Worst Pension Problems of All
What's one of the worst pension problems of the world? Developed economies offer pensions based on emerging market assumptions.
When emerging economies emerge they enjoy a rapid growth spurt. Labor costs are low. Regulations are few. Farmers moving from the land to the factory need little training and offer one of the cheapest boosts in productivity of all. Small business people work day and night. Safety, fair wages and the health of workers are not prime factors. Survival is the key. Low wages and poor conditions are better than starvation, which is the worst condition of all.
A middle class forms. Workers gain some political clout, demand more (as they should) and their children move into higher level careers. Costs and the time required to prepare the population for the workplace rise. Some money has to be set aside for the portion of the work force that does not step up to the next level. Growth slows.
If the economy gets it right, some new technology and new way to produce and live and cooperate comes along; electricity, the steam engine, the car, radio, TV, computer internet and so forth. Each product creates new productivity and a new market and even developed economies surge ahead from the making and buying of the innovation.
In between each great innovation, there is a transition stage where economic growth stagnates: the people, government and industry try to stimulate growth in artificial ways and when this does not work, they panic as a whole and become risk-averse.
During the emerging stage of an economy, the option for poor people is to put in full effort, or die or live a life too miserable to contemplate. Developed economies in a transition stage have some fat available, some capital to hold onto and fight over the way its shared.
The developed Western economies are in eras of transition. There is plenty of innovation, artificial intelligence, gene therapy, robotics and software apps. But almost all of it is incremental innovation, not revolutionary and none of this brings better standards of living for the majority.
For example, driverless cars are an incremental innovation integrating cars and computers. This innovation can free hundreds of thousands from having to work as drivers. But what will those who were the drivers do? A few will become richer, Tesla, Uber and such will make billions. Maybe the economic numbers will even rise. Yet a higher portion of the population will be poorer.
The car on the other hand was a revolutionary innovation. This replaced the horse and buggy, but every horse and buggy driver could become a car driver and everyone who had access to a car could go further, carry more, reach new markets, etc. The majority became richer.
Economies grow by helping workers labor more effectively. When changes help everyone work together to produce more, the total factor productivity rises. The majority profit. The total factor productivity is the real factor behind a nation's economic growth. The growth peaked in the US in the 1950s at a rate of 3.4% a year as technology such as electricity, aviation and antibiotics worked their way into the mainstream.
"Total factor productivity" has steadily slowed since the 1950s and in the last ten years has averaged about half a percent.
A Wall Street Journal Article "The Economy's Hidden Problem: We are Out of Big Ideas" points out why the standard of living for the majority has stagnated. "Outside of personal technology, improvements in everyday life have been incremental, not revolutionary. Houses, appliances and cars look much like they did a generation ago. Airplanes fly no faster than in the 1960s. None of the 20 most-prescribed drugs in the U.S. came to market in the past decade."
Until the next big technological advance comes along, economic stagnation is likely to continue.
The global economy continues to grow. There are more people making and consuming more products and services, but that growth has slowed down to the point that those who have not advanced technologically do not get a big enough slice of the pie to be satisfied. Even without any great new thing, the developed world has still created incredible riches over the past half century. The global economy has more than doubled. Yet a huge portion of the developed workforce has had almost no growth in real income. Slow growth in developed countries has been the norm for decades. This has caused the workforce and voters to be unhappy.
One way politicians and big businesses quell this discontent is by promising future benefits, without creating a way to actually delivering them. Pensions and Social Security are prime examples.
For example Calpers, (California Public Employees' Retirement System) the largest pension in the U.S, promises future benefits based on the calculation that it will earn 7.5% on its investments each year. Last year it earned only 2.4%.
Calpers is reducing this 7.5% expected rate 7.5% with a goal to ultimately reduce the rate to 6.5%, although that could take decades. The rate was already reduced from 7.75% after a disappointing 1% gain in 2011.
The problem is that even 6.5% will be too high unless some revolutionary innovation comes along.
This puts politicians and businesses between a rock and a hard spot because lower investment returns for future benefits mean greater contributions are required now. Government costs and taxes increase or there is a reduction in government services. Businesses are forced to increase pension funding or reduce promises of future benefits that are offered to workers.
Social Security is in the same boat. Even before the new federal administration takes office the chairman of the House Social Security subcommittee, has introduced a 54-page bill, "Social Security Reform Act of 2016", that would slash Social Security benefits for all but the very poorest beneficiaries. The bill helps the lower level earners in some ways by eliminating the retirement earnings test so its easier to double-dip wages and Social Security benefits. Minimum benefits for those who worked their lives through with low wages would also be increased.
Yet there are many downsides for those on the lower side of earnings and wealth. The retirement age would be raised to 69. Cost-of-living adjustments would be cut. Taxes that high earners now pay on a portion of their benefits would even be cut. In other words, higher earners would benefit. The poorer segment of the economy would also be far more vulnerable to most government's biggest trick: inflation. More dollars promised for the future, but those dollars when delivered buy less.
Unfunded promises made in years past with overly optimistic promises have sold the future short. The future is here and now and the purchasing power of pensions and Social Security are deteriorating. Many investors, economists, politicians and leaders are confused. The slow growth has angered much of the public.
We can profit from this fact because most people don't realize that this is the norm. Since the 1800s, the industrialization of the world has risen in 30 year fits and starts in a "Cycle of War".
The "Cycle of War" begins when there is a conflict of such urgency that all concepts of return on investment are thrown out the window. Huge resources are thrown at refining new technology to help win the struggle. After the war, the technology shifts from military to domestic use and great increases of productivity are gained. The productivity leads to new fortunes and starts an economic bubble. The bubble overextends and bursts. The burst leads to economic stress and new struggles. Once again R&D accelerates and leads to new and refined technology.
We can see the "Cycles of War" by looking at this chart of the Dow Jones Industrial Index. WWI, WWII, and the Cold War (Reagan and Thatcher fighting the Evil Empire) could be called War III.
The chart below suggests that the cycle is out of whack, with the Dow nearing 20,000. Perhaps low interest rates or worries about the Middle East, China, Europe. The yuan and euro leave investors with fewer options than the US stock market. If so and if the theory is still relevant, we'll see a sharper than normal correction.
Logic dictates that we should ask, "When and where is the next war?" An even more important question, "What new technology which changes everything will emerge?"
The thrust of the next war might have to do with cyber security and communications. If so, we can see skirmishes heating up from the hacking of political emails, theft of a billion Yahoo accounts and viruses in NSA code.
The reality is we cannot know what war will erupt. We have even less chance of guessing what the next revolutionary innovation will be. Startup investors protect against this by investing a little in many innovators, expecting to lose on most but win big on a few. Venture investors who bet on Compaq, Commodore, Burroughs, Control Data, Honeywell, Netscape, Origin Systems, Sirius Software, Apple and Microsoft, may have had an 80% failure but probably did well overall because of the two winners in the portfolio.
This type of investing suits some investors well. A little of such speculation may be good for most investors. Mostly, though, we should protect our wealth and savings beyond our pensions and Social Security with slow moving, low cost, highly diversified good value investments.
The simplest such investment is a single global equity ETF such as the Vanguard Total World Stock ETF (VT). If you seek a balance to US investments, the Vanguard FTSE All-World ex-US ETF (symbol VEU) invests only in 2,537 non US shares. VEU is huge ($24.6 billion under management) and has a really low expense ratio of 0.13%, 88% lower than the average expense ratio of funds with similar holdings.
Pensions and Social Security may not be enough to secure a future. Unfunded promises based on unrealistic growth are subject to reduced purchasing power. Whichever approach you take to securing your future, look beyond the promises and put your trust in value rather than political promises.
See how I diversify in slow moving, low cost, highly diversified good value investments with Pi.