It is increasingly likely that Charlie McCreevy will introduce some form of pension bond in next month's Budget. Regular readers of these pages will be aware that Oliver O'Connor and Rosheen Callender, an economist with SIPTU, recently debated the logic of such a proposal. Mr O'Connor attacked the plan, while Ms Callender replied in its defence. In her response, Ms Callender said that Mr O'Connor displayed a "fundamental misunderstanding of the proposal". While I wouldn't put it so harshly, Mr O'Connor did focus on the technicalities of the proposal, while he missed a fundamental flaw in its basic logic. Ironically, it was Ms Callender who unintentionally highlighted the plan's real danger. The pension bonds, and other deferred compensation mechanisms, are supposed to be a magical solution to the tax dilemma that the Government is facing. The dilemma, if you weren't aware of it already, is that the Government needs to increase take-home pay in the Budget if it is to save the Programme for Prosperity and Fairness (PPF).
However, as everyone from the International Monetary Fund to the European Central Bank is trying to tell the Government, the economy is already booming and doesn't need more fuel in the form of tax cuts. This has left the economic planners with a circle that's impossible to square. Impossible, that is, until SIPTU came up with its pension bond proposal. The logic of the plan, in a nutshell, is to reward workers with pension/savings bonds that they cannot spend straight away. This gives employees a greater share of the boom, while not adding to Ireland's overheating problem.
The problem with this "solution" is that both economic theory and recent experience suggests that it won't work. To see how a similar policy has worked in practice, one has to go as far as Japan. (The lack of precedents, in itself, is an initial cause for scepticism). The problem the Japanese authorities were trying to address was the opposite to that faced by Ireland. While Ireland's domestic economy is too strong, Japan's is too weak.
The Japanese public has been worried about the future and responded by saving a large proportion of its income for the rainy days they expect. With everybody saving rather than spending, Japanese fears have become a self-fulfilling prophecy. Reduced spending has weakened demand. This has caused the economy to deteriorate further which, in turn, has caused people to save more . . . and so on.
In an attempt to escape this vicious circle, the Japanese government came up with a novel solution: provide every worker with a voucher that had to be spent within a certain time-frame (or it became worthless). With consumers being unable to save the vouchers, the belief was that the spending would kick-start the economy.
Naturally, given their lack of choice, the Japanese public did spend their vouchers. However, they also reduced spending of their regular income by a comparable amount. With voucher expenditure and the reduction of "regular" expenditure balancing each other out, there was no discernible impact on overall consumer spending.
It's not difficult to see the similarities between the Japanese consumption vouchers and Ireland's savings bond. The Japanese government gave the public a handout, which it forced it to spend. The Government is set to give the public a handout, which it will force it to save. The overall impact on Ireland will be the same as giving people a tax cut. Whatever form the handout takes, the response will be similar: if we know that we will have extra income in the future, we can save less of our regular income today. Spending will increase much in the same way that it would if the money was given immediately.
This is not to say that the pension bond plan is damaging in itself. Whether money is given over in the form of a bond or in tax cuts, it's liable to contribute to economic overheating in the same manner.
The danger is if we believe that the pension bond proposal represents a free lunch, a payment that will not contribute to overheating. We should not for a second believe that this proposal represents a quick fix to our dilemma.
