The bathtub problem

ONE more thought on pensions, before I return to the markets. Roger Lowenstein's book While America Aged is quite brilliant and should be made compulsory reading for every elected official in the developed world. He even manages to make pensions dramatic! The book concentrates on three case studies; General Motors, the New York subway system and San Diego.

In each case, managers made promises to appease the unions that were hugely expensive over the long run. But in the absence of proper accounting, this expense was not recognized upfront. And the executives and politicians who made the concessions were not around when the problems emerged.

Perhaps the most egregious example was in San Diego. The soaring stock market of the late 1990s persuaded the city to improve benefits. But there was an agreement on a safety clause, requiring the city to stump up a lot more money if the funding level dropped too far. As the stockmarket fell, that trigger level was reached - of course, the city did not want to make the extra contributions because it was short of money. However, officials needed the agreement of the unions on short-changing the fund, and the unions insisted on higher benefits as the price.

Yes, that's right. the answer to a fund shortfall was not to increase the contributuions but to raise the benefits. "The bath isn't filling up!" "Then, turn the tap on full." "No, I've a even better idea. I'll make the plughole bigger."

The examples of folly were enough to make one weep. Workers were allowed to get benefits based on their earnings in the final year, including overtime. So they racked up the hours in the last year and earned more, doing nothing, than they did working. Officials were then surprised to find that lots of workers took early retirement.

GM is a cautionary tale for national and local governments. It granted generous benefits when its profits, and market share, were high, and there were few retirees relative to workers. But the workforce fell and the Japanese! came in to the market. Those pension (and healthcare) costs became a competitive burden. Stretch the analogy and the developed world granted high welfare benefits when it dominated the global economy, and its workforce was growing; but now its share of world trade is declining and the baby boomers are retiring. The taxes need to pay those benefits may be the equivalent of GM's legacy costs.