The next 100 years

The Bill to reform pensions and appoint a pensions regulator is stranded because the trade unions want a government-guaranteed pension. The remarkable if paradoxical fact is that it is better for civil servants and for the country if no guarantee is given. It is now well understood that every time the government gives out such guarantees, it is a fiscal transfer at a future date. The trade unions pushed exactly this position with the Employee Pension Scheme (EPS) in 1995, which now has a hole of over Rs 20,000 crore. Such a fiscal transfer is both unfair and dangerous. It is dangerous because India's debt is already over 80 per cent of GDP, and Parliament must be careful to place no new time bombs for the future. It is also highly unfair because it perpetuates the pattern of relatively small trade unions grabbing privileges for their members at the expense of the economy.

Paradoxically enough, workers in a modern pension system do better when there are no benefit guarantees. When guarantees are present, the regulator will constrain investment patterns to match the assets and liabilities of the pension fund. This will inevitably generate a strong bias in favour of low-yield government bonds, which is not in the best interests of workers, who are better off letting go of the notion of a fixed pension to be received many decades in the future. Instead, the sensible strategy consists of having a high savings rate coupled with an investment strategy that emphasises corporate bonds and equities. The latter assets are the ones known to generate the best returns over multi-decade horizons, in India and all over the world. Through the power of compounding, small improvements in the rate of return generate much higher pension wealth.

When the world is looked at from the viewpoint of a 20-year-old, there are huge uncertainties about the next 80 years of life. The best deal for this young man is to embark on a game plan involving thrift and self-help. Nobody knows what will happen to asset returns and mortality patterns in the next 80 years. This uncertainty cannot be removed by anyone""certainly not by the government. An attitude of demanding a motherly state that removes uncertainty is a recipe for trouble. It induces lower returns, and inspires populist schemes like the EPS which involve making extravagant promises, promises which will be reneged upon in the future. In a system based on net asset values, the worker knows that he will do well in old age, even if a specific number for pension is not known at the outset. The worker stands on his own feet, without being deluded by rosy promises made by a government.

Trade unionists appear to have been overly influenced by the gloomy outlook of Social Democrats in Europe, where the future is daunting largely because of the far-reaching damage to fertility, education, the work ethic and entrepreneurship, which has been wrought by the welfare state. But in India, the next 100 years should be a time of great growth, particularly because welfare programmes that can damage fertility, education, the work ethic and entrepreneurship do not exist. It makes sense, in India, to be optimistic about the next 100 years, to trust in the power of a high savings rate coupled with investment in corporate bonds and equities, and to mistrust government guarantees.