate that some very large superannuation issues are currently attracting. We are set for a reprise of past superannuation initiatives as the present government chisels a new monument in the superannuation graveyard. Even if the Big Cullen Fund actually gets off the ground, it will have a limited life because we aren't discussing the things that really matter. The Big Cullen Fund will be large but it will be an even larger distraction to future generations.

Here is my take on the Minister's latest contribution to this process of sleepwalking our way to yet another unsatisfactory "solution".

The Budget is being presented on Thursday. The Select Committee is due to report back on its consideration of the New Zealand Superannuation Bill on 12 June.


Under these circumstances it is very difficult for me to offer you a detailed report on progress under way.

What I intend to do today is to restate the high level policy objectives of the government with regard to superannuation, and to respond to some of the issues that have emerged in the public debate since the Super Bill was introduced.

There are two very powerful drivers of our approach to superannuation: macroeconomic stability and personal security. They rank right up there with the core responsibilities of the modern state, and underscore why I see superannuation as a key strategic issue rather than a political tactic. This attempts to place the government on the moral high ground but fails - why is superannuation so different an issue from future health costs (that have the same demographic content) or unemployment (of much more immediate importance to economic growth) or education or entrepreneurship both of which are more important to the issue of the future affordability of New Zealand Superannuation (NZS) than a pot of money run, ultimately, by politicians.

The economy faces a number of structural problems, not the least of which is the problem of substantially upgrading our collective human capital. A less visible, but similarly important problem is our low rate of national savings.

The free market purists would say that the savings rate does not matter. I think "purists" would argue that flows' measurements of so-called "savings" are of doubtful value given that their focus is really on the absence of consumption (it's simply the difference between income and expenditure and says nothing about what happens to the difference). Quality investment is likely to be more relevant in this area. They point to countries with high savings rates, like Japan, experiencing protracted stagnation, and countries with low savings rates, like the USA, having a strong currency and have experienced protracted growth. The Minister doesn't actually address this seemingly unexpected situation. According to the thesis that underpins the BCF, higher savings should lead to higher growth. They also argue that in purely rationalist terms, we benefit by borrowing from foreigners. We can benefit, but not necessarily - again, the investment issue is the one that matters. The theory is that rational individuals would not borrow if they could not get a better return than the rate of interest they are paying on the borrowings, so there is a net gain in economic wellbeing by leveraging returns off foreign borrowing. The flip of this is that rational investors wouldn't lend unless there were profit to be gained from that. I don't see anything wrong with that as a concept.

I do not buy these arguments for two reasons. The first is that borrowers do not have perfect knowledge - particularly about the future! Neither do governments or investors or taxpayers. In the last few decades we have seen evidence from widely different economies that what seems rational for the individual is not necessarily rational for the collective. Agreed - putting surplus income into retirement saving plans may be rational for an individual but it doesn't follow that having governments put tax "surpluses" into overseas shares for the whole country is a sensible idea, particularly when there is debt to be paid off. If there are capital gains to be made, it makes sense to borrow. If there are equity-related profits to be made, it also makes sense to borrow. The concept of borrowing for just "capital gains" isn't relevant. A sensible investor borrows for the total return.


But if everybody chases the same capital gain there is eventually an oversupply of investment funds relative to potential investment returns.
Which is one of the major impacts that the Big Cullen Fund is likely to have on local markets unless it is all or mostly invested overseas. There is evidence of this effect in Australia from the pressure of funds created by compulsory private provision. There is also evidence of that same effect from Chile. More savings (such as from the BCF) will put upwards pressure on local prices but won't necessarily increase quality investment (which is what really matters).


Assets are inflated above values that would be justified by underlying earnings potential and the bubble bursts. Investors herd in and stampede out.
In the case of the BCF, taxpayers will be the losers from this effect. Remember that the BCF will eventually be bigger than the entire NZ share market. And that also ignores the potential effect that the large international flows from and back to NZ will have on the NZ$.

Secondly, even if we could enhance economic growth and production by using the savings of foreigners to do so, the benefit to New Zealanders is reduced to the extent that we have to divert a part of that production to pay the foreigners for the use of their capital. But NZrs will still be better off than if the investment had not taken place.

The last work done by Bryan Philpott stressed this point. He calculates that between 1984 and 1999, GDP - the total value of output from within our national boundaries - increased by 1.8 percent a year in real terms.


However, because of our very poor savings record
(investment record actually including, most spectacularly, the stunningly bad investment record of past governments) and our reliance on the savings of others, the net income paid overseas - to the overseas owners of capital used in production here - rose from $1.6 billion a year in 1984 (before which the NZ economy was unrealistically walled up from the rest of the real world - that's a conveniently chosen starting point) to $7.4 billion in comparable dollars in 1999. The issue here is whether this change is "bad", "unusual", or a trend and it also ignores the impact of that increased foreign investment on growth, wages and taxes. It might be nice to isolate these various elements. The point is a populist one and not necessarily helpful.

The result is that national income - the total value of output accruing to New Zealand nationals - only grew by 1.4 percent a year. And just how is the BCF likely to help improve this dismal record?


When population growth is taken into account, national income per head grew by 0.2 percent a year. And this, ultimately, is what drives living standards - the amount of output per person that New Zealanders can lay claim to.
And how is the BCF going to help with this?

The latest Monetary Policy Review put out by the Reserve Bank last week projects a government operating balance 2 percent of GDP in the 2002 March year, and 2.5% percent in the year after that. By contrast, the household savings rate is a negative 3% of household disposable income in those years.


Superannuation policy has to be seen as a part of the solution to raising the savings rate. By transferring a good part of the emerging structural surplus
I'm suspicious. Just what is a "structural surplus" - is that real money? into the Superannuation Fund, the government translates short term fiscal surplus into long term national savings. This is simplistic stuff - for example, it ignores the, probably, negative effect that the BCF will have on individuals' saving decisions. It ignores risk. It ignores the fact that maintaining any debt while investing in share markets is the same as borrowing to invest. It assumes that the future amount required to support NZS will inevitably increase (no discussion on possible benefit changes). In fact, it skips past nearly all the important immediate issues before sweeping on to the grand fallacy.

Equally, there is little point in lifting the public sector savings rate if that is immediately offset by a fall in the private savings rate. In my view this is not happening. Evidence? Does the "in my view" mean that there is no evidence? It would only happen if people increased borrowings in a way that they would not have if the money put into the fund was paid out as tax cuts instead. Tax cuts are not the only alternative - reducing debt is another, cutting future entitlements to NZS is a third. Where is the information and debate on alternative strategies? Which strategy is more likely to promote growth while at the same time ensure intergenerational equity and also fairness between the different groups of taxpayers today and in the future?


Our experience with tax cuts in the 1990s was that they seemed to have an almost invisible effect on private savings.
Evidence?
This does, though, raise the issue of improving private savings.
Or improving the quality of private investment? If this is, in fact, the more important issue, what does the government intend to do about it?

I have said it time and time again, but it still bears repeating, that the government does not see the New Zealand Superannuation Fund as the solution to the problem of promoting national saving and improving income in retirement. That's a relief. In fact, economists say that there is not a lot that governments' policies can do directly to "improve" national saving, except with regard to governments' own activities. However, this plays with words. The Minister has said that the BCF is the answer to questions about the future sustainability of NZS. It most certainly is not that, whatever else it might be.

It is a vital part of the solution but it is still only part of the solution.

The second core justification of the Super Scheme is that contributes to enhanced social security. Which may explain the risk of reduced private provision in the presence of the BCF. The need to restore confidence among people that a decent pension will be there for them has increased in direct proportion to both the level of interference and instability in the provision of public pensions in recent decades, and the scaremongering that has gone on that the pension cannot be sustained when the baby-boomers retire. When did we have an informed debate about this? What are the alternatives? Just what notice has this and the last government taken of the alternative strategies presented by the 1997 Periodic Report group on this key issue? That's a rhetorical question. In case the Minister hadn't noticed, the answer is "none".

I have a strong philosophical commitment to the view that security in retirement is the least that citizens should expect from their governments in a civilised, developed country. It is also the most they should expect. "Security" doesn't necessarily mean a high (or "high enough", however that may be defined) pension. It could mean certainty of outcomes, low inflation, high and sustained growth, net real rates of return, lower income taxes, fairness between generations and across groups of taxpayers. What does the Minister mean by "security in retirement"? Unless this key issue is defined and agreed on, we are all talking past each other.

t is not the function of the government to maintain in retirement the incomes that people earned during working life. That is the responsibility of the individual. Again, when did we have that debate?

This is what leads me at the personal Meaning? level to reject compulsory individualised, earnings-based savings: the government is intruding too far into what ought to be personal decisions about how to spread consumption over the life cycle. But the Minister is quite happy to take a view on that for taxpayers as a whole.

Having said that, while NZS will provide enough to enable participation in life Evidence? What, again, are the alternatives?, it is not designed to do more than that. When was that decision made? What measures does the government use to assess that test and whether or not NZS does/is likely to meet it?


Just as there is need to increase public savings from a social security
Pardon? and economic stability perspective, the imperatives of security in retirement coincide with the imperatives of raising private savings from a economic stabilisation point of view. Evidence? Growth is more important to sustainability than "savings". The Minister implies that "savings" causes growth (which can be future pensioners' only real security) when economists seem to conclude that growth produces "savings" and not the other way around.

I have given two speeches in recent months on this topic: one to the annual meeting of Grey Power, and one to the annual meeting of the Association of Superannuation Funds of New Zealand, and there is not a lot more that I can add to this topic at this stage.

Instead, I am going to comment on three of the core criticisms that have been made of the super fund scheme.

The first is that it is not necessary: that the increase in the proportion of the elderly in the population will be offset by a reduction of those of younger age, so that the overall dependency ratio will not change much.

Secondly, that it is unfair as between the generations.

Thirdly that we should wait until there is a consensus in Parliament before introducing the scheme.

On the matter of the dependency ratio, the question for me, as Minister of Finance, is not what share of total economic production goes to each age group within the population.

It is what share of the consumption needs of each group has to be paid for by the government.

In this respect, young people (generally), need much less by way of payments from the government than do the retired. Basic costs of support (housing, clothes, food, phone, power, insurance, transport) are essentially "private" for the young (parents support them), and "public" for the retired (the government pays NZS which is the primary income out of which those things are paid for).

One (less) fewer young person does not equal one more retired person as far as the government's financial obligations are concerned.

A rough calculation done by Treasury concludes that each person under 16 costs the government $4,603 each year, and each over 65 year old costs it $16,866. It would be nice to see the full analysis as a contribution to understanding this issue. Generally, we would have to agree with the Minister's point though, for a "rough calculation", the results seem remarkably precise.

The older age cohorts in the dependent population are nearly four times as expensive, per head, fiscally, as the younger cohorts.

I do not buy the argument that less will be spent on education. It is sensible to plan on the basis that in the future, we will need to spend much more per pupil than we do now in order to remain competitive in the modern world (smaller class sizes, more computer and technical supports and so on).

Even if we do spend less at that point, I imagine that we will spend more on health treatments if the proportion of the elderly in the population increases.

If demographic change "frees up" tax money I am sure there are many other good uses that people can see it being put to.

The dollar freed up cannot fund both NZS and health costs. By partially pre-funding NZS I am creating more capacity for future governments to respond to pressures for more health and other spending. By making sure that governments of today have less flexibility.

I have a great deal of difficulty understanding the National Party's argument on intergenerational fairness.

As I understand the sort of compromise they are floating, they would guarantee New Zealand Superannuation to those who are already retired or near retirement - say those over 45 or 50 - but make no such commitment to the next generation. I can't speak for National but I understand them to be saying that we need, as a country to resolve how to treat the superannuation expectations of younger New Zealanders and that we can't do that without proper information, a national debate and consensus on the way forward. The government will have none of this. As I understand it, the reason for the "promise" to older workers is that politicians have eliminated any further change to the expectations for these people by the constant changes of the last 25 years.


Later generations would have to rely on a fairly vague promise of tax cuts and possibly tax incentives to save for a much larger share of their retirement income.

I cannot think of a scheme that is less fair to the coming generations. They will have paid to keep their parents and grandparents up to current NZS formula levels only to see it evaporating before their very eyes as they move into their sixties. Political hyperbole.

On present plans, we will pay net into the fund for the next 20 or 25 years If we can afford it. and draw net out of the fund after that. That means that people who are now between 40 or 45 and 65 will pay extra, but never have their taxes subsidised by fund earnings. That can't be right, remembering that when they reach retirement, they will still be taxpayers and still be helping to pay for their own NZS. To the extent that the BCF's subsidy to future payments of NZS include fund earnings, then their taxes will be subsidised.

Those under 40 or 45 will at least benefit from some of the tax modification that the fund allows.

The sandwich generation is in fact the baby boom generation, but I would argue that they are best placed to absorb the cost. This begs the huge question of what it is that any generation of workers might be expected to pay for. When did we discuss or resolve that?

They have come through the era of free education, near full employment and affordable home ownership, and many came through the era of more extensive employment-based superannuation. This is simplistic stuff. Where is the evidence that the baby boom generation is (or is likely to be able) to better cope with paying twice than any other generation?

The next generation has the student debt, is more likely to experience at least intermittent periods of unemployment or low earnings, and has a harder job getting a start with owning a home. Again, simplistic stuff. Let's look at the evidence.


We must be clear. Unless we can restart history, we cannot have a state pension regime that is absolutely fair as between the generations.
But unless we have a proper discussion (that this government is assiduously avoiding) we cannot count on tomorrow's generations of taxpayers having the same view on all this as today's. If we don't have the full debate, backed by proper research, we are condemned to repeat the mistakes of the last 25 years and future change will be inevitable. That's mainly because tomorrow's generations of taxpayers won't know the basis. Intergenerational fairness is partly about limiting change through much better information about relative affordability. The task is to allocate any inter-generational burdens to the generation that is most able to shoulder them. No it's not. It may be the Minister's task but that's not what "fairness" means. My super scheme does that. Economic hyperbole even if we forget that the BCF will, at its peak, contribute less than one fifth or any year's cost.

Finally, I want to talk a bit about the consensus argument. This is a sham.

It is an excuse for ducking the hard decision on the fund. See how the Minister automatically assumes that "consensus" is about not agreeing with him. I realise that consensus is a hard concept for politicians to accept because, among other things, it means that not just the current government will be making the "hard decision" - that other people might have a different opinion and might actually be able to contribute to the debate and the required decisions. Those who say that we must wait for consensus are in effecting rejecting the super fund An imposed "solution" but do not have the courage to front and say that. There is no hope for consensus because the Minister has re-defined it and the unilaterally dismissed it. That's one way of avoiding the idea. After the experience of the last 25 years, this is an unsurprising result. The Minister has one more opportunity to make his mark in the superannuation debate (remember his "Guaranteed Retirement Income" and the "Retirement Income Tax"? You don't?) and, by golly, no-one is going to get in his way. "Consensus" and the BCF are like oil and water. In fact, the BCF itself is a metaphor for the way things tend to get done in Wellington today.

I have been Labour's spokesperson on superannuation for nearly 15 years now, and in all that time consensus has been the catch-cry No it hasn't. My first introduction to the concept was the 1992 Task Force's report. That's something less than 9 years ago., and the more it has been talked up the more likely it was that people calling for it were trying to avoid consensus. Not so. But, given the Minister's present strategy, we must expect him to denigrate the idea.

There was too much political advantage in having a different position on super. I think that actually a bit harsh. In my experience, the differences in the various political stands on superannuation have been mainly the result of ignorance rather than political advantage though the one leads quite naturally to the other.

My view is that the great and enduring consensuses on superannuation policy , like those in the USA and in Australia Australia does have consensus but it's stretching things to say it's "great and enduring". It actually happened by accident and as the result of political opportunism. At best, it's only had a nine year life, have followed rather than led new schemes. Not true in Australia.

They have followed by the law of political gravity. As the funds have grown The Minister doesn't understand how the US Social Security system works - the Social Security "fund" is an economic hall of mirrors., and as they have been seen by the population as a whole to be a clear indication of where their pensions are going to come from, they have become too strong a force to try and deny. So, that must explain why Australia's household saving rate (as deficient as that measure is) is nearly as bad as New Zealand's. I wonder if it also explains why the Australian Reserve Bank thinks it will be at least 10 years before any conclusions can be drawn on the success or otherwise of Australia's compulsory saving regime. The Minister should provide better examples than these.

So it will be with this fund. Because the BCF will be a monument to one man's view of the world (and might slide through Parliament by 61 votes to 59), it will be a continuing focus of attention. And that's because we haven't talked about the things that really matter. Like, not ever talked about the things that really matter. Just to take one small example, when did we agree that the State pension age should be 65 for ever?

I am going to end this presentation by reflecting on one area that is perhaps more of concern to the fund managers that would seek to do business with the Guardians of the Fund.


This is the question of ethical investment, sustainable investment, socially responsible investment or other variations on that general theme.

The debate on this starts at one level of disagreement.

Any attempt to fetter fund managers with non-commercial - such as ethical - constraints is seen to lower the long-run returns achievable. Agreed - tobacco companies' shares and the shares of companies that cut down native forests or manufacture armaments could well be very good investments for the BCF (if it ever gets off the ground).

You can have ethical investment, but at a cost because it limits the full range of choices a fund manger has. The subsidiary argument is that giving fund managers dual objectives always gives them an excuse: if returns are low it was because they were pursuing ethical investments; if they invest in controversial companies it was because they were seeking better returns.

The jury is out on this.

There is certainly a lot of evidence around that socially responsible funds do not produce weaker financial results than conventional ones We should see that evidence, but the counter-claim is that there has not been the time horizon or the scale of funds under management to make valid comparisons.

At the next level, the argument is that investment that is not sustainable would not be selected by fund managers. Sustainable investment is best practice.

Also, socially irresponsible investment will eventually attract sanctions in one form or another: government regulation, consumer boycotts and the like. Evidence? Hence prudent fund managers would build into their calculations the risks of reducing returns from socially irresponsible entities. This is a bit too simple. Agreed

There are profitable investment outlets, particularly short term outlets, that do generate good returns from bad labour and environmental practices.

I said earlier that the terms socially responsible, ethical and sustainable tend to be used interchangeably, when there are some subtle but important differences between them. There are also differences in approach to this type of investment.

Since the Superannuation Bill was introduced, a number of investment organisations have been making presentations - not just to the government - about how the ethical dimension might be incorporated into fund management decisions.

There are a number of models.

The first is the prohibitionist model.

Certain types of investment are simply declared to be off limits: arms manufacturers and tobacco companies are two examples. There are two problems with this model.

Firstly, it only narrows the range of potential investments marginally, and can be seen to be tokenist.

Secondly, the prohibited product groups can be produced by corporates with other legitimate products, and companies that profit from the products need not be the companies themselves. Banks, for example, make money from tobacco when they lend money to tobacco companies. It is very hard to fully screen a prohibition list.

The second model is the investor values model. Here the investor decides what sorts of values it wants reflected in its portfolio and the fund manager selects accordingly.

That seems to be viable when the value system of the investor is tightly defined: say a religious organisation with funds to invest.

It is harder to define the values of the investor when the ultimate investor is the people of New Zealand, or even the government of New Zealand. Values are diverse and at times conflicting within the body politic.

Thirdly, there is what is known as the best of sector approach. The best of sector recognises that there are sectors that will have an inherent disadvantage when it comes to some aspects of social or environmental performance.

A computer software company will always generate less environmental damage that a mining or chemical company. However, a modern economy does need minerals, fuels and chemicals, so screening some sectors is simply hypocritcal.

The best of sector ranks companies within sectors against standards of (say) social, labour and environmental performance. It then limits investment to companies in the (again, say) top 30% in the sector.

It chooses from among those that make the grade according to conventional financial performance indicators.

The approach does limit choice to the companies that have gone through the ranking process. It is also of limited use when investments in intermediary organisations like banks are being considered.

The final model I want to talk about is the active partner model. Under this model, there are some prohibitions, but apart from that organisations that the fund invests in are encouraged to work with agents of the fund manager to improve ethical performance.

That involves a mix of improving reporting on the triple bottom line: financial, social and environmental, and improving performance in each of these categories, but especially the last two.

The incentive for companies to engage with the agents is that if they do not, the fund manager will not invest in them.

I am not sure that this intimate level of active engagement can be maintained with a fund of the size that the NZSF is expected to grow to, but that will be something that the Guardians will have to look at.

I don't think that the best way forward is to select a model in advance and prescribe it in legislation. The whole field is evolving too rapidly for that.

My preference is to stay with the emphasis on process that is outlined in the Bill. That process might be fine-tuned, but it operates through a number of re-inforcing procedures.

It starts with a high level value statement. The Guardians must invest the fund on a prudent commercial basis, but must also "avoid prejudice to New Zealand's reputation as a responsible member of the world community". This is virtually impossible to define and implement. Any nod in this direction will almost be tokenist, to use the Minister's expression.

That could imply a prohibition screen, but the Guardians do have scope to develop other methods to avoid irresponsible investing prejudicing New Zealand's reputation.

The Guardians must then establish investment policies, standards and procedures and review them annually. These are published in a statement, and the statement has to cover a wider range of factors that include ethical investment.

This is important. There has to be an annual statement that covers all three dimensions of ethical investment: policies on ethical investment, standards on ethical investment and procedures relating to ethical investment.

Each year, the Guardians must publish a report that includes a statement certifying whether or not the investment policies, standards and procedures have been complied with.

There is adequate scope for Parliamentary and public scrutiny of whether the policies on ethical - and of course other dimensions of - investment are appropriate, whether standards are adequate, and whether standards have been met.

To round things out, at least every five years there has to be an independent review of how efficiently and effectively the Guardians are performing their functions. That includes whether the policies et al on ethical investment are appropriate and whether they have been complied with.

This package is sufficiently specific, sufficiently flexible, sufficiently transparent yet sufficiently accountable to allow us to move forward with some confidence on this new investment frontier without compromising the financial imperatives of the fund.

There are other key issues that the Guardians will need to grapple with about the investment performance of the fund, but there is no time for these today.

The programme you have in front of you is varied, and allows for a very stimulating discussion of all aspects of superannuation policy.

I noted that I saw superannuation as crucial from the point of view of macroeconomic performance and personal security.

I am sure your deliberations will allow further insights to be gained into how superannuation policy can contribute to both.

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