Social Security privatization can work

A recent poll found that more young Americans expect to meet an extraterrestrial being than believe the Social Security system will be able to provide them with a decent pension.

Maybe they are right.

Because, whereas extraterrestrials may or may not exist, the Social Security fund certainly doesn't.

Young people have rumbled the fact that none of their Social Security contributions have been genuinely invested in wealth-creating industry.

They have all been used to pay the pensions of people who have already retired, or they have been borrowed by the government.

The Social Security "fund" contains nothing but paper promises that a future generation, not yet born, will pay the pensions of today's young working people.

Yet in every developed country people are living longer, working lives are getting shorter, and there are proportionately fewer people of working age. And most countries operate a system like the American one where Social Security funds are run on a pay-as-you-go system. Contributions are used to pay the pensions of people who have already retired. Nothing is actually saved or invested for the future.

So as more and more pensioners live longer and longer, the burden of Social Security contributions and taxes on working people will grow higher and higher, imposing a crushing burden on their economies.

Britain is almost unique. We have partly solved this problem. We have encouraged people to opt out of the earnings-related portion of the state pension scheme.

Nearly two-thirds of those entitled to do so have opted for private provision.

When they do that they receive a rebate from their Social Security contributions. This is worth about 5 percent of their income. And it is payable into any approved pension plan.

So their money is genuinely saved. It is invested in business. It will generate the profits to pay for their pensions in 10, 20, or 30 years - without imposing a heavy burden of taxation on the economy.

Meanwhile it strengthens the economy through a huge accumulation of committed long-term investment.

The British have now invested some $1.2 trillion to pay for future pensions. That is not just more than any other country in Europe. It is more than all the other countries in Europe - combined - have bothered to invest to meet their future pension liabilities.

The IMF has calculated that, if countries stick to their existing policies, by 2030 Germany and France will have national debts nearly double their national income. Japan's debt will be three times its national income.

Yet the United Kingdom, uniquely, will have been able to pay off its entire national debt and started to accumulate assets. It's not just Britain's national finances which benefit from this approach. British pensioners have benefited too.

The rebate they receive when they opt out was set at a level which would generate an equivalent pension to that promised by the state to those who stay in. The calculation assumed that private investments would yield 4.25 percent a year on top of inflation.

Yet, British private pension funds on average have earned nearly 10 percent a year more than inflation in the past 15 years. So pensioners' incomes have outstripped the rest of the population.

The Labour party used to be hostile to this approach since it reduced reliance on the state.

Before he was elected, Tony Blair suggested we should move toward the Singapore approach since that involves the state Central Fund - instead of private funds - investing people's contributions. However, he had to abandon the idea when it emerged that the Singapore fund had only achieved a return of 2 percent a year: Britain's private funds were doing five times better.

Labour then tried to discredit the British reliance on private investments by attacking the so-called "misselling scandal" of the late 1980s. There was indeed a genuine scandal. But it did not involve people opting out of the state scheme into private funds. (It resulted from unscrupulous salesmen persuading people to leave company pension plans and invest in other plans, even though that meant they lost out on the contribution their employer was paying into the company fund. But none of those who were missold inappropriate pensions lost a penny, because the rules require the firms who gave bad advice to compensate them fully.)

So now, even the Labour Party accepts the benefits of our system of private-funded pensions.

A system which has won the support of its most rooted enemies at home may well have lessons for those abroad - not least for our American friends.

* Peter Lilley is a Conservative member of the British House of Commons. He is a former secretary of state for social security.