Self-censoring on superannuation

When applying for a job recently I was asked to write a 500 word opinion piece about using superannuation funds for home deposits. I didn’t get the job so there is no reason to waste 500 good words; I’ve published the piece at the bottom of this post.

But that’s not what this post is really about.

I am writing this post to reveal that I severely self-censored in that opinion piece. Those are not my genuine views about superannuation. Like many before me I twisted my words to fit within the Overton Window of acceptable public discourse. Maybe it was the wrong thing to do. But I did.

I want to say what I really think, even if some find it too far outside the range of acceptable conversation.

My view is this: Australia’s superannuation system will not survive another 30 years in its current form, or anything like it.

The reason for that view is that there was never an economic logic for a compulsory superannuation system in the first place.

The modern superannuation system was introduced in 1992 to relieve pressure on the age pension system by forcing all workers to save for retirement reduce wages and has since been reinterpreted as a retirement funding system. But forced saving does nothing to address the fundamental problem of a shrinking workforce - all the income streams drawn down from superannuation upon retirement rely on purchases of assets from those currently working. The net effect is exactly the same as if the working population simply gave retirees money through the tax system. Any problems with the age pension system due to demographic change also affect the superannuation system.

Furthermore, the problem of a shrinking workforce has been dramatically overblown. While the age-dependency ratio will increase when baby-boomers retire, this effect will be balanced out by relatively fewer births and a declining youth-dependency ratio. On balance, the share of the population out of the workforce under the worst-case population growth scenarios (yes, higher population growth makes the dependency ratio worse), will peak around 70% - exactly the same as the 1960s and 1970s.

To be clear about how the same demographic patterns affect the superannuation system just as they do a public pension system we must think in terms of goods and services produced in aggregate, and assets and their prices in aggregate.

In aggregate, the total goods and services produced depends on the size of the workforce and installed capital. Whether boomers retire in pensions or superannuation incomes, the rate of growth of this total production will be lower as the growth rate of the workforce decreases.

This lower rate of growth of goods and services must still be shared amongst all workers and retirees. Who gets what out of the economic pie depends on who has which rights - which claims on incomes streams in any form, either assets, public pensions, or wages. Under a public pension system workers give up some of their rights to wages by paying taxes which would go directly to the pensions of the retired. Under a private superannuation system, workers give up some of the rights to wages to buy assets, which would be sold by retirees who had previously accumulated them, in order to provide a retirement income. The net effect of both of these schemes, shown below, is identical.


Whereas with public pensions it is clear that more retirees in the population requires larger contributions by workers to support them, the superannuation system disguises this element. It does this through incremental changes to the minimum contribution requirement - from 4% of wages in 1992 to soon 12%, along with increases in the preservation age, from 55 as of this year, to 60 in 2024. This means that new contributors to the super system pay more and get less - exactly as would occur under a public pension system when increasing pension funds come from direct transfers from the workforce.

What’s more, the net effect of superannuation as a mere transfer between workers and retirees will become all too obvious when the ever-growing rate of new money pouring into the asset classes held in superannuation accounts begins to fall as the rate of superannuation drawdowns grows faster than the rate of new contributions. In the chart below the benefit payments in green will increase faster than the contributions (the red, blue and purple) as boomers begin to retire en masse.





When this occurs, the asset classes that dominate the super system, like Australian shares, will see fewer buyers and more sellers, depressing currently inflated prices and reducing the investment income of superannuation account holders. With lower account balances more funding will be needed from public pensions anyway. To be clear about this asset price effect, does anyone think the share market, or even the property market, would be at its current value without the massive inflow of funds from the compulsory super system?

Depressed incomes from super accounts will again see the need to increase contributions, or increase public pension funding, or otherwise rejig the rules to inflate asset prices at the expense of wages.

At the moment the music is still playing. But in the next 20 years there will be a generation who puts more than 12% of their wages into the super system for half their working life only to find the system requires a complete rethink. They will lose out due to their demographic destiny with the superannuation system, just as they would with a public pension system only. But the super system allows us to pretend that this is not happening by disguising transfers as investment.

This is the big issue with Australia’s superannuation system, and one that is till now outside the range of acceptable discourse. In any case, here’s my self-censored opinion piece.

...

Hockey’s housing ideas are anything but super

If you think home ownership is out of reach for the average family in Australia today, you ain’t seen nothing yet.

If Federal Treasurer Joe Hockey has his way, superannuation funds could be used by first-time buyers as a home deposit.

Taken at face value, Hockey’s idea reveals a deep misunderstanding about not only the role of superannuation in the welfare system but of the housing market itself.

Worse still, allowing access to super accounts will increase prices above even their current astronomical levels.

Compulsory superannuation was introduced in 1992 to anticipate and counteract the age pension tidal wave as baby boomers entered retirement.

Yet one big issue we are seeing as this demographic tidal wave approaches, is that many retirees have low superannuation savings, but very high home values, yet they are unable to tap into their home value to generate a retirement income.

The great majority of retirees prefer the stability of their own home within their local community, and are unwilling or unable to use their home as a source of income during retirement.

Directing more retirement savings into home ownership will only amplify this problem, rather than amplify retirement incomes as superannuation was designed to do.

While reforms could improve the ability for retirees to utilise their home values to generate retirement incomes, one thing that cannot change is the economics of the housing market.

Hockey’s proposal would produce a massive boost in buyer activity and turn superannuation funds into subsidised quasi-home deposit accounts, with associate tax savings advantaging the highest income earners.

Like many home buyer initiatives, such as the First Home Buyers Grant (FHBG), increasing buyer purchasing power has a clear and definite effect of increasing home prices, negating its supposed benefit and passing it directly to the home seller.

To see how this works, imagine you are at a home auction, and after great excitement and fanfare, the bidding has stopped at $500,000. The final two potential buyers are now on edge as they decide whether to tip their hats one more time.

In one scenario the second buyer stays quiet and the home is sold at that price.

But in another, the government steps in and allows the last two bidders to use their super accounts to help buy the home, or alternatively give them a FHBG. What do they do?

The extra funds allow the auction to continue as the losing bidder sees value in outbidding the previous winning price, and the previous winner is able to also outbid that new price.

This only stops when the extra buying power from the new regulations is completely absorbed into the price. If it was a $7,000 FHBG, the sale price would be $507,000.

It is clear then that Hockey’s proposal is at odds with the intention of using superannuation to provide retirement incomes, and by making the housing market more expensive, will completely contradict its intentions of facilitating home ownership and saving.

Macroeconomics = Fallacy of Composition

I am teaching an introductory macroeconomics course for graduates this semester at the University of Queensland. Coming up is soon is the AD-AS model and I must say, I’m having a hard time generating useful tutorial questions for my students.

The illogical contrivances required to interpret any real economic events in terms of the model are almost laughable. I've asked a number of experienced macro teachers in the school to explain the model to me in an internally consistent way. It turns out that most economic professors don’t have a clear grasp of what aspects of the macroeconomy the model is meant to be capturing. None could explain what the concept of the price level in the aggregate even is, nor what mechanism was meant to be at play in generating the relationship between price level and output. If anything I learnt that I should use the curves to support some kind of Keynesian story-telling exercise.

What kind of serious intellectual could be happy with this situation? Is this the way we pass on our discipline’s knowledge to the next generation?

So far my tutorials are looking quite different from your typical introduction to the AD-AS model. More like an introduction to defending oneself against the claptrap sprouted by many economists.

Perhaps we may soon leave this nonsense out of economic teaching altogether. Here's my compromise for the time being.

Question 1

What is the fallacy of composition?

Create a list of phrases, sentences or paragraphs from the description of the AD-AS model in Chapter 10 of the textbook that commit the fallacy of composition.

Additional reading material is here, here, here, and here.

Discussion

A common definition for the Fallacy of Composition is

the fallacy of inferring that a property of parts or members of a whole is also a property of the whole

In terms of the study of macroeconomics this is of particular interest, since we are trying to take lessons from the behaviours of individuals and determine the likely aggregate response in the economy as a whole.

Here are some examples from Chapter 10, though many others may be included.


1. The aggregate demand curve shows the relationship between the price level and the quantity of real GDP demanded by households (p268). 



The AD curve is downward sloping because a fall in the price level increases the quantity of real GDP demanded (p268)



The fallacy at play here is that there is an aggregate price level. As we saw in Chapter 8 on Inflation, price levels are not absolute but relative to some base year. In the economy as a whole there is no external price from which to determine a price level. Hence the idea of an economy-wide price level is in a given time period is a fallacy. 

Often the AD-AS model is interpreted as showing Real GDP related to the rate of inflation in a period (not the level, but the rate of change of price levels relative to a base year). This overcomes the fallacy of composition because it compares the price level with last year’s price level, but contradicts earlier discussions about anticipated vs unanticipated inflation. If inflation is anticipated at any reasonable level then there should be no economic effect, and hence no relationship (no curve, or a vertical line at best).


2. As income rises consumption will rise, and as income falls, consumption will fall (p269)



In aggregate the total consumption (or demand) in the economy is equal to the total incomes in the economy be definition, since someone’s consumption is somebody else’s income. This sentence, allowing from proper aggregation that avoids the fallacy of composition, merely says that aggregate incomes and consumption just rise and fall together since they are equal at any point in time by definition. 



3. When prices rise, households and firms need more funds to finance buying and selling. Therefore when the price level rises, household and firms try to increase the amount of funds they hold by withdrawing from banks, borrowing from banks or selling financial assets, such as bonds. These actions tend to drive up the interest rate charged on bank loans and the interest rate on bonds. (p269)



First, if all prices rise then households and firms also have more income, since wages and profits are also prices in the economy. 



Second, as we discussed in Chapter 4, Measuring GDP, transfers of financial assets are not included in gross value added because they are mere transfers between on individual and another. Hence, a household selling financial assets requires another household to buy those financial assets leading to no net change in the aggregate ability of households to spend on current consumption. 



Third, if these actions have no aggregate affect by their own definitions it seems implausible that there will be aggregate affects on interest-rates (another price) set in the economy.



The end of the paragraph goes on to admit that it just committed the fallacy of composition when it says



The impact of the price level on investment is known as the interest-rate effect, and is a second reason why the AD curve is downward sloping. However there is caveat to this explanation. Lenders to banks and other financial institutions - people with savings are lenders - will have their wealth increased as the interest rate rises, and will increase their consumption spending. 



Essentially this contradicts all that went before it. In addition, the wealth effect on savers is incorrect in general (higher interest rates decrease the value of financial assets, not increase it).


4. Table 10.1, government purchases and tax effect on AD curve (p272).



The second and third rows in Table 10.1 show; 1) the effect of an increase in government purchases on, 2) the effect of an increase in government taxation. If the economy is at equilibrium prior to and after either of these changes then by definition one effect must counteract the other - the shift of the AD curve from an increase in government purchases must be accompanied by an equal and opposite shift from an increase in taxation. 


5. Because changes in the price level do not affect the number of workers, the capital stock or technology, in the long run changes in the price level do not affect the level of real GDP (p275).



This contradicts all that went before it, and relies on an undefined notion of the short and long run. How can there simultaneously be both an effect and no effect?


6. The main reason firms are willing to supply more goods and services as the price level rises is that, as prices of final goods and services rise, prices of inputs - such as wages of workers to the price of natural resources - rise more slowly. Profits rise when the prices of the goods and services firms sell rise more rapidly than the prices they pay for inputs (p276).



Here we see the fallacy of composition result in many confusing comments. First, the inputs of one firm are the outputs of another firm, hence in aggregate input and output prices cannot differ systematically.