In the days of Fred Goodwin’s knighthood, even high interest rates and Monkees reunion concerts couldn’t persuade the average Brit to save enough for their retirement. But the government believes a gentle Nudge can make a decisive difference. Between October 2012 and 2015, all UK employees over 22 will be enrolled into defined-contribution pension schemes unless they actively opt out. Inertia is intended to achieve what rational persuasion never did – get young workers to put aside enough to live on comfortably in later life, without relying on the necessarily niggardly basic state pension.
Past attempts that relied on voluntary enrolment were never especially successful, even with the lure of reduced charges (as with stakeholder pensions) or employer contributions (as in late, lamented defined-benefit occupational schemes). Fewer than half UK citizens regard saving for a pension as worthwhile, and more view house-buying as the best way to store up assets, according to the first run of the ONS’s Wealth and Assets Survey. Enrolment in occupational pensions has relentlessly fallen (to the lowest level since the 1950s). But the political response – designed under New Labour and reaching its launch-date under the Coalition – has stepped back from making occupational schemes compulsory. Instead, ‘choice architecture’ is expected to do the trick.
Giving history a push
The idea – which behavioural economists Richard Thaler and Cass Sunstein must wish they’d patented – is to create situations where people still do their own thing, but are steered down a better route. That’s the route that government experts thinks is good for them – but, crucially, also a route that can be shown to serve their own best interests. The new ‘behavioural’ approach contrasts with old-style Behaviourism, which implied that someone could be cajoled into any action that was given good associations (and avoid any action given bad ones) by the architect of choice. That authoritarian form of liberation, propounded at the tail-end of an age of dictators, is irreparably tainted by Pavlov’s salivating dogs and Skinner’s rats in a box.
The new approach only pushes people, say the ‘Nudge’ theorists, in the direction they really want to go. It rescues them from demonstrable biases that deflect them from the rational decision, and from the ‘akrasia’ that – to our eternal regret – makes us do one thing when we pledged to do another. We all want to save more tomorrow; it’s just that we keep forgetting to do so when tomorrow comes. So a nudge towards deduction-at-source is all we need for those retirement plans to succeed. That’s what the pension schemes under the National Employment Savings Trust (NEST) are intended to provide.
Later this year – as it becomes clear how many are opting-out and fleeing the NEST – we’ll know whether the NEST can deliver a hard enough nudge. But the troubled history of personal finance advice and savings promotion raises a serious question about whether governments should be pushing people in this direction.
Stocks vs socks
There are plenty of NEST-supporting tales on the virtues of deferred financial gratification. If you put aside £10 every week of a 40-year work life, you’ll have £20,800 at the end – eroded of course by inflation, but more than compensatingly expanded if it’s been saved or invested wisely. By the magic of compound interest, each £10 invested today at 2.6% (the average real interest rate on UK 10-year government bonds from 1970-2010) will be worth £27.92 – in today’s money – in 2052. Put into the stock market, with dividends re-invested, it could be worth several times as much, if fund values grow as they did from 1950-1990.
But there are also some powerful cautionary tales. Of people whose life savings disqualified them from means-tested benefits so that they were no better off than their spendthrift neighbours. Of pension pots destroyed by the late Robert Maxwell, or an inopportune stock-market crash. Of years of self-denial in pursuit of some late-life leisuretime which never came because of premature death.
And those compound-growth comparisons may be misleading. The long-term growth of stock-market values is bounded by the growth of national output (real GDP), which for the UK averaged just 2.2% annually in 1970-2010, not as high as long-term real interest rates. [Data in Table 1 of a recent Bank for International Settlements working paper]. Investment banks’ much higher historical averages, based on fund performance, display a significant survivor-bias, and also ignore the large management charges that erode retail investors’ return, as well as the amplification of returns in 1950-90 by the influx of new funds. Real stock market returns have been substantially lower since 1990, and there is no guarantee they will regain their former glory.
The steerers and the steerage
So Nudge theorists’ basic premise – that people are unable or unwilling to act in their long-term interests, and ‘choice architecture’ can move them closer to a rational choice – is not beyond dispute, at last in the case of retirement saving. Some people genuinely believe it is better to spend now than put money aside – given that such sequestered sums could, not inconceivably, be eroded by inflation, swept away in a financial crisis, stolen by a corrupt accountant or taxed away to leave them no better off than others who don’t save. Paternalist administrators with a hotline to the life-assurance actuaries will tell them that they are under-estimating how long (on average) they will live after retirement, and failing to visualise the distress of mixing destitution with decrepitude half a century from now. But people know that averages are no guide to their own longevity, and that savers who die prematurely end up subsidising Methusalahs’ annuities.
Equally seriously, there are many who would like to save more for tomorrow, but genuinely need to spend all they have today. Those who bemoan the irrationality of buying a car for “£199 a month”, when this involves borrowing at interest rates that will double its eventual purchase price, forget that £199 is the most that many households can afford. People on low incomes borrow at extraordinarily high interest rates because their prime concern is keeping monthly outgoings within income, not counting the total cost. The government recognized the inevitability of the poor paying more when it decided to penalize early student-loan repayment – a cost-saving option only open to graduates who get rich quick – and reinforced that inevitability when it chose to scrap the early repayment penalty.
The first edition of Thaler and Sunstein’s bestselling ‘Nudge’ came out in 2008, just as the financial system that looks after people’s savings was getting a taxpayer bailout after gambling them all away. In a Postscript to their revised (2009) edition, they claim the crisis reinforces their case. But the failure of most (including ‘behavioural’) economists and financiers to foresee the banking and market meltdowns should deliver a warning to experts who claim a superior insight that entitles them to nudge. Those who kept their spare cash in an old sock would have been the only ones still solvent, if governments had lacked the will or resources to rescue the system. And those who didn’t put enough capital aside were only emulating the supposedly moneywise bankers.
It’s easy to show that someone was financially foolish if they end up with unrepayable debts, or too small a pension. But these judgements are reached with hindsight, and would also reveal the idiocy at businessmen who go bankrupt – like Henry Ford and Walt Disney, who soaked their creditors before showering them with riches. And they often betray an affluent disregard for how hard it is to save from low income, even when there’s a safe place to put the savings.
If people ‘hyperbolically discount’ – economists’ largely pseudoscientific term for under-valuing future consumption opportunities compared with the present – then they should be more indifferent to retirement saving the further they are from retirement. But most respondents to a survey reported in 2010 by insurance group Axa said they would save more if the statutory retirement age increased: Governments should look – very carefully – before they make others leap. There is a long and regrettable history of overconfident technocrats pushing the masses in a direction they realise (too late) is profoundly wrong. The people who preferred to stay in their slums rather than move into high-rise blocks, who queued outside Northern Rock despite assurances it was solvent, or who didn’t take the ‘outstandingly safe’ thalidomide drug, proved better judges of their self-interest than those in authority at the time.
The danger is no different when the experts are dangling carrots, rather than wielding sticks. That’s why the existence of a Downing Street ‘Nudge Unit’, engineering choices far beyond the NEST is disturbing as well as amusing. We may be idiots to walk into a wall, but if it’s been build across the pavement, the architects won’t escape blame.