Call for think tanks to help benefit systems

Nobel prize winner James Heckman calls for European think tanks to help tackle the issues facing welfare states and their pension systems.

Speaking to IPE at the sidelines of the recent European Colloquia in Prague, organised by Pioneer Investments, Heckman said in order to provide pensions to their ageing populations, countries need to have a think tank to initiate significant reforms and a shake-up of their economic policies. He says that most European states lack such groups, and this lack is to blame for worsening economies. But despite the great pressures on the western welfare state, he remains positive about its future.

He says: "We substitute resources all the time and I have faith that the state will continue to be able to provide pensions." And he is convinced that markets and states will be able to cope with increasing longevity.

A combination of higher taxes, an extended working life, an increased skill base, a flexible immigration policy and the dismantling of welfare state features that cause low productivity can ensure old age income, health and care, Heckman believes. The 2000 Nobel prize winner attributes the current pension problem to old, unsuitable state systems in which people have been allowed to retire much too early for too long. He calls for more flexibility and openness of venture capital markets, but less regulation to help tackle the problem.

On top of this, Heckman believes that the provision and adjustment of incentives will help secure pensions and the survival of the welfare system in the future. He names Sweden as a generous welfare state model whose economy has performed well due to high education levels and incentive provision. With the highest productivity level in Europe, which stems from a good education system and reduced tax on capital, Ireland is another good welfare state example.

Heckman says that people respond well to incentives. If more incentives were given to work and succeed, fewer people would stay at home, claim unemployment benefits and retire early, for example. He argues that large welfare participation and protection, as well as the reduction of incentives, have led to an eroding work ethic.

He warns that states, which become locked up in one system, will face difficulties. To avoid that, Heckman advises countries to strive for reform, flexibility, experimentation and recognition of human capital. In the past, powerful US think tanks have given a big boost to the US economy, he says.

But Heckman does not expect any reforms to take pace in Europe in the short term and claims that the current western welfare state is unsustainable. However, he adds: "Successful reforms have all come in the wake of a crisis."

To help sustain the western welfare state, chairman of the Kiel Institute for World Economics Dennis Snower proposes moving away from the current tax system to a social account system with accounts created for unemployment, human capital, health and retirement, which is sustained by minimum contribution and maximum withdrawal rates.

Nobel prize winner of 2001 Joseph Stiglitz is critical of the idea of privatisation, explaining that the old-age pension system was better as a state run system, as administrative costs were lower. He says underinvestment in certain sectors is to blame for poor economic performances in Europe and joins the call for reform, research and incentives to attract investment.

Stiglitz says that the changing global landscape and new global imbalances, such as the US's large bilateral trade deficit with China, which has led to confidence erosion in the dollar and exchange rate volatility and might
lead to a frail dollar reserve system, present new challenges to investors which need to be tackled.

Allen Sinai, CEO at Decision Economics, says the world is undergoing four seismic shifts: an economic and geographic change, globalisation, a proliferation of financial markets and increasing prominence of the emerging world. This can be seen, for example, in the slowing down of the US, but the speeding up of the Asian economy, while pension funds have surfaced as alternative investors across the globe.

Head of wealth management at UniCredit Dario Frigerio says that investors are faced with long-term retirement issues in many countries, particular in central Europe. He says the second pillar offers high dispersion, as it is apparently not linked with demographics. He adds that default solutions have proven very powerful, for example, in enhancing participation in US DC pension funds.

Pension funds, according to Frigerio, play a big role in defining the right default rate and have led to much bigger diversification. He says that DB schemes are unsustainable for companies, while DC schemes are deemed risky. Frigerio says that plan sponsors can offer risk-based default solutions and automatic enrolment as well as investment advice.

He concludes that asset managers must develop new capabilities in product design and distribution because retirement and wealth management require longer-term oriented advice systems and the development of defaults.