Monday, November 15, 2010

Pensions: You Mean Paying Someone to do Nothing Doesn't Work?

The Capital highlights a problem that has been creeping up since, well, since pensions began.  (See HERE and HERE).  Labor economics theory predicts that a person will be paid an amount roughly equal to the value of what they produce.  The key here is that a person has to be producing something of value, i.e. working, in order to earn a salary.

Unlike 401K's, which are investments that provide a variable rate of return, pensions are guaranteed future payments.  

Problem #1: Pension funds rely on markets to grow their asset base and meet their obligations, and markets are variable.

Problem #2: The longer somebody works for a company / the government, the bigger the pension.  So, the more well trained the workforce, the more of an advantage a company has, but it also has a higher future labor cost, so it has a relative disadvantage.  See the paradox?

Problem #3: The burden of funding pensions falls disproportionately on the employer as compared to other fringe benefits.

Problem #4: Taxpayers are on the hook for existing pension obligations--they cannot be adjusted ex post facto.

The main problem is #1.  Pensions assume a certain rate of return that probably won't happen.  5 years ago, AACo's pension was like 98% funded.  Now it's 85% funded according to one of those articles up there.  This is because the rate of return on their assets was not what they expected, and they couldn't divert enough of our tax money to make up the difference.

Pensions have already destroyed the competitiveness of American automakers, who might very well shift their pension liabilities to you and me.  Governments aren't competitive in anything, so their pension cost goes directly to us.  

Fringe and retirement benefits need to be able to move up and down (specifically down) with market movements.  Pensions do not allow for this.  More appropriate benefits would be 401K's or other investment accounts.  Hopefully the transition can be made soon enough.

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