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In our third edition of It’s the Economy, Stupid, the Global Affairs team takes a look at the biggest economics, business, and technology stories across the world. This week, we dive into the case against the UK’s pension Triple Lock and the reasons for optimism in the US economy.
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The UK’s Pension Triple Lock makes no sense
This time next week Chancellor Jeremy Hunt will deliver his autumn statement. It is one of the biggest financial events of the year and there is much speculation about what might be included. One element that I think cannot be ignored is the need for pension reform.
UK government finances are not in great shape and reform in this sector could save the Treasury a lot of money in the future.
If you were born after 1978, then you are set to receive your state pension at age 68. Currently, the UK state pension uses a ridiculous triple lock system to decide how much to increase the state pension every year. Under the triple lock, the state pension increases each year, by either the rate of inflation, wage growth, or 2.5%, whichever is largest. Such a system has greatly benefited pensioners, but it is hard to rationalise such an economically unsound and unfair policy. The Institute for Fiscal Studies has said this system has cost the government an extra £11bn since 2011 and has a huge range of estimates for how much this will cost in 50 years time.
Some increase in the pension each year is necessary to protect against inflation. If not, then as the economy grows, prices rise and workers earn more money, pensioners would quickly find their regular government transfers to be worth very little at all. However choosing the right size of increase is tricky.
Firstly, there is an argument that pensions should increase by the inflation rate each year, since this means that pensioners will always be able to buy the same amount of stuff with their pension, even when prices rise. This is fair to pensioners since it guarantees their payments in real terms (i.e. when you account for inflation). However this method makes it hard to run government finances, because it becomes tricky to forecast how much they will need to borrow in the future.
Next up is using average wage growth. This option is great for government finances, since pension payments are in principle funded by national insurance contributions, which will rise if wages rise. This means it is much easier to predict government spending and borrowing into the future. However this measure bears little relevance to pensioners themselves, since they are no longer part of the labour force.
Last up is a fixed percentage, for example just increasing by 2.5% year on year. This is the simplest way to control government finances, but it is also the most unfair. It means pensioners could be left behind if inflation ever rises above 2.5% (if you can imagine such a world). Additionally, this method is left open to political misuse, since the level could be changed, for example, the year before an election in order to win votes – a strategy not grounded in economic reasoning at all.
Each of these methods has their merits, but there is no merit to using all three at once. The chart below shows the level of inflation and wage growth together.
As you can see there were a number of occasions since 2011, where inflation and wage growth was very low (even negative at some points), yet the state pension was guaranteed to increase by at least 2.5%. This means that even when prices were falling in the economy, pensioners were getting paid more. This can be viewed as unfair, as it either takes resources away from other government departments (e.g. NHS or schools) or increases government debt unnecessarily.
The government should announce that they are cancelling this triple lock system before it distorts pension payments anymore and blows a huge hole in government finances. Simply increasing the pension by the inflation rate each year seems a much fairer system to pensioners and non-pensioners.
Some argue that the pension was never generous enough and that the triple lock has gradually brought it to a more acceptable level, but this argument is weak, since it would be much easier to provide a one off increase and then revert to just using the inflation rate in perpetuity.
Ultimately, Jeremy Hunt faces a difficult challenge, given the poor state of the UK government’s finances, and high interest rates making more borrowing very expensive. Reform of the state pension would make the system fairer and save the government money in the long run.
A sigh of relief for the US economy
November provided US consumers and investors with optimistic news over the state of America’s economy. Headline inflation continued to fall towards the Federal Reserve’s 2% target with October reporting 3.2% inflation on a year earlier, slightly below expectations of 3.3%. Although core inflation, where volatile food and energy costs are taken out, remains slightly higher at 4.0%, it similarly continues a downward trend that analysts say represents the success of the Federal Reserve’s interest rate rise campaign to tame inflation. At the beginning of this month, Federal Reserve Chair Jerome Powell held interest rates steady at 5.25-5.50%, raising hopes that the Fed’s tightening campaign had come to an end. On the back of the latest inflation figures, US stocks rose by their greatest amount in one day since April, with the S&P 500 climbing 1.9%.
Also buoying market sentiment was the passing of a temporary government funding bill by the House of Representatives, continuing current levels of government funding until mid-January and thereby averting an imminent government shutdown. The House’s new speaker Mike Johnson had to rely on Democratic support to pass the bill to circumvent opposition from far-right Republicans, with the bill passing 336-95 in an ironic twist of bipartisanship. Johnson had replaced former speaker Kevin McCarthy, after McCarthy was ousted by far-right Republicans for cooperating with Democrats to avert a government shutdown at the end of September. Although the temporary measure will only last until early next year, the US economy has once again steered clear from the brink.
This optimistic news only builds upon positive economic growth figures from the third quarter of 2023, which recorded record real GDP growth of 4.9%, far above the US’ Western peers. With cooling inflation, rising growth and a government that continues to fund itself, it might be expected that US consumer sentiment should be healthy. However, a recent poll by the Financial Times and University of Michigan found that only 14% of American voters believed that President Biden’s policies had benefited them economically. With a still uncertain economic outlook and pessimistic consumer confidence, the US economy remains far from safe waters.