Britain needs bold pension reforms – or we face more Thames Waters

More than a decade of ultra-cheap money is obviously a large part of the problem. This has further added to the already long-standing tax advantages of debt leverage over equity.

But the root causes run much deeper. It’s what Tom Tugendhat – one of the few candidates in last year’s Tory leadership contest talking any sense on the array of chronic challenges facing the UK economy – has called the difference between “dead and live money”.

It’s not as if Britain lacks the capital to invest in our crumbling infrastructure; there’s trillions of pounds-worth of it tied up in pensions and housing wealth. 

But it’s not getting through to the industries that need it. 

Instead, our pension wealth is overwhelmingly invested in the seeming safety of government debt, rather than chasing the higher long term rates of return promised by riskier equity investment. Dead money, in other words.

This has created a void into which the “live money” of international finance has stepped, with Thames Water and many of our other public utilities leveraged to the hilt and substantially in private or foreign ownership. 

A clinically minded focus on sweating the assets has replaced almost all sense of loyalty to country and civic duty.

Stripped down to the last lightbulb, it is no surprise that our utilities can no longer deliver the services the public expect.

So shamelessly reliant on the hot money of international finance has the economy become that nationalising Thames Water and other struggling water companies without compensation, so that they can walk away from their collective £60bn of debt, is in practice no longer an option. 

To do so would risk cutting off the flow of international money on which so much else has come to depend. Myriad other projects would go up in smoke, with the UK deemed politically too high-risk to be a dependable investment destination.

It wasn’t always like this. Our pension funds could once have been relied on to provide the steady stream of evergreen funding that British business, and as they were privatised, the major utilities needed to invest in the future.

That they no longer do this is both unacceptable, and, on any objective analysis, bizarre, given the extraordinary quantity of the savings involved. It is therefore worth spelling out some of the reasons for how we got to where we are.

First came globalisation. This relegated our own stock market and economy to the position of just another minor player in a very large pond. 

Pension funds began to spread their equity allocations around global stock markets as a whole, rather than just the UK, prompting a massive switch by UK pension funds away from UK equities into international markets. 

Chronic underperformance of the London stock market followed naturally from this development.

Then came demographics. An ageing workforce saw numerous final salary pension schemes closed to new accruals, depriving the funds of the stream of new money needed to support future liabilities.

These closures were greatly accelerated by the reforms to solvency regulation that were imposed after the Maxwell scandal, when the boss ran off with the money, leaving Mirror Group pension schemes short.

Changes to accountancy rules, forcing companies to recognise any pension fund deficit on their balance sheets, compounded the belief that final salary pensions were too big a liability for companies to bankroll.

Rules that require companies to match the present value of assets with future liabilities were the final straw, driving a wholesale switch out of volatile equities into the supposedly risk-free home of government bonds.

Transparency is normally a good thing; the more of it the better. But sometimes it can work in perverse ways, as in this instance. 

The superior, long-term rates of return on equities and other riskier assets, such as infrastructure investment, would appear tailor-made for the long term liabilities of pension provision, but any such strategy has to recognise that all such investment is volatile. 

Sometimes the current value of the assets is going to fall short.

Yet if that shortfall is there for all to see, then companies and their shareholders are almost bound to run a mile, and seek to insulate themselves from the risks.

Corporate profits that might otherwise be spent on productive investment are instead devoted to closing deficits via matching purchases of government bonds.

The Government is deeply complicit in the process, because it relies heavily on pension fund money to fund its own burgeoning spending commitments. 

The leviathan of current government consumption deliberately crowds out private investment in the productive economy.

The Chancellor, Jeremy Hunt, promises to address the deficiencies in pension investment in his speech to the Mansion House dinner in the City of London later this month. 

He could not have been given a more timely wake-up call than the disaster that is Thames Water, a company that for many years now has been shamelessly run for cash to the exclusion of its wider civic obligations. 

That this has been allowed to happen is only so because Britain’s biggest repository of savings has substantially recused itself from investment in the nation’s productive asset base. 

Getting this right is fundamental to Britain’s future, even if it is not the sort of issue that wins elections. 

There are few votes in reform of this sort, and also powerful vested interests and backward looking ways of thinking to overcome. I’m hoping Hunt will be bold in his pension reforms. But I’m not holding my breath.