QE cannot both boost asset prices and wreck pensions

Quantitative easing is complex and difficult to understand—economists aren't even sure exactly if and how it works. It would be unreasonable to expect non-economists to fully grok its workings even if journalistic explanations were clear and overall true. Since economics journalist's explanations have been largely lacking (including, I expect, my own, when I was an econ journo), it would be very difficult for others, further removed from economics, to 'get it'. Still, this piece on Bank of England staff pensions from Richard Dyson, the Telegraph's personal finance editor, has a number of problems which I can't help but try and correct. Dyson argues that (a) the Bank of England's pension scheme is 'eye-catchingly-generous'; (b) final salary pension schemes have died in the private sector substantially because of the BoE's quantitative easing (QE) programme; (c) QE has harmed pensioners; and (d) the Bank's policy of investing in pension pots in bonds is too low-risk and earns insufficient returns. All are substantially false.

Firstly, the Bank of England's 'generous' pensions are (as Dyson notes at the end) to compensate for lower regular and bonus pay than the jobs that very smart and qualified BoE staff could get elsewhere. Dyson might be right that this, overall, is larger in the public sector, indeed there is a literature suggesting that the total pay + benefits for public sector workers of a given skill and experience level is higher than for private sector workers. But the simple fact of a relatively large fraction of that coming out in pensions doesn't tell us anything on that point—and I would wager that the Bank is run much more like a profit-maximising private organisation than most arms of the state.

Secondly, as we see in Dyson's graph, private sector final salary/defined benefit pension schemes have been declining since a peak in the mid sixties, with about half of the drop coming in the 70s and about half in the 90s. Practically nothing has happened to them since the introduction of QE.

Which brings us onto thirdly: QE boosts asset prices. QE raises the value of stock markets and bonds and pretty much all securities that people hold in their pensions. QE makes pensioners better off, like it makes pretty much everyone better off. Yes, you've heard that QE leads to lower interest rates. I'm not sure that's true. Remember we are at the bottom of a 30-year slide in real risk-free interest rates, and it seems much less clear that QE is a big factor.

Finally and fourthly, is the Bank too careful with its money? I don't actually have an answer here but I'd suggest that Dyson (and Ros Altmann, who he quotes on this) are a tad too confident. If the Bank invested in riskier equities or emerging markets or whatever, then sure it would be likely to earn a higher return, but would the Bank's critics really give it any slack if these investments went bad, as they'd be more likely to do? I don't really know how the BoE should invest its pension fund, but it seems to me that they are going to be damned if they do and damned if they don't.

So I think we should leave off the Bank and its pension scheme, whatever issues we might have with its macroeconomic management. It pays high pensions to attract talent. It didn't cause the decline in private sector final salary pensions (I think government is probably to blame for that). It's not to blame for high interest rates and it has helped those with pension investments. And we probably don't have the right info to choose its investment portfolio for it.

You can have cheap pensions and you can have interventionist pensions

But you cannot have cheap and interventionist pensions investment. That combination being what The Guardian is demanding:

Indexation keeps charges low – Nest is fantastically cheap. There are lots of good reasons to spread your investments over a diversified range of international companies, which Nest is doing. What’s more, in achieving returns of 10%-plus a year since launch, it hasn’t had to face too many awkward questions.

Nest is cheap, that's the way it has been designed. And the only way to have it that cheap is to be sticking the money into low and no load index funds. Any other system would mean having to cream off substantial parts of any likely return for those who do the managing to make the return. In fact, that's rather why Nest was first designed: to make it quite clear that there was a way of gaining pensions savings without having to pay over all of the gains to the Men In The City.

All of which is fine but it's entirely incompatible with this next demand:

Conventional City of London ideology is informing its investment decisions. Yet in Singapore, the country’s compulsory pension fund has been mobilised to held build local housing. Ottawa’s pension fund is extraordinarily interventionist. Given that we will be throwing hundreds of billions of pounds into a pension scheme for British workers, could we at least have a wider debate before sending half of it to Wall Street?

We've had that debate. And the answer was that we'd rather not send 2 and 20% to hedge fund operators, one or two percent to more traditional fund operators, for we've noticed that those fees almost inevitably eat up, and more, any extra performance they produce. And that's why all of these schemes for different methods of pension savings crash into a brick wall set up by reality. Yes, even these ideas that pensions should be in bonds to pay for infrastructure. The extra costs of managing the money, the extra costs of the requirement to have the people managing the money, are greater than the increased returns from having done so.

That's why indexation. For you can have pensions with cheap charges and you can have pensions with interventionist, active, management strategies, but you can't both pay for the activity and also have a cheap pension.

Five intriguing papers I discovered this week II

As the second in a series, here are summaries of five interesting journal articles I read in the last week. All of these ones are new, although that may not always be the case. 1. "Very Long-Run Discount Rates" by Stefano Giglio, Matteo Maggiori and Johannes Stroebel

Giglio et al. use the difference between the prices of leasehold and freehold properties in the UK and Singapore to compute long-run discount rates. They find that over 100 years, the discount rate is 2.6%—whereas properties with 700-year or longer leases trade at par with freeholds. They point out that this 2.6% discount rate may have implications for climate change policy; the famous and influential Stern Review recommended using a 0% discount rate, which may justify much more extensive anti-CO2 measures now. Some slides explaining their findings are available here.

2. "Is the stock market just a side show? Evidence from a structural reform" by Murillo Campello, Rafael P. Ribas, and Albert Wang

Campello et al. look at a 2005 reform that, in a staggered 16-month basis and after a trial, allowed $400bn worth of Chinese equity, previously untradable, to be bought and sold. Using "wrinkles" in the roll out that provide quasi-experimental tests, they find that firm profitability, productivity, investment and value all improved substantially. "Policies that ease restrictions on [capital] markets may have positive effects" runs the final line of their conclusion—quelle surprise!

3. "Social security programs and retirement around the world: Disability insurance programs and retirement" by Courtney Coile, Kevin S. Milligan and David A. Wise

These three authors add to the burgeoning literature proving that those on the edge of retirement respond to incentives just like anyone else. This shouldn't really be a surprise, but the heavy flow of publications adding evidence in this direction suggests that maybe there was once a bizarre consensus in the other direction. Coile et al. show that delaying eligibility to pensions, increasing the stringency of disability insurance programs, and other welfare reforms for older people have "very large" effects on how much labour they decide to supply. Not exactly shocking, but certainly important in ageing societies.

4. "What Happens When Employers are Free to Discriminate? Evidence from the English Barclays Premier Fantasy Football League" by Alex Bryson and Arnaud Chevalier

In this nifty and quirky paper the authors try and isolate "taste-based" racial discrimination, by looking if fantasy football players pick footballers differently based on their race, controlling for "productivity" (i.e. their expected points tally). They find no evidence of taste-based discrimination here, suggesting that much of the apparent discrimination found in other studies (e.g. studies of fake CVs where different ethnicities see different acceptance rates even when they have similar qualifications and experience) could be statistical. That is, since employers cannot directly observe productivity (unlike in fantasy football), and since different ethnicities have different productivity distributions, certain ethnicities are on average less valuable to employers. Of course, it might be that people exercise taste-based discrimination as well when they have to interact regularly with the group/race/ethnicity in question—fantasy football is much more at arms length.

5. "The Role of Publicly Provided Electricity in Economic Development: The Experience of the Tennessee Valley Authority, 1929–1955" by Carl Kitchens (ungated)

The most fun kind of research to read is one that confirms a niggling view you've had for a while, but one that nevertheless overturns a happy consensus. The Tennessee Valley Authority is a classic example of "enlightened" central planning, targeting a hard-up area with massive coordinated infrastructural investment and widely believed to have delivered substantial benefits. But if these dams and systems were really such good investments wouldn't private companies have got around all the barriers to such an investment already? There are some cases where I suppose that sort of basic argument doesn't hold, but it's a pretty good first approach to any area, and it turns out the TVA is one of them. Kitchens newly-published paper finds "that the development of the TVA during its first 30 years did not cause manufacturing, retail sales per capita or electrification to grow any faster in areas receiving TVA electricity than in other areas in the Southeast."