ARTICLES

a plan to protect our savings against inflation

Pensions and retirement income that people worked hard to prepare in the Thirties have almost been wiped out by the shrinking value of the dollar. Unless the government will sell “indexed annuities,” says this expert, the pensions a new generation now looks forward to will be practically worthless

H. SCOTT GORDON professor of economics at Carleton University, suggests November 21 1959
ARTICLES

a plan to protect our savings against inflation

Pensions and retirement income that people worked hard to prepare in the Thirties have almost been wiped out by the shrinking value of the dollar. Unless the government will sell “indexed annuities,” says this expert, the pensions a new generation now looks forward to will be practically worthless

H. SCOTT GORDON professor of economics at Carleton University, suggests November 21 1959

a plan to protect our savings against inflation

H. SCOTT GORDON professor of economics at Carleton University, suggests

Pensions and retirement income that people worked hard to prepare in the Thirties have almost been wiped out by the shrinking value of the dollar. Unless the government will sell “indexed annuities,” says this expert, the pensions a new generation now looks forward to will be practically worthless

“A little inflation probably hurts no one—except retired people with fixed incomes.”

REMEMBER the insurance - company ads that used to picture a happy elderly couple basking in the sunshine on an annuity of $100 a month? Insurance companies, as everyone knows, are very conservative institutions. They still picture the elderly couple enjoying a secure and comfortable retirement but the annuity figure now usually reads $400 a month.

What has happened to the people who thought they were making adequate provision for retirement by contracting for the recommended annuity or endowment policy forty years ago? The contract they entered into was for a certain number of dollars. But those dollars will purchase far less now than they would forty years ago. The result is that we have in Canada today thousands of people, who saved during their working years to make what they thought was adequate provision for retirement, who now find themselves with a standard of living below that of our lowest-paid unskilled laborers. Less than one percent of the young working population in 1920 could have saved enough to provide a retirement pension of $400 a month, but even those who could have done so didn’t think it was necessary, because they didn’t consider the extent to which their savings would be eroded by inflation.

These elderly citizens, many of whom have made distinguished contributions to Canadian society, are condemned to a retirement of poverty. There is nothing they can do to raise their incomes now. for their working years are over. Worse still, there was nothing they could have done forty years ago to protect themselves from the danger of inflation.

There has been a great deal of discussion about inflation in recent years, but most of it has been concerned with preventing inflation. It is true, of course, that if we could prevent inflation altogether we would have the best possible protection for retired people. There is, however, no good reason to think that we will succeed in preventing inflation altogether and, to the extent that it occurs, retired people will suffer. We have firemen to prevent fires, but we also have fire insurance to enable people to protect themselves from the loss of home and property. It would be wonderful if no fires ever occurred but. until that Utopian day arrives, fire insurance performs a useful service. Why not have inflation insurance so that people can protect their

retirement living standards just as they now protect their property with fire insurance?

The kind of inflation we have been having in Canada in recent years has been quite moderate, especially if we compare it with certain other countries. Since the end of the war Canada has experienced two major upward spurts in prices—in the immediate postwar period (up to about the middle of 1948) and during the Korean war. Aside from these two periods, prices in Canada have risen, on the average, between one and two percent a year since the end of the war.

Economists do not have unanimous views about a “creeping inflation” of one or two percent a year. Some believe that the creep inevitably becomes a gallop and must therefore be prevented at all costs. Others go so far in the opposite direction as to suggest that rising prices to this extent are necessary to maintain full employment and an expanding economy. In my own view, there is not much evidence in either history or economic theory one way or the other. An inflation of one or two percent a year doesn’t necessarily do the economy any good, but it doesn’t necessarily do any harm either.

A creeping inflation may not do the economy as a whole any harm, but there is one section of the community that is very seriously affected by it — retired people whose sole or main source of income is a pension contract. A steady erosion of two percent a year adds up to quite a bit over the course of a whole lifetime. With such a moderate “creeping inflation,” a person who begins contributing to a pension when he is twenty-five will find that a third of its value has been eaten away before he even begins to draw retirement benefits. If he lives until the age of eighty-five he will receive in his latter years about half of the real income he thought he was providing for.

During the past few years, the contributors to pension funds and the mana ers of pension schemes have become very much aware of the effect of inflation on the welfare of retired people. Various plans have been put forward to protect pensions from inflation erosion. The most common inflation hedge adopted by the pension funds is to recommend that a portion of the money be invested in common stocks of leading corporations. The reasoning behind this recommendation is that the yield on

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a stock is not fixed in dollar terms; that of a bond is. If inflation occurs there is reason to expect that stock dividends (and the market value of stocks themselves) will rise. The pension fund to v/hich I contribute decided last year to permit its members to instruct the managers to invest up to fifty percent of the funds in common stocks. Those who chose to do so ( I was one and I chose the full fifty percent) were agreeing, as it turned out. to have their money invested in stocks that currently yield around two or three percent, in preference to Government bonds that are yielding more than five percent. This is just a measure of the fear that people have of continuing inflation.

Hedging against inflation by investing in stocks is a very imperfect solution. It is perhaps better than nothing over the long term, but it does not really meet the needs of pensioners. This need is not met by any investment that is currently available to Canadians. But such investments can be made available, and my thesis is that the federal government should make them available.

Government must do it

What pensioners want is a guaranteed purchasing power. They don’t care how many dollars they get but what those dollars will buy. The best way for them to invest their funds is in an annuity which would go up and down with the general price index.

I suggest that the federal government make such an annuity available because no private insurance company can do so. The private insurance company can predict with fair accuracy what the death rate will be. but it cannot possibly predict the probable future inflation. Moreover, insurance companies invest most of their funds in bonds with fixed dollar yields so their own earnings are eroded by inflation. Endowment-type insurance policies have always been a poor investment (though they have enjoyed great popularity in Canada) and inflation danger makes them poorer still.

The federal government already operates an annuities scheme. At the present time the maximum retirement income that can be purchased through this scheme is $1,200 a year. My suggestion is that this scheme should be greatly expanded. The limit should be raised to, say, $5,000 per year at 1959 price levels, and the amount actually paid should be linked to the price level.

If a person contracted for a $4.000 annuity, and prices rise two percent, his benefits would automatically rise to $4,080 a year. (We may have to give some thought to constructing a special price index for this purpose — one spe-

dally designed to reflect the expenditure patterns of retired people.)

If an indexed annuity of this sort were made available, I would expect that a great many of the pension funds that have recently shifted their money into common stocks would alter their investment plans again and purchase the indexed annuities.

It should be pointed out that an annuity scheme of this sort would not mean that the government was subsidizing the pensioners. On the contrary, this would only assure that pensioners were getting the full value of the contribution that their savings were making to the Canadian economy. The funds they contribute would be used for the expansion of the productive capital of the nation. When prices in general go up the money value of the services rendered by that capital goes up as well. If those who contributed the savings that made that capital possible receive only a fixed dollar return, they are, plainly, having a part of their real contribution filched from them.

Providing indexed annuities for pension funds will not give the pensioners something for nothing. It will merely assure them that they will continue to receive the full productivity of their savings. However, even if the scheme were subsidized to some extent by the government, this would be quite justified, for government revenues are substantially increased by a creeping inflation. Because of the structure of our taxation system, government revenues rise at about twice the speed of the money value of national income. If prices increase two percent, government revenues will, due to the price rise alone, increase by about four percent. It seems hardly more than fair that the government, which is a major beneficiary of inflation, should provide compensation to those who are hardest hit by it.

At the present time, however, the government should actually be able to gain from the sale of indexed annuities. The fear of inflation is very great and pension funds would probably be quite willing to take a rate of interest considerably below that now ruling on long-term government bonds to get “inflation insurance.” The result would be that the government would be able to borrow funds at lower interest rates by selling indexed annuities than by selling ordinary bonds. To the extent that the fear of inflation is greater than the actual danger of inflation, as it undoubtedly is at present, this would be

a permanent gain to the federal treasury.

I have no doubt that there will be objections to this scheme. The insurance companies will fight it because it might reduce very substantially their own insurance and annuity sales and therefore would reduce the amount of investment funds under their control. The funds in the hands of Canadian insurance companies are. however, much too large at the present time, and a substantial reduction in them would be an all-round benefit to the Canadian economy in a number of ways.

Some people will argue that if you start indexing pensions you will be forced to go on and index practically everything. 1 would agree that an economy in which all money contracts were linked to the price index would be an exceedingly cumbersome one. But I cannot see why the offering of indexed annuities for sale will inevitably force us to go on and index everything else. We can stop wherever we want to as long as we have the sense to do so.

I suspect that the greatest opposition to a scheme of this nature will come

from the Bank of Canada. The idea of linking anything to the price index is anathema to the Bank of Canada. That august institution, however, has a rather warped list of anathemas these days. On this matter its apparent views are not well founded and should be disregarded.

A government annuity linked to the price index would protect the savings that people make for their retirement. This is a necessary objective and the scheme itself is entirely feasible. It should be instituted at the earliest propitious opportunity. ★