Pension Funds as a Policy Tool Used by the Government
Theoretically, pension funds are large institutions that are free from any kind of influence. In fact, they are said to have the power to change the fundamentals of the stock market because of the large sums of money that they control. This is true to some extent. However, it is also true that pension funds have not been operating independently for a very long time. There are various ways in which government agencies hijack the functioning of such pension funds in order to meet their own interests.
In this article, we will have a closer look at how governments can take undue advantage of pension funds and how it can be harmful to the people who invest in pension funds.
How Governments Influence Pension Funds?
Pension funds have large amounts of funds that they want to invest in for the long run. Ideally, pension funds should have a lot of choices to invest their money. In a deregulated market, pension funds should be able to generate income from their investments.
However, governments create situations wherein pension funds are influenced to invest money in government securities even though they offer lower returns.
A good case in point would be the recent coronavirus pandemic. During this pandemic, governments all over the world tried to keep interest rates artificially low in order to bail out the economy. Pension funds invested significant sums of money to help governments during this period. However, it can be argued that the government bailed out certain companies and the economy at the expense of the savers. This is because the low-interest rates that the government and other companies had to pay resulted in lower earnings growth for the person who invests in pension funds.
Why do Governments Influence Pension Funds?
The fact of the matter is that governments know that pension funds are a captive audience. This means that they are somehow forced to invest money at the behest of the government. Also, lowering the interest rates payable to pensioners is easier to do politically.
The other alternative would be to raise taxes to support the economy during the coronavirus pandemic. However, both raising taxes or debt would be a wildly unpopular decision and would damage the reputation of the company. Lowering the interest rates, on the other hand, is much less open to scrutiny and criticism. Hence, from the governments point of view, it is a stealthier way of raising money.
Why the Government Must Refrain from too much Interference?
It must be understood that the government is not able to do this without artificially influencing the outcomes of financial markets. Even though there is no apparent cost to such policies, it must be understood that they do cause economic harm.
When the government artificially lowers the interest rate, they are taking money away from the savers and the pensioners. At the same time, they are taking this money to the younger generation. The younger generation is then compelled to consume since the interest rates are so low. The end result is that this is a transfer of wealth from older generations to younger generations. It must also be understood that younger generations do not actually benefit from this transfer. The younger generation also ends up in debt because of the high consumption.
The Limits of Government Interference
The pension markets are strong enough to sustain some degree of government interference. However, excessive government interference can cause problems in the market.
Hence, the manner in which the government can sustainably influence pension funds has been listed below:
- If governments have a defined benefit pension system, then they can interfere more aggressively in the functioning of pension funds. This is because the government is responsible for providing the cost of retirement to the investors in defined benefits funds anyways. Since most countries around the world follow a defined contribution pension fund, they must be careful while lowering the returns. This is because if retirees are unable to cover their cost of living from pensions, ultimately the government will have to pay in the form of welfare payments.
- Secondly, if the government is only interfering during special periods such as when a pandemic has ravaged the global economy, the situation may not be considered to be very bad. Desperate times call for desperate measures and as long as the status returns to normal, the pension funds will be able to sustain temporary interference. However, if the government has made it a policy to continuously interfere with pension funds, they are likely to suffer the after-effects over an extended period of time.
- The government must ensure that any money which has been channelized from the pension funds must be used only for inclusive growth-related projects. This means that the pensioners funds must benefit society as a whole. If the pensioners funds only benefit a certain section of the society, then it would exacerbate financial imbalance within the society.
- Lastly, it is very important that there is a governance mechanism in place. It would be very easy for corrupt politicians and bureaucrats to siphon away large sums of money from the pension funds if adequate oversight is not present. It is the duty of the government to prevent such embezzlement since it would hit the pensioners hard because pensioners have no alternate source of income to make up for the loss.
The fact of the matter is that over the years, government bodies have increased their influence over pension funds. They use them to obtain the money that they cannot raise otherwise. It is important to note that excess interference by the government can lead to the collapse of the pension funds which can have far-reaching effects on the entire economy.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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