Forcing pensions to invest in Britain is a foul, lousy, idea

We seem to be getting financial repression coming back:

Emma Reynolds, UK pensions minister, has left the door open to forcing pension schemes to invest more in British assets if reforms fail to drive savings into domestic infrastructure and companies. 

We’ve long suspected that this was going to be the other shoe dropping of that consolidation of all those 86 small pensions funds. Fewer, larger, are easier to force into governmentally preferred actions.

Reynolds said that while ministers had not taken steps to force pension funds to invest in British assets, it could reconsider “mandation” if the measures did not boost pension investment in the UK.  

“We’re not talking about it for now, but let’s see where we get to,” Reynolds said, in an interview with the Financial Times. “Investment in pensions is, as you know, very generously provided for in terms of tax relief.”

Reynolds added that a decision to take further measures to push a higher allocation to the UK would be “left to the second bit” of the pensions investment review. 

As we all know all economics is either footnotes to Adam Smith or wrong. Here’s we’ve one of those undesirables, a footnote which is wrong.

For Smith did point out that invisible hand thing:

A capital employed in the home-trade… necessarily puts into motion a greater quantity of domestic industry, and gives revenue and employment to a greater number of the inhabitants of the country…. Upon equal, or only nearly equal profits, therefore, every individual naturally inclines to employ his capital in the manner in which it is likely to afford the greatest support to domestic industry, and to give revenue and employment to the greatest number of people of his own country….

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it…

At which point the unperceptive will demand more being invested at home because lovely, lovely, invisible hand. Or, of course, those looking for an excuse to spend - sorry, “invest” - the money of others will use it as an excuse.

Which is to footnote Smith the wrong way around. He’s describing what people already do. Even though the profits of the foreign trade are higher some just do still invest at home. That is, we’ve already got home bias in our investing activities.

As most of portfolio theory goes on to explain. Vastly - and it is vastly - too little of British capital is invested abroad. Sensible diversification would have investment allocation at something like, roughly at least, proportionately to each foreign market as a percentage of the global market. No one at all comes anywhere near this, foreign or domestic, but everyone should.

For the sake of the pensions to be paid in the future to those current savers hugely more should be invested in foreign, not at home. For that’s both what modern economics tells us and also the point Smith was making - we already have a significant domestic bias and we shouldn’t.

But they’re already talking about “mandation”. Which will, no doubt, come with insistence upon “investing” in MiliEd’s green schemes, diversity and possibly the recycling of rubber boats collected from the shores of Kent.

The actual way to increase investment in the UK is the other way around. Instead of forcing people into it tempt them. Make investing here something people want to do. Because the returns from a freer and faster growing economy are such that it will increase the pensions that can be paid in the future. At which point, of course, we might even get some of that foreign pension money coming in to overcome their own domestic bias.

We know that capitalists are profit hungry. They’ll invest in any old thing if they sniff that profit. So, if we desire investment we should have a system which promises decent profits. Make Britain a capitalistically interesting place to invest and see how the money rolls in.

Tim Worstall