Macro-Economic Implications of the Pensions Crisis

The most obvious cause for concern regarding the meltdown of retirement savings vehicles is that current and future retirees will face major shortfalls in their retirement incomes. The scale of the problem reinforces the long-standing argument of progressive economists that we need to expand our system of public pensions moving forward, and reduce reliance on fickle financial markets and on the costly apparatus of private as opposed to public savings vehicles.

The pension crisis also has significant implications for the job market and for economic recovery.

In round numbers, employer sponsored defined benefit pension plans in Canada had about $1 trillion in assets going into this crisis, and have probably now lost as much as one quarter of their peak value, or about $250 Billion. (This is said on the basis of various expert estimates, and on the basis of rough arithmetic which shows that the average plan has close to 60% of its assets in equities, which have now on average fallen by close to 50% from recent highs.)

One implication is that – unlike the last recession – there will be few if any large pension surpluses to cushion the blow of layoffs. In past downturns, surpluses have been used to encourage older workers to take early retirement on decent terms, minimizing layoffs of younger workers. This time around, we are also far more likely to see older workers laid off on reduced pensions as a result of bankruptcy.

Another implication is that many pension plan sponsors will have to significantly increase their contributions to pension plans to keep them adequately funded moving forward. This usually has to be done over 5 years following the emergence of a funding deficit, though many governments are or are contemplating relaxing regulations to allow for a longer period of up to 10 years. While some plan sponsors have strong balance sheets and can fill shortfalls fairly easily, the fact remains that many others – including large industrial employers and public sector plan sponsors – will have great difficulties. Universities, for example, have recently announced big impacts on expected revenues as a result of pension shortfalls.

Let us assume that a $250 Billion pension hole shrinks to $125 Billion becasue of a 50% increase in equity values over the next five years as the economy recovers. That will still leave something in the order of $20 Billion to be paid in by sponsors each year over five years. That is a big number in relation to the current level of total household savings in the Canadian economy, which now runs at about $30 Billion per year, or 3% of total personal income.

Pension contributions are counted as labour income and represent deferred wages. From the point of view of workers in pension plans, they are effectively a form of forced saving (through welcomed for the security they provide.) About 80% of Canada’s 4 million unionized workers belong to employer sponsored pension plans, and pension shortfalls and required contributions are bound to have a big impact on collective bargaining outcomes.

The prospect is, then, for much lower nominal wage settlements moving forward in both larger unionized companies and the public sector where defined benefit pension plans are still the norm. In macro economic terms, there will, as a result, be a significant shift from current consumption to savings, with a depressing effect upon household saving. This is likely to be quite significant, easily enough to keep union sector wages from rising in the 2-3% range which is needed to prevent wage deflation. (Wages should rise by at least the 2% annual inflation target plus in line with productivity to prevent a decline in real wages and knock-on deflation effects on the real economy.)

In the non union part of the job market (70% of employees but perhaps 60% of total labour income), non managerial/professional workers depend mainly on RRSPs and, sometimes, defined contribution plans for their retirement security. RRSP losses have probably been on proportionately about the same scale or even bigger than pension plan losses. With perhaps $700 Billion in total assets before the crisis (we lack recent data), RRSP losses since the peak probably come in at about $150 – 200 Billion. Again, this is a big number relative to the current rate of savings. One can guess that this loss will lead many older workers to stay in the job market for much longer than they had planned, and that these older workers will try to rebuild their savings.

In sum, the pensions crisis is likely to have big impacts, not just on the income security of retirees, but also on the level of unemployment among younger workers, and on the overall savings rate. If we do not deal with the crisis, it is going to be much harder to bring about an economic recovery.