SAVINGS: Policy Issues and options

It does not use cross-references to sources and studies for every assertion or observation made. The main sources used are listed in a brief summary of references in the appendix. A number of the observations come from conversations with stakeholders with an interest in the savings debate. They have not been identified because there is a need to avoid any pre-positioning of viewpoints in the lead-up to a workshop, forum or summit on savings.

Savings policy is complex. There is a summary of the issues at the beginning of the discussion document. We hope that you will read the fuller version but, if pressures of time prevent that, we would draw your attention to three sections that we do put in the "must read" category.

The first is the overview of what is actually happening with savings. That is on pages 10 to 14.

The second is the section that looks at possible instruments that might be used to promote broader access to and take up of employment based superannuation. That is on pages 21 to 24.

Finally, there is the discussion of the design of savings instruments that might help overcome some of the psychological barriers to savings. That is in pages 32 to 34.

"Savings policy" is not just about what the government ought to do by way of tax incentives for savings. Indeed, the thrust of this report is that that is probably one of the least cost-effective strategies for boosting private saving and increasing personal financial flexibility.

The design of a savings policy framework would ideally be helped if there were more information about "why" people save, and about some of the dynamics that are changing the financial status of the next generation(s) of savers. More work on that, to complement the very large strides made in recent years to improve information on "what" and "how" people save would be ideal.

In the meantime, it is possible to make progress. A robust savings framework is one in which all with a responsibility for a contribution to make to improving peoples' capacity to deal with their financial health in the future accept that responsibility and make the contribution. More importantly, it is one in which each part of the framework complements the others.

A comprehensive and complementary framework cannot be imposed. It has to emerge through discussion and compromise, and present as a consensus.

This paper is offered as a starting point in fleshing out the agenda for that discussion.

Saving:

• increases the financial flexibility people have, and
• (generally) increases the amount of money they have in the future.

Despite these apparent advantages, saving rates in New Zealand are low. At the personal level this means that most New Zealanders enter retirement substantially dependent on the state-provided New Zealand Superannuation for income, or to supplement what can be taken out of savings. 70 percent of the income of single New Zealanders over 65, and 60 percent of the income of couples, comes from New Zealand Superannuation.

At the national level, low savings rates mean that there is a limited pool available to finance investment in new plant and projects. In 2001, 73 percent of New Zealand’s investment was financed by foreigners (either by equity or loans). While there is no apparent inability of New Zealand borrowers to access foreign savings, the dependence on them

• ensures that a portion of any increased economic output accrues to foreigners and is not available to enhance the living standards of New Zealanders;
• creates a possible source of volatility and instability.

Savings that do take place:

• build up over the life cycle, so that assets rise with age and income;
• are highly unequally distributed (in all age brackets over 35, there is a consistent pattern of the top 20 percent owning 60 percent of the assets of the group);
• are significantly impacted by inheritances;
• are heavily concentrated in owner-occupied housing (equity in the home accounts for 36 percent of the assets of New Zealanders);
• are increasingly less likely to be through employment based superannuation schemes (These schemes covered 22.6 percent of the employed workforce in 1990, but only 14.6 percent in 2001. They account for six percent of household assets compared with 15 percent in Canada and 11 percent in the USA);

The dynamic aspects of savings (and the related accumulation of debt) are not well known, but there is a real risk that a life history of beneficiary debt, student debt, more frequent periods outside paid employment and greater recourse to high-interest, short-term credit card debt will leave a substantial proportion of future retirees asset and income poor, or – even worse – indebted, asset poor and income poor.

Decisions on whether to consume or save income, how much to put aside for future lifestyle needs, and where and how to save, are inherently personal decisions. Why then, should other agencies – the government, employers, unions, providers of financial products – intervene to influence the level and form of savings?

There are four main reasons.

• "Market failure". A number of studies have shown that there are information, confidence and psychological barriers that get in the way of converting what people objectively think they need and want to do, and what they actually do. Overcoming psychological barriers to savings can effect a change in the savings culture.
• Risk. The less consumers save to protect themselves from adverse circumstances, the more risk transfers onto the provider of last resort: taxpayers.
• Investment. A higher rate of domestic savings will ensure that more of the benefits from investment accrue in and to New Zealand(ers).
• Standards. There is a need to protect savers from poor standards, bad practice and inappropriate (often concealed) costs and fees.

A robust savings policy should not rely on a single vehicle through which saving is channelled. Nationally, saving can be done by the government, by businesses and by households. It can also take many forms, from temporary and liquid balances in bank deposits, to locked-in, workplace based and largely inaccessible retirement savings schemes.

If saving is seen as a means to an end (greater financial flexibility and protection from loss of regular income) a comprehensive savings policy has three core elements: the basic income protection provided by the government (especially in retirement, when income earning options are effectively closed); employment based, longer-term savings; and individual savings for targets that can vary in amount and timing. The policy would need to address incentives and disincentives to saving (including tax incentives and disincentives) especially for the second and third elements.

The elements are not entirely independent. Provisions in one area can impact on the incentive to save through other vehicles, and can create tensions when the ultimate beneficiary seeks to move savings to other uses (e.g. to access funds in a retirement scheme to pay off credit card debt or to put a deposit on a house)

It is clear that different interests can support enhanced savings for different reasons (e.g. an employer can support savings by individual employees as a recruitment device, or to assist with a retirement/ disengagement policy). The problem with this is that there are benefits to third parties (e.g. the government, if savings reduce the risk of extra demands on state support or if they increase investment and net national income), that may be higher than the benefits to the party bearing the cost (like an employer subsidising a superannuation scheme).

The workplace is a highly efficient and effective location and instrument to use in boosting savings, but there is very limited benefit to employers and unions in allocating time and money to boosting workplace based saving.

In this case, a number of policy options arise:

• Compulsion (in various forms, such as a requirement for employers above a certain size to offer access to a superannuation scheme).
• Incentives (to either the employee or the employer or both).
• Conscription (to find a way for unions to mobilise the collective interests of workers around a diversion of some part of salary into saving).
• Reward (kick-starting savings or augmenting savings with one-off boosters once certain milestones are passed).

The third element of a savings framework (individual savings in different and more flexible ways) is very difficult to "steer", because motivations and personal circumstances are so incredibly different. Policy here could well focus on the product on offer: fees, ethics, transfer values, and on education about the product range that savers have access to.

There is also a life stage, or mid-life milestone that might trigger a different attitude to and urgency about saving. It is not clear if this is simply something that changes motivation and behaviour, or whether policy or savings product can be designed to support and enhance savings that are stimulated by both need and capacity to save at certain life stages.

At present, there is no generally agreed approach to the elements that ought to go to make up a savings policy package, or about the weight that ought to attach to each of them. A "conversation" (workshop/forum/summit) between groups with an interest in developing a national consensus on savings policy can help progress initiatives that might boost savings.

There are a large number of complex elements that need to be integrated into a comprehensive savings policy framework. It will not be possible to cover them all in an initial forum on savings policy. There are, though, four core elements have to be covered in the first round of policy development.

1. The "first tier": New Zealand Superannuation.

Is it time to move on: to put NZS behind the debate on saving and to concentrate on promoting other forms of saving? There is a link between NZS and these other forms of savings: is it possible to explore the implications of that link without relitigating the issues of entitlements to and sustainability of NZS, and taking attention away from the need to improve performance in the other areas?

2. Expectations: defining the level of support that savers can reasonably expect?

What reasonable expectations can be placed on employers to offer superannuation as a condition of employment? What level of cost should the government meet in supporting workplace saving? What is likely to be a cost effective form of support: tax incentives, tax deferral, cost offset or rewards?

3. Quality of savings products and consumer protections.

Are consumer protection and disclosure requirements at the retail end of the savings industry adequate? If not, what additional interventions are necessary and justified?

4. Promotion: education and scheme design.

Where should the emphasis go in overcoming the psychological and information barriers to saving: education; design of default options around employment and saving; or restrictions on access to savings? What measures are likely to be counter-productive and build up resistance to saving?

A number of additional issues need to be worked through in the fullness of time. They refine and complement these core elements of a savings policy.

• Is there enough clarity around the links between domestic savings, investment, and national benefits from production, employment and income to create a basis for establishing what level of cost the government ought to bear in designing a package of measures to stimulate saving? If not, should the emphasis for policy design go on the personal benefits of savings with the wider macroeconomic benefits providing background comfort (that there will be a greater good as a by-product)?
• Where should the emphasis go in refining statistical and psychological understanding about trends in saving and the financial status of groups of New Zealanders?
• Do existing approaches to saving (by all parties) mean that "serious saving" is only being done by the top twenty percent of New Zealanders, and if so, where are the key interventions that will spread that practice?
• How serious is debt in its emerging forms, and does debt management have to be a part of a savings framework? If, so, what are the options?
• Is the dominance of the home in the asset plans of New Zealanders an issue that should – or can(!) be managed in both diversifying the asset base of households, and contributing more to supporting income and consumption in retirement?
• How far should the policy go in trying to establish good practice in employment relations, and who should take the lead in doing so?

These lists are not exhaustive. They provide a basis that parties interested in pursuing the savings policy debate can add to or delete from. Further input will then allow a structured and reasonably comprehensive agenda to be developed for a subsequent workshop/forum/summit on this important and pressing dimension of public policy.

The Investment, Savings and Insurance Association (ISI) has instigated a process that will bring a variety of stakeholders and interested organisations together to discuss the components of a new framework within which personal savings are encouraged and facilitated.

A robust savings policy should not rely on a single vehicle through which saving is channelled. Nationally, saving can be done by the government, by businesses and by households. It can also take many forms, from temporary and liquid balances in bank deposits, to locked-in, workplace based and largely inaccessible retirement savings schemes.

If saving is seen as a means to an end (greater financial flexibility and protection from loss of regular income) a comprehensive savings policy has three core elements (or "tiers"): the basic income protection provided by the government (especially in retirement, when income earning options are effectively closed); employment based, longer-term savings; and individual savings for targets that can vary in amount and timing.

These elements are not entirely independent. Provisions in one area can impact on the incentive to save through other vehicles, and can create tensions when the ultimate beneficiary seeks to move savings to other uses (e.g. to access funds in a retirement scheme to pay off credit card debt or to put a deposit on a house)

Much of the debate on savings policy has focussed on the first element or tier, and while no element is independent of any other, the biggest gap, in terms of a settled policy on savings is around tiers two and three.

The intention of the process that the ISI has initiated is to work collaboratively to structure an environment that will enable New Zealanders to accumulate personal savings in order to give them more financial freedom. There is a need to take a lifetime perspective, recognising that there are milestones against which individuals can plan their finances. Although the framework envisages an integrated approach to the various forms that savings may take, there will be special emphasis on the workplace as an instrument that can leverage savings levels.

Any discussions that may take place will be more constructive and productive if:

• the issues that concern participants are outlined in advance;
• there is a comprehensive agenda that both identifies the issues and elaborates on them;
• background information explains the context in which the issue arise.

This report is not a conclusive outline of that comprehensive agenda. It is an initial attempt to sketch out the conceptual and practical issues that have arisen around the savings policy debate. Potential participants are invited to use the report as one perspective on savings policy, and to see if there are major areas and issues that have not been covered.

Responses will allow a revised draft to be presented to a workshop/forum/summit as a background document that can be used as the agenda in forming a consensus on savings policy.

This initial report:

• Sets out some of the "national interest" perspectives that would provide the common cause around which a partnership on savings might form.
• Defines the core interests and concerns of a number of interest groups.

Provides a preliminary list and definition of the issues that would need to be explored in developing the framework.

"Saving" is a slippery concept. In its most simple form, it is that part of income that is not consumed. By deferring consumption, the individual (or group, or even nation) is able to consume different things in a later period. Savings changes the scheduling of consumption (its "inter-temporal dimension" in the jargon). If savings are channelled through an instrument that earns income, more is consumed in the future time period.

Saving therefore not only shifts consumption through time, but it also increases the level of consumption in the later time period. In this sense, "saving" is inextricably linked to "investment".

Saving:

• increases the financial flexibility people have, and
• (generally) increases the amount of money they have in the future.

Savings may well be a slippery concept, but when it comes to measuring who saves, and how much they save, statistics can prove just about anything! It all depends on what is being measured and who is doing the measuring.

Unfortunately, different series not only show radically different patterns of savings, but different trends in savings behaviour.

What can be said from the array of measures is that:

• at the personal level, savings rates are low, and it is only a small percentage of the total population that will accumulate sufficient savings to sustain living standards at a reasonable level when earned income stops (usually through retirement):
• from the point of view of the national economy, saving is insufficient to finance total investment, so there is a reliance on the saving of foreigners (as evidenced in a persistent deficit in the current account of the balance of payments).

An aspect of the low level of national saving that might be relevant for developing a policy framework on saving is that while government and business saving is generally positive, household saving is extremely low, and on some measures negative.

Some of the (confusing) technical detail about measures of savings is recorded in appendix II. The appendix also lists the questions that need to be addressed if it is felt that developing a policy on savings needs to work off a more consistent and more relevant information base.

[National savings has three components: saving by the government, saving by businesses and savings by individuals – "households". All are important. Business saving – through retained earnings – tends to be most directly connected with new investment. It is also linked to household savings. To the extent that New Zealanders own businesses, their savings go up pro rata with their share in the business. In this section, no attempt has been made to isolate the special features that might impact on business saving. The data record the effects of business savings, not their cause. If private households own farms, businesses or commercial property, or have interests in family trusts, the value of those interests are shown as household assets. There is no information available on which to judge whether those asset values are a result of conscious savings decisions by businesses or simply a matter of luck (windfall capital gains or losses)]

(It is useful to distinguish between flows of saving (set amounts of current income that are not consumed) and stocks (the accumulated effects of past income, consumption, borrowing and saving). The stock of saving can be influenced by "outside events" – how profitable trading conditions have been, whether interest rates have been rising or falling, and how capital values have been moving. In this section – unless it is clear from the text, references are to the stock of savings)

{Except where it is clear from the text, data in this section come from the Household Savings Survey. The HSS defines "assets" widely. They include conventional definitions of assets such as bank deposits, shares, farms, property and the like. They also include some things that might be regarded as consumer durables like motor cars and collectables. "Other" assets cover any asset with a value of more than $1,000 and include home computers, and sporting or hobby equipment. They do not cover furniture, household appliances and clothing}

Qualifications aside, a general picture of private savings in New Zealand shows:

On average, individuals have $97,900 in net assets, and couples $322,300. The average is misleading. It is boosted by small numbers with large assets. The median value of assets (the middle of the range) is only $10,300 for individuals and $172,900 for couples. By comparison, the average wage is a little under $39,000 per annum.

The Household Savings Survey data show that savings tend to rise in rather regular steps with age and income. This could simply reflect the dominance of the house in the asset portfolio of New Zealanders. As people grow older, their equity in their homes rises. Given that 36 percent of all assets held are in the house that is being lived in, this factor would smooth any observed variation in the composition of asset ownership by age group.

The effect is that in the age group approaching retirement (55 – 64), a higher percentage of the population have a reasonable stock of assets. The absolute values, though, are not particularly high. Only 35 percent of individuals in this age bracket, and 60 percent of couples, have net assets of $200,000 or more: and that includes the house.

In 1998, Lynne Middleton wrote a Masters thesis that built on the USA work of L C Hayes. Hayes isolated the factors that enabled women to do well in retirement. The factors were a strong and independent identity, a healthy lifestyle, secondary employment skills and financial security. Significantly, all were developed during middle age, which reinforces the prospect of retirement savings developing a distinct identity at some cut-off or turning point in life stages.

Middleton carried out in-depth interviews with six women in order to gain some insights into women’s attitude towards and actions around retirement income. The sample was somewhat biased: all six were middle-aged, they had good incomes and had a degree of knowledge about the issues. There was, though, a mix of lifestyles (single, partnered, divorced) and asset status (own home, no home, high credit-card debt).

All of them wanted to save for their retirement as a distinct objective related to a post-work lifestyle change. (Reducing hours, doing unpaid work). They probably had false expectations about ease of access to lower-paid alternative work, but all wanted to face a change in their work patterns with some confidence about being able to live to an acceptable degree of personal comfort.

They faced different savings imperatives (pressure to freehold the family home, need to get on top of out-of-control card debt), but saw retirement savings as something that was distinct from more general asset and debt management. Interestingly, the home was not seen as an assessable asset for retirement income/consumption. In one case, freeholding the house was seen as a pre-condition for starting or increasing retirement savings. In another, the fact of not owning a house was countered by the individual’s expectation that she would inherit the house from her parents. (In this case, the expectation was from one generation that the older generation would not/should not see the house as a consumable asset).

Despite the fact that HSS data do not show an observable shift in savings at a set point in the life cycle, those data could be dominated by the accumulation of equity in the house. If data on the value of managed funds and of financial assets are examined separately, there does appear to be a quantum step up for groups over 45 years of age.

Few assets and high debts mean that savings patterns for the young are difficult to interpret. However, for all age groups over 35 there is a fairly consistent pattern of the top 20 percent of the age bracket owning 60 percent of the assets.

This figure probably understates the concentration of asset ownership. Assets build up over the life cycle. Those in the older age groups have larger absolute (as opposed to relative) net assets, so for the population as a whole, the top of the scale owns an even greater percentage of the whole. The top ten percent own nearly half (48 percent) of all assets and the top twenty percent hold 67 percent).

One measure of equality is the "Gini coefficient". The closer a coefficient is to one, the less equal is the distribution. The coefficient for the distribution of wealth is 0.689, while the coefficient for the distribution of income is only 0.322.

In each age group, Pakeha have more assets that Maori, and the margin is very wide: Pakeha have at least three times as much as Maori in net assets.

Especially before retirement, single people who have inherited assets have median net assets more than twice the value of single people as a whole. The gap narrows a little in the immediate pre-retirement age band (55-64) as people accumulate assets and the proportionate influence of the inheritance declines. In this bracket net assets of those who inherit are "only" 80 percent higher than for the population as a whole. In absolute terms the differences remain the same at around $100,000.

Similar patterns are shown for couples, although the relative differences are not quite as large. This probably reflects the fact that couples accumulate more assets between them during the life cycle, so the asset base is larger relative to the inheritance. In absolute terms, inherited assets boost wealth by a little more than for single people, probably because there is a greater chance that both partners will inherit something.

The home accounts for 36 percent of the total value of the assets of New Zealanders. If other properties are added, the total rises to 45 percent.

Together, farms, businesses and family trust make up the next largest category at 24 percent. These will be much more important in the portfolios of particular categories of New Zealanders (the self-employed and professionals) than the overall average suggests.

Assets in superannuation schemes account for a very small six percent of total assets. Life insurance policies add another two percent to that total. This compares with 15 percent in Canada and 11 percent in the USA.

A surprisingly high six percent of assets are held in bank deposits. The same amount is held in bank deposits as is held in superannuation schemes.

Interests in shares and managed funds also make up six percent of the asset stock, but intuitively it seems possible that in this case the average masks quite wide variations between distinct groups in the population. Managed funds are particularly significant for those over 65.

A very small percentage of the population (four percent) owned family trusts, but the median value in trusts was relatively high (at $216,000).

In 1990, there were 333 employment based registered superannuation schemes covering 22.6 percent of the employed workforce. By 2001, the number of schemes had fallen to 263. In itself that may not be too alarming: a number of stand-alone schemes have folded into master trusts. The alarming thing is that coverage of the employed workforce has declined from 22.6 percent to 14.6 percent: the penetration of super has fallen by more than a third in only a decade.

What is not clear from the available data is where coverage "bottoms out" under current policy settings. A number of schemes have closed to new members, and have not been replaced with alternatives. As pre-closure members retire, the coverage will gradually decline. There is no estimate of the percentage of new entrants to the workforce or of those starting new and different jobs who have access to a super scheme. There is therefore no good benchmark available to estimate what a "steady state" may look like under the current policy regime.

The "current regime" is not just the tax regime. It is also influenced by employer practice, (emphasis on total remuneration packages, outsourcing of trustee functions) by employment patterns (more labour market churn) and by employee attitudes (a desire to make personal decisions on levels and forms that saving will take).

The Insurance and Superannuation Unit of the Ministry of Economic Development has a database that could generate some insights on how many "new members" joined schemes in any year. There are difficulties with definitions (for example when members leave a stand alone scheme and join a master trust the form of transfer may classify them as "new members" of schemes), but it is possible to get a better feel for the way employment based super is evolving.

There is also very little information available about changes that have been made to the details in these schemes: for example about ease of access to past savings.

The decline in employer sponsored schemes has been offset by an increase in the numbers in retail superannuation schemes. Membership of private sector employer and NPF schemes fell from 273,065 active members in 1990 to 218,284 in 2001. However, this fall was more than offset by a strong rise in the membership of retail superannuation schemes: up from 234,590 active members to 434,583. Balances in the retail schemes rose from a little under $1.5 billion in 1990 to nearly $8 billion in 2001.

Anecdote suggests that a lot of this growth was driven by a desire to avoid the NZS surcharge during the 1990s. However, the surcharge has gone, and there does not appear to be a wholesale withdrawal of money from the schemes. Contributions in 2001 almost matched benefit payments. This may reflect scheme rules (designed to comply with surcharge avoidance), and more analysis is needed before any conclusions can be made about what appears – at least superficially – to be an avenue of savings that has attracted large numbers of savers and considerable savings balances.

The general patterns revealed in this snap-shot of saving practices raise a number of issues that need to be explored in any debate on savings policy.

Consumption can be postponed – that is the essence of saving. It can also be brought forward – by borrowing. Borrowing is not simply an erosion of saving: the interaction is more complex than that. Borrowing to buy a house may well improve the overall pace at which assets accumulate.

What, then, can be said about debt?

Mortgages overwhelm the debt profile of New Zealanders. 80 percent of debts are by way of mortgage. Next is bank overdrafts and the like at 10 percent, student loans at five percent and credit card debt at three. There is almost nothing else, with hire purchase debt having retreated to obscurity.

A perhaps surprising feature of mortgage debt is that it is fairly common right up until retirement: fifty percent have a mortgage in the 45 – 54 age bracket and even in the 55-64 bracket mortgages are still held by 30 percent. Obviously the level of debt reduces with age. By age thirty-five, the average level of owners’ equity in the house has passed fifty percent. The fact remains that large numbers of New Zealanders do not "pay off the mortgage" early!

There is concrete evidence of a rapid build up of credit card debt, probably associated with easier access to cards, ready increases in credit limits and more aggressive promotion of card use (such as by loyalty programme points for card use).

The Household Savings Survey identified credit card debt as the most common form of personal debt (with about half of those surveyed having such debt), but contributing a modest amount to total debt (3 percent of the total, compared with mortgage debt at 80 percent).

This may understate the importance of credit card debt. The Reserve Bank estimates outstanding credit card balances at $3.6 billion at February 2003, compared with the HSS estimate of $1.9 billion. Some of the difference will be the outstanding balances on business credit cards and some will reflect the growth of debt since the HSS survey.

However, the impact of card debt at the margin – on savings outside of the purchase of a family home – may be more significant than its overall share of total debt, and there is no doubt that it is an area of rapid debt growth.

Outstanding advances on credit cards increased by 9.6 percent in the year to February 2003, by 13.9 percent in the year before that and by 22.2 percent in the year to February 2001. Anecdotal reports suggest that a more than fifty percent increase in card debt in only three years is impacting on household financial management, and all other things being equal, (i.e. if all savings are treated in the same way) the risk is that some household balance sheet management would see long-term savings reduced to take some pressure off short term debt repayment problems.

This does not suggest that regulating a "lock-in" of retirement savings is needed, but it does at least suggest that retirement savings need special attention: if only in the form of education and advice to limit unmanageable credit card debt exposure in preference to liquidating retirement savings.

Organisations that work with financially distressed families report that debt traps are a major constraint on any capacity for them to get on top of their finances. It is not quite clear if this is simply a life-stage impact, or whether beneficiary debt has the potential to create a group that enters retirement not just asset and income poor, but indebted as well.

Beneficiary debt compounds for a number of reasons. Many if not most beneficiaries will at some stage need a special benefit which is often in the form of a loan. Low incomes mean that they have difficulty making lumpy payments like registering a car. This in turn means that they get fined for not having a current registration and so end up in debt to the Courts. If they are not in work they have less access to both conventional (bank) and informal (workmates) lines of credit and are forced into the high-interest "street front" lenders.

Beneficiaries therefore end up with layers of debt, as one debt mitigation tactic simply adds another layer.

The interface between saving, debt and asset accumulation means that debt cannot be left out of a framework for thinking about savings policy. Issues that arise include:

Assuming that people will not save if doing so puts them under excessive financial stress (i.e. that they will save what they can "afford" to save), savings are "good" for the individual. The question that arises is whether they also generate additional public benefits. (This becomes crucial if other parties are to make a contribution – in whatever form – to promoting personal saving).

In a "Robinson Crusoe economy" (no trade, one unit of labour, and a natural endowment of resources) savings and investment are the same thing. Crusoe (ignore Friday) stops fishing for a day to build a net. Consumption is deferred so that more fish can be caught in the future. Saving is a necessary precondition for investment. But it is not a sufficient condition: Crusoe could simply have had a day off. By channelling the saving (no fishing) into investment, Crusoe increases his capital stock: he has produced the means of production (the net).

In a complex economy, savings and investment are decoupled.

The people who save are (mostly) not the people who invest. Not only that, but the reason they save has absolutely nothing to do with the reason investors invest.

Savers save for a host of reasons: to buy a lumpy consumer durable like a car, to guard against adversity (the rainy day), to build up assets to consume when they no longer have the will or capacity to work (retirement income), or simply because they had more money than they needed to spend at that time (a residual).

Investors invest because they see a profit opportunity and need to spend money to create the asset that can take advantage of the opportunity. They can either save the necessary money themselves (such as a company retaining earnings to plough back into new projects), or more likely borrow it from the savers (by issuing them shares, or by paying interest to them for the use of their money).

In this specification, the question arises as to whether there is any need for a savings policy. Individuals will make personal choices about spacing consumption according to their needs and their expectations of future income and risk (adults making adult decisions). Investors will similarly make personal decisions about opportunity, risk, and how much to offer to induce savers to lend them their money. Why should the government interfere?

It doesn’t interfere in a whole host of decisions about what consumers buy and what traders offer for sale, so why is this product – the price on offer for the use of money – any different?

There are four reasons to develop a savings policy.

• Standards. Governments are not indifferent about what traders offer consumers and what consumers buy. There are hosts of regulations on product standards, truth in advertising and so on. Savings policy needs to identify the appropriate range and form of standards if savers are to be given the same protection from exploitation that consumers of other products expect.
• Transfer of risk. The less consumers save to protect themselves from adverse circumstances, the more risk transfers onto the provider of last resort: taxpayers. The standard view is that low savings creates pressure to maintain a relatively generous state pension. Because those who do save resent state pensions being paid to those who don’t, the irresistible political pressure is to make that state pension universal. In practice, this "income support" when consumers have not saved can have a much wider catchment: the state paying more for tertiary education, health care, and even unemployment benefits (compared with, for example, the USA).
• "Market failure". A number of studies have shown that there are information, confidence and psychological barriers that get in the way of converting what people objectively think they need and want to do, and what they actually do. Overcoming psychological barriers to savings, providing more effective access to relevant information and improving confidence about savings decisions can effect a change in the savings culture.
• Promoting investment. If (and it is a big if) higher savings leads to more investment, there are multiple benefits to be had from increased saving: more production, more employment, higher incomes, a larger tax base, more protection from adverse economic circumstances and so on.

This list suggests that there are some benefits to the government in managing its fiscal risks if individuals are encouraged to save more. There are also benefits that the government can capture "on behalf of" savers because only the government has the capacity to capture those benefits. These benefits are those associated with consumer protection standards, and overcoming the information and confidence aspects that contribute to "market failure".

Sitting in behind these immediate and tangible advantages in encouraging saving is a bigger picture question: how much all stakeholders in the economy - the government, employers and unions – should promote savings in order to reap a much wider economic dividend.

Economic theory reduces the relationship between savings and investment to one that equates them: savings equals investment.

(Simplifying), no-one can produce something that some-one else will not buy. (They can, but it is not economic production). Hence the level of production will be set by the level of overall spending. In a simple economy, spending can either be on consumed items, or through investment (spending on new plant or equipment, or building up stocks for later sale). That spending creates incomes for those engaged in production. But income can only be spent or saved.

Elegantly

• Income equals expenditure.
• Income can be consumed or saved.
• Expenditure can be on consumption or investment.
• Consumption is common to both income and expenditure.
• Therefore the residuals – savings and investment – must be equal.

If savings are not equal to investment (remember that savers and investors are separate groups and their motivations are entirely different, so it would be an extraordinary coincidence if the plans of savers matched the intentions of investors), production (and hence income) adjusts until they are.

If savers save more than investors want to invest, total production cannot be sold, and hence firms cut back, reducing incomes (and savings) until saving again aligns with investment.

The point behind this very brief foray into the economics of savings and investment is to illustrate that because the definitions of economic theory assert that savings equal investment it does not follow that savings cause investment.

Savings policy cannot rest on an assumption that raising savings raises investment. Investment is driven by the availability of profitable investment opportunities. Savings can facilitate investment because if savings levels are below investment intentions, competition for the scarce savings drives up interest rates and makes some investment options uneconomic.

There is another way in which savings link to investment: they influence the benefits that accrue to New Zealanders from the investments that are undertaken.

In an actual world, no economy is a sealed unit. Investors can access the savings of foreigners if local savings are insufficient to fund their investment plans. There is still the expansion of activity, and the growth of jobs and incomes associated with it, but some part of the economic activity that flows from the investment accrues to foreigners in the form of the interest and dividends paid to them for the use of their money.

It is estimated that in the year to March 2002, 5.5 percent of total economic production in New Zealand accrued to foreigners who had financed past investment. (This was slightly lower than recent ratios which have been in the six to seven percent range). This is a not insignificant "leakage" of potential national income. However, it is not then correct to say that if New Zealanders did not use the foreign capital, New Zealanders would be 5.5 percent better off. There is no way of knowing what level of investment would have taken place in a sealed economy, what interest rates would have been needed to persuade locals to forgo consumption, and what investments would have been burned off at those higher interest rates.

In the limit case, savings are crucial to investment: this is where foreigners perceive the risks of lending as too high and in that case an absence of domestic savings does limit the level of investment that can be undertaken. It is not clear when that limit is reached, and certainly at this stage there is no apparent inability of New Zealand borrowers to access foreign savings (although they may do so at the extra cost that any "country risk premium" adds to interest rates.)

While economic theory can put saving and investment into neat conceptual boxes, those boxes are not particularly helpful when it comes to forming policy on savings. Specific activities can "migrate" between saving, investment and consumption, depending on who is doing the classifying. Take the example of buying a house. Is the buyer "saving" (by building up an asset that can be sold at a later time to finance consumption), "investing" (in the asset, which will generate future income by the owner not having to pay rent), "consuming" (shelter) or bits of all or all three at the same time?

There are major conceptual difficulties about what constitutes an "asset" as far as investment is concerned. Is education an investment, or is it a consumption good because education allows people greater enjoyment of life? If it is an asset because it increases capacity to produce goods, how is it valued: on the cost to the state or the total cost to the state and the individual, or on the extra productive value that the human capital can create? Is it an asset if it can leave for Australia tomorrow?

A final difficulty is that when attempts are made to link savings that are designed to improve personal financial flexibility and to protect against adversity, the link to economic concepts breaks down completely. The individual simply wants to "save" by "investing" in assets that align with their preferences for return and risk. This can be a bank deposit, a company share, a residential property, a unit trust, a work of art or any such instrument. Very few are "investments" in the conceptual economic sense. In economic terms, investments add to the stock of capital and improve productive capacity.

Buying a Telecom share, or an existing house, or a work of art does not add any productive capacity: it merely transfers the ownership of existing assets from the seller to the buyer.

This raises a contentious question around whether a policy framework built around saving could or should attempt to "channel" savings into some areas that are deemed to be more beneficial from the national interest perspective. There have been a number of reports from the OECD, IMF and even from the NZ Treasury that suggest that the current tax regime is inefficient in directing investments into areas of low net benefit (or at least of not being neutral as to where they are directed). Rental housing and forestry are two such.

Conceptually, there is economic "good" associated with higher savings.

They can lubricate local investment, capture more of the benefits that flow from investment for New Zealanders, and act as a hedge against a risk that foreigners desert New Zealand for greener or less risky pastures abroad.

That said, macroeconomic objectives should not be the primary guide to the structure of savings policy. The benefits are too difficult to quantify, and it is too hard to establish a link between steps that may be taken to boost savings and an eventual lift in investment, production, employment and incomes. These objectives can provide a comforting backdrop to a framework within which positive measures are taken to boost private saving, but not a lot more than that.

This is perhaps a surprising and heretical conclusion.

A robust savings policy should not rely on a single vehicle through which saving is channelled. Nationally, saving can be done by the government, by businesses and by households. It can also take many forms, from temporary and liquid balances in bank deposits, to locked-in, workplace based and largely inaccessible retirement savings schemes.

If saving is seen as a means to an end (greater financial flexibility and protection from loss of regular income) a comprehensive savings policy has three core elements (or "tiers"): the basic income protection provided by the government (especially in retirement, when income earning options are effectively closed); employment based, longer-term savings; and individual savings for targets that can vary in amount and timing.

These elements are not entirely independent. Provisions in one area can impact on the incentive to save through other vehicles, and can create tensions when the ultimate beneficiary seeks to move savings to other uses (e.g. to access funds in a retirement scheme to pay off credit card debt or to put a deposit on a house)

The centrality of the "second tier" to a lot of thinking about saving is that it is almost the entire focus of the terms of reference for the 2003 Periodic Review Group on retirement income policies.

This begs the question, though: why should employment be the focus, and why is there an expectation that employers should bear costs in facilitating savings by employees?

There are three main reasons to focus on the workplace.

• Paid employment is still by far the most common way that individuals earn income from active labour market participation. Employers and the self-employed are significant and should not be ignored, but just over eighty percent of the economically active are on a payroll. A robust employment based savings regime captures four-fifths of the population that are at that stage of the life cycle when stronger savings might be expected.
• Saving via the workplace is efficient. It is easier to communicate with groups of potential savers who gather on a regular and predictable basis at central point. Deducting contributions to savings schemes before residual income is handed over is cheap and reliable. "Bulk buying" a savings product reduces the overhead (commissions) of selling savings product one by one, house to house.
• Workplace saving is likely to be more effective. Surveys show that employees tend to place more store by information received from the employer about savings, because the employer is not seen as having a vested interest or ulterior motive (as opposed to the savings and insurance industry, and politicians, who are). Schemes can be designed to get around the psychological barriers associated with starting savings (putting it off until later, lack of confidence about personal knowledge of savings options, and taking the line of least resistance – see above).
• This form of saving is likely to lift the level of saving compared with attempts to encourage saving out of income that has already been received. Because workplace scheme deductions are at source, the perception is that the "net" pay is what is available for spending (or saving through the third tier). Contributions are out of sight, and out of mind.
• There is a greater likelihood that these savings will be "new" savings rather than a result of shifting saving from one form or vehicle to another, which is a more likely result if an individual is encouraged to join a "retail" savings scheme.`

None of this addresses the question of why employers should bother. Even if the workplace is an efficient and effective focus of savings campaigns, making a scheme available, explaining it, and administering it costs money. If a workplace based scheme is accompanied by an expectation that employers will subsidise or match employee contributions, a scheme can add to labour cost.

Michael Littlewood identifies three main potential benefits to employers.

• To remain competitive with other employers, and to retain valuable workers. This can be enhanced if access to a scheme is by invitation, and if there are vesting rules that link access to an employer contribution to length of service. Even without these restrictive provisions, the availability of a scheme can make some employers "good" to work for. They attract a larger number of applicants for vacancies, allow the employer to be more selective in hiring, and to retain those who are selected.
• It reduces problems of retiring workers when age is starting to impact on performance. This might be particularly advantageous in a era where age discrimination is illegal. Under that regime, employers are tempted to introduce competency tests, which can be damaging to workplace morale, cause tension and unpleasantness and open up scope for litigation around unfair dismissal. Moving into retirement in the knowledge that there is additional income available has a subtle effect on changing expectation and of easing the process of exit from the labour market.
• Saving may be a good way of identifying good workers. If an employer has a savings scheme, it tends to attract workers with a positive attitude to savings, and some studies have found that "savers" tend to be more diligent and effective workers than "non –savers".

Apart from the financial advantages of providing a scheme, employers may do so for two other less tangible and quantifiable reasons.

One is simply to be a "good employer". Workplaces are part of a wider social order, and employers have rights that are matched with responsibilities. They can expect to have access to a supply of skilled workers (largely trained at the cost of the rest of society), who have access to health services, (not paid for by the employer) and who are bound by certain standards of performance (attendance at work etc). These rights are matched with some responsibility to ensure that there is some asset to fall back on when the worker terminates employment.

The other reason that employers may provide schemes is simply that other employers do! There is very little solid evidence available on why employers offer schemes, and those that do give reasons have difficulty in establishing the extent to which the schemes actually achieve their purpose. Doing what others do may be linked to the recruitment and retention factor, but there are other retention strategies available (higher wages, for example!). It is fully possible that norms and conventions are a strong influence on practice.

The general conclusion here is that:

• the workplace has the potential to be an effective platform on which to construct better savings practice; but
• it is by no means clear that the private benefits to employers match their private costs in providing a scheme.

If there is a divergence between public benefit and private benefit, a limited number of options suggest themselves.

Compulsion (in one form or another).

Compulsion can either be compulsory contributions (say on the Australian model) or a requirement to have a scheme available (like the Irish model). It is highly unlikely that the circumstances under which compulsory employer contributions came into being in Australia will ever exist here, and if they did whether the scheme would not come under subsequent pressure from workers to access their savings.

Compulsory access would normally be for employers of a particular size, but compliance of constant change in the regulatory environment employers face would be factors that influenced the timing of any move to compulsory access.

Incentive (through some form of subsidy)

Tax incentives are notoriously expensive because they reward the "intra-marginal" saver: the saver who would have saved anyway. Tax advantages are also expensive simply because of the weight of numbers. There are nearly two million employed New Zealanders. If only half of them took advantage of a subsidy, and the subsidy was as small as $100 per annum, this would cost $100 million per annum. It is unlikely to be a strong pull on saving, particularly if access to the subsidy meant that access to savings was restricted.

Government advisors are adamant that tax incentives will not increase national savings: they are made at the expense of reduced government savings, and some of the private savings that attract subsidies are simply a shift in the form of saving (to the tax advantaged vehicles).

None of this applies to tax disincentives when either employer contributions or earnings in funds are taxed at a higher marginal tax rate than the worker can obtain through other products. If employment based savings is both efficient and effective, overtaxing savings through that vehicle must be bad policy. There are a number of anomalies in the tax treatment of different types of saving. Details are contained in Appendix III.

It is less clear if the same conclusions apply to tax deferral. The present tax regime taxes savings at the front-end and exempts withdrawals from tax. Exempting savings from tax at some other stage of the saving cycle (on contributions to qualifying schemes, or on earnings) but taxing the saving when the income is drawn out does "cost" taxpay

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