The Sustainability of Ireland’s Sovereign Wealth Fund

The dramatic decline in Irish public finances is apparently causing the Irish government to reconsider its commitment to pay 1 percent of GNP into the National Pension Reserve Fund (Ireland’s own Sovereign Wealth Fund, established in 2000). In the article below (published in the August 3rd edition of the Sunday Independent), I discuss the proposed suspension of the annual payment.

See also the newspaper version

By borrowing insights from pyschology, the field of behaviourial economics has grown rapidly in recent years. A major area of study has been to identify mechanisms by which individuals can more easily resist short-term temptations, in order to attain long-term goals that are typically best achieved by committing to a fixed plan of action. These ideas are now gaining popular currency through best-sellers such as Nudge (by Richard Thaler and Cass Sunstein) and the website which allows an individual to enter a commitment contract that imposes financial penalties for failures to stick to a weight loss programme or give up smoking. Similar issues arise in assessing current media reports that the government is considering the temporary suspension of payments into the National Pension Reserve Fund (NPRF). The NPRF was established in 2000 in recognition that Ireland faces a rising bill for social welfare and public sector pensions over the long-term. In the absence of any pre-emptive action, rising pensions costs will require either very sharp increases in future taxation or will impose pressure to cut the generosity of benefits. Accordingly, the creation of the NPRF can be interpreted as a far-sighted and enlightened public policy that smooths out the burden of financing future government pension liabilities. Indeed, several other countries (including France and Australia) have established similar funds in recent years and have looked to the NPRF as a pioneering model. Under the National Pensions Reserve Fund Act 2000, one percent of GNP is paid into the NPRF each year, which adds to its founding endowment provided by the proceeds from the privatisation of Eircom. The legislation mandates that the sequence of annual payments will continue until 2055, with withdrawals from the NPRF only permitted after 2025. Accordingly, payments into the NPRF have a unique status in the Irish budgetary system, since no other spending commitment is protected through legislation. The rationale for a legislative commitment is to “tie the hands” of the government, by making it difficult to renege on the commitment. A similar philosophy lay behind the SSIA scheme, since there was a substantial penalty for those that failed to maintain the monthly savings habit over the five years of the programme. It is understandable that the government is tempted to suspend payments, in view of the emergence of a budget deficit, the increase in interest rates and the difficulties in managing the transition to tighter controls on public spending. However, it is important to appreciate that the payments into the NPRF have no impact on the general government deficit (which is the deficit number that is monitored by the European Commission under the Growth and Stability Pact): if the exchequer borrows to fund the payment, the general government is simultaneously issuing a liability and acquiring an asset, such that the aggregate net financial position of the general government sector is unchanged. Accordingly, the payments into the NPRF are not relevant in terms of attempting to achieve a given target value for the general government deficit. That said, a suspension of payments would improve the exchequer balance, allowing the government to reduce the level of gross government debt. This may be attractive to the government to the extent that the level of gross debt is inaccurately employed by the political system and the media as an indicator of the quality of the government’s economic management. In addition, for a given target value for the general government deficit, the saving on debt interest payments would permit an increase in other spending items or a reduction in taxation. However, the long-term financial position of the government would be better served by maintaining a higher level of leverage if the long-term return on the NPRF’s portfolio exceeds the cost of government borrowing. (Since the NPRF has a long-term horizon, quarterly fluctuations in its investment performance should be largely ignored – what matters is the average return over the long term, which should be higher on a diversified portfolio than on a debt-only portfolio.) A suspension of payments into the NPRF would also send a negative signal about the government’s credibility in making long-term commitments. Since legislation can always be reversed, the quality of government commitments is always subject to some level of suspicion but this will be amplified if the government deviates from its legislated commitment to pre-fund future pension liabilities. Moreover, even a temporary suspension now sets a precedent that opens the door for future governments to also identify exceptional circumstances that would justify subsequent interruptions to the schedule of payments. Indeed, it will also make it difficult for the current government to re-start payments rather than seek an extension to the temporary period of suspension, since myriad spending lobbies will seek to divert the resources to other ends. Since the trend pressure on public spending is clearly upwards due to the ageing of the population (requiring an increase in health-related spending in addition to pensions), the temptation to prioritise short-term fixes over long-term sustainability is bound to also grow over time. If the government itself cannot stick to its pre-funding plans, it will also make it more difficult to encourage more private individuals to save for retirement through the types of automatic savings plans that are the most effective way of ensuring that adequate levels of pension assets are accumulated. Since improving the coverage of private pension provision is a major strategic goal for the government, it would be a strike against `joined-up’ policy for the government to give a bad example by suspending payments to the NPRF. (However, in the other direction, it is just possible that increasing the level of uncertainty about the government’s commitment to maintain publicly-financed pensions may motivate individual workers to rely more on personal pension plans!) Finally, the government has won many international plaudits for its economic policy management over the last decade. The implementation of action plans to ensure proper provision for ageing populations is a key indicator by which governments are judged on the international stage. A suspension of payments will be poorly received by the European Commission, fellow European governments and the global investment community.