In this article, I will make some random comments about the implications of that policy. Although I believe that the procedure is somewhat silly from an economic standpoint, there is a logic behind it.
Sub-Sovereigns: No Choice
Sub-sovereigns that want to run pension funds (mainly for their employees, but Quebec opted out of the Canada Pension Plan) have very little choice but to fund pensions like the private sector. Although provinces can hope for more demographic stability than private corporations, entities that can theoretically default have a hard time making credible long-term uncertain growing payments. (My previous employer was the asset manager for Quebec.)
The rest of this article will just refer to the currency-issuing central government, and not sub-sovereigns.
Why Do We Need Contributions?
One commenter (“DFWCom”) on my previous post argued that the central governments do not need to enforce pension contributions — just pay the pensions. However, that is implied by the pure pay-as-you=go system: the “pension contributions” are just a tax that ends up in the government coffers. If the government abolishes them, they need to raise taxes elsewhere to keep cash flows unchanged (to have the same economic outcome).
Why have this regressive tax? Realpolitik. The Canada Pension Plan is not seen as a handout — it is earned. This makes it politically untouchable — all the free marketeers can hope to do is try to get the funnel of money into a trough that private asset managers can get their snouts into. When you look at the fate of the rest of the welfare state over the post-war decades, this is not something that should be ignored on ideological grounds.
If we do not track “contributions” versus the pension payments, payments are purely arbitrary, and would be the result of democratic outcomes. Such an arrangement does not offer long-term security. (One may note that the incessant attacks by free marketeers against the alleged insolvency of public pensions since this is an obvious angle. Although this works for deluded loudmouths on the internet, politicians will end up getting hammered by actuaries if they start lying about the pensions in Parliament.) For government employees, pensions are part of overall compensation — and a point of competition versus private sector employers. Handing out pension benefits that appear to be cost-free is a great way to store up future trouble (as many sub-sovereigns and private employers discovered when pension accounting was more lax).
Pension accounting involves a lot of guesstimates, but the exercise needs to be done.
We Cannot Send Goods to the Future…
If we do a simple closed economy model of an unfunded public pension plan, we run into the reality that we cannot send goods and services from the present to the future. In an imaginary world where we could, the baby boomers could have saved up in their peak earning years and sent their production to themselves when they are drawing on their pensions (essentially now). However, the goods and services bought by pensioners have to produced in the present, which implies reallocations of income flows within the economy.
Buying domestic financial assets might appear to solve the problem, but financial assets are just claims on future income. The income flow displacement still has to happen, and the income flows are large enough to implicate to the Federal Government to balance them.
… But We Can Get Them From Foreigners!
As my previous text hinted, we can use foreigners to act as our “economic time machine.” We buy foreign financial assets when we have a large working population (which of course, Canada did not), and can then sell the assets and use the proceeds to import goods and services. To the extent that the aging population has an inflationary impact, we export the inflationary pressures. This strategy is well known, and normally called a “sovereign wealth fund.”
Although this would have been a bright thing to do in the 1970s (and not 1997), one may note that this is not a policy that all large countries can pursue at once (unless there are major demographic differences between the countries, which is the case in emerging markets).
“External Constraint” Whacked
One of the advantages of such a fund is that it will tend to have an internationally diversified risk asset allocation matched versus local currency liabilities. So long as the neoliberals managing the plan are working in the national interest, this creates a chunky public buyer that can lean into any short-term currency panics. Canada already has a lot of assets managed by private and sub-sovereign pension and insurance funds that have that asset/liability mismatch — which explains why currency panics die out. (Unlike the fantasies of the Canadian economic establishment.)
My retirement savings are split between pension funds and a self-directed account. If anyone wants to organise a simultaneous plunge in Government of Canada bond prices and the Canadian dollar, please try to do it when I am not on vacation. Thanks.
For a small extremely open economy like Canada, I see the attractions of funded public pensions. A country like the United States is in a different boat.