Restoring contracting-out: Towards a voluntary system of private pensions
Both men were aware that the social insurance schemes they had in mind would not be built on a clean slate, but amidst pre-existing institutions of working class self-organisation. And they were also aware that the relationship between those institutions and the state schemes would be an uneasy one: the state would not simply be just another provider.
The big difference is that for Beveridge, the crowding-out of private initiative was a lamentable side-effect which ought to be minimised, whereas for Bismarck, it was the whole point. Social security was meant to foster economic dependency on the state, in order to change attitudes towards the state in a favourable direction. As various well-documented quotes from the Iron Chancellor show, his very intention was to promote a perception of the state as a strict, but benevolent paternal authority figure. Beveridge, in contrast, was fond of independent private provision, and wanted to preserve as much of it as possible. His hope was that state welfare would complement rather than displace private initiative.
This is not just an intellectual difference. At least in the area of pensions, it had real consequences for welfare design for decades to come.
Britain’s initial post-war pension was just a basic flat-rate payment. Later on, though, an earnings-related pension was added, and then gradually expanded. Yet policymakers at the time must have realised that earnings-related pensions would be much more in conflict with private alternatives, contravening Beveridge’s aim of allowing public and private provision to coexist. This led to the adoption of a peculiar feature which was probably unique in Western welfare states: the right to ‘contract out’. People who were already covered by equivalent pension schemes through their workplace could opt out of the earnings-related state pension, and if they did so, they would not have to pay the corresponding tax. The system became more multi-layered and complicated over the years, but the principle remained: People had the freedom to opt out of part of the public pension system, receive National Insurance rebates equivalent to the pension entitlement foregone, and use those rebates to build up their own pension pot. Millions of people did, and a thriving pension fund industry developed as a result.
It is a legacy of this system that over half of the working-age population in the UK are covered by an occupational pension scheme, while one in five have an individual pension fund (with some overlap between those two groups). The total value of pension fund assets amounts to 73% of GDP. Contrast this to those parts of Continental Europe which went down the Bismarckian path: There, private pension funds are a niche phenomenon, much like private health insurance is in the UK. In France, Belgium, Austria, Germany, Sweden and Norway, private pension fund assets account for less than 10 per cent of GDP.
But as the Game of Thrones character Ramsay Snow would say, if you think this has a happy ending, you haven’t been paying attention. In our new IEA Discussion Paper, my colleague Prof Philip Booth and I show how successive governments have eroded the contracting-out system. Ironically, just as parts of Europe have been trying hard to promote private pension savings, Britain has carelessly abandoned a successful system that has stood the test of time. If Bismarck and Beveridge were watching this spectacle from the afterlife, the latter was probably banging his head against a wall while the former was roaring with laughter.
But the system’s foundations are still there. Our paper shows how the contracting-out system can still be saved, and even improved upon. Restoring contracting-out would take us a long way from a PAYGO system to a funded system; from a system that encourages rent-seeking and vote-buying to a system that encourages work and thrift. We show how this would improve people’s old-age living standards, while also taking long-term pressure off the public finances, as well as boosting investment and capital formation.
Some countries in Latin America and Eastern Europe have moved towards partially funded systems under much more difficult circumstances, with no prior experience of private pension savings and rudimentary financial markets. With this in mind, our proposals are not particularly daunting. We merely suggest that a country which has an age-old tradition of private pension savings, and which is a world leader in financial services, might want to make some use of that potential.
Kristian Niemietz is the co-author, with Philip Booth, of Growing the Pension Pot: The Case for Privatisation.