In his Budget on March 19, the Chancellor of the Exchequer, George Osborne, announced fundamental changes to the way people access their pensions. Previously, many people with pension savings were forced to buy an annuity. These pay a set amount of income per month from retirement for the remainder of a person’s life.
But, with annuity rates (along with other interest rates) being at historically low levels, many pensioners have struggled to make ends meet. Even those whose pension pots did not require them to buy an annuity were limited in the amount they could withdraw each year unless they had other guaranteed income of over £20,000.
Now pensioners will no longer be required to buy an annuity and they will have much greater flexibility in accessing their pensions. As the Treasury website states:
This means that people can choose how they access their defined contribution pension savings; for example they could take all their pension savings as a lump sum, draw them down over time, or buy an annuity.
While many have greeted the news as a liberation of the pensions market, there is also the worry that this has created a moral hazard. 
When people retire, will they be tempted to blow their savings on foreign travel, a new car or other luxuries? And then, when their pension pot has dwindled and their health is failing, will they then be forced to rely on the state to fund their care?
But even if pensioners resist the urge to go on an immediate spending spree, there are still large risks in giving people the freedom to spend their pension savings as they choose. As the Scotsman article below states:
The risks are all too obvious. Behaviour will change. People who no longer have to buy an annuity will not do so but will then be left with a pile of cash. What to do with it? Spend it? Invest it? There are many new risky choices. But the biggest of all can be summed up in one fact: when we retire our life expectancy continues to grow. For every day we live after 65 it increases by six and a half hours. That’s right – an extra two-and-a-half years every decade.
The glory of an annuity is it pays you an income for every year you live – no matter how long. The problem with cash is that it runs out. Already the respected Institute for Fiscal Studies (IFS) has said that the reform ‘depends on highly uncertain behavioural assumptions about when people take the money’. And that ‘there is a market failure here. There will be losers from this policy’.
We do not have perfect knowledge about how long we will live or even how long we can be expected to live given our circumstances. Many people are likely to suffer from a form of myopia that makes them blind to the future: “We’re likely to be dead before the money has run out”; or “Let’s enjoy ourselves now while we still can”; or “We’ll worry about the future when it comes”.
The point is that there are various market failings in the market for pensions and savings. Will the decisions of the Chancellor have made them better or worse?
Articles
Pension shakeup in budget leaves £14bn annuities industry reeling The Guardian, Patrick Collinson (20/3/14)
Chancellor vows to scrap compulsory annuities in pensions overhaul The Guardian, Patrick Collinson and Harriet Meyer (19/3/14)
Labour backs principle of George Osborne’s pension shakeup The Guardian, Rowena Mason (23/3/14)
Osborne’s pensions overhaul may mean there is little left for future rainy days The Guardian, Phillip Inman (24/3/14)
Let’s celebrate the Chancellor’s bravery on pensions – now perhaps the Government can tackle other mighty vested interests Independent on Sunday, Mary Dejevsky (23/3/14)
A vote-buying Budget The Scotsman, John McTernan (21/3/14)
L&G warns on mis-selling risks of pension changes The Telegraph, Alistair Osborne (26/3/14)
Budget 2014: Pension firms stabilise after £5 billion sell off Interactive Investor, Ceri Jones (20/3/14)
Budget publications
Budget 2014: pensions and saving policies Institute for Fiscal Studies, Carl Emmerson (20/3/14)
Budget 2014: documents HM Treasury (March 2014)
Freedom and choice in pensions HM Treasury (March 2014)
Questions
- What market failures are there in the market for pensions?
- To what extent will the new measures help to tackle the existing market failures in the pension industry?
- Explain the concept of moral hazard. To what extent will the new pension arrangements create a moral hazard?
- Who will be the losers from the new arrangements?
- Assume that you have a choice of how much to pay into a pension scheme. What is likely to determine how much you will choose to pay?
The supermarket industry is a classic example of an oligopoly. A market dominated by a few large companies, which is highly competitive and requires the companies to think about the reactions of the other competitors whenever a decision is made. Throughout the credit crunch, price cutting was the order of the day, as the big four tried to maintain market share and not lose customers to the low cost Aldi and Lidl. Morrisons, however, has found itself in exactly that position and is now looking to restructure to return to profitability.
Morrisons is well known for its fresh food, but it seems that with incomes still being squeezed, even this is insufficient to keep its customers from looking for cheaper alternatives. Morrisons’ market share has been in decline and its profits or the last financial year have been non-existent. It’s been losing ground to its big competitor, Tesco and part of this is due to the fact that Morrisons was late to enter the ‘Tesco metro’ market. It remained dependent on its large supermarkets, whereas Tesco saw the opportunity to expand onto the highstreets, with smaller stores. It was also late arriving to the online shopping business and while it has now developed more sophisticated IT systems, it did lose significant ground to Tesco and its other key competitors.
Another problem is that Morrisons has found itself unable to compete with the low cost supermarkets. The prices on offer at Morrisons are certainly not low enough to compete with prices at Aldi and Lidl and Morrisons has seen many of its customers switch to these cheaper alternatives. But Morrisons is fighting back and has announced plans to cut prices on a huge range of products across its stores. The fresh food aspect of the business will still remain and the hope is that the fresh food combined with cheaper price tags will allow Morrisons to re-gain lost ground to Tesco and take back some of its lost customers from the low-cost alternatives. However, it’s not just Morrisons that has been losing customers to the budget retailers. Tesco, Sainsbury’s and Asda have all lost market share to Aldi and Lidl, but it is Morrisons that has fared the worst.
The latest news on Morrisons’ profits and overall performance, together with its promise of restructuring and price cuts worth £1 billion has caused uncertainty for shareholders and this has reduced the value of shares. However, Morrisons’ Directors have tried to restore confidence by purchasing shares themselves. With expectations of price wars breaking out, the other supermarkets have also seen significant declines in their share values, with a total of £2 billion being wiped off the value of their shares collectively. The consequences of Morrisons’ performance will certainly continue: customers are likely to benefit from lower prices in all of the big four supermarkets, but investors may lose out – at least in the short run. The impact on jobs is uncertain and will certainly depend on how investors and customers react in the coming weeks. The following articles consider this sector.
UK grocer Morrison warns on profit, threatens price war Reuters, James Davey (13/3/14)
Morrisons and the threat to mainstream supermarkets BBC News, Robert Peston (13/3/14)
Morrisons expected to sell property in response to profit drop The Guardian (9/3/14)
Morrisons restructuring sparks fears of new price war BBC News (13/3/14)
Morrisons’ dividend up while profit falls? It’s hard to believe The Guardian, Nils Pratley (13/3/14)
Morrisons boss talks tough as group slides into red The Scotsman, Scott Reid (13/3/14)
Morrisons plots price cuts after annual loss Sky News (13/3/14)
Morrisons’ declaration of £1bn price war with budget stores hammers Sainsbury and Tesco shares This is Money, Rupert Steiner (14/3/14)
Ocado on track for first profit in wake of Morrisons deal Independent, Simon Neville (14/4/14)
Questions
- What are the key characteristics of an oligopoly?
- To what extent do you think the supermarket sector is a good example of an oligopoly?
- Why is the characteristic of interdependence a key cause of the potential price war between the supermarkets?
- Why has Morrisons been affected so badly with the emergence of the budget retailers?
- By using the income an substitution effect, explain how the big four supermarkets have been affected by retailers, such as Aldi and Lidl.
- Using a demand and supply diagram, explain how the share prices of companies like Morrisons are determined. Which factors affect (a) the demand for and (b) the supply of shares?
- What do you think will happen to the number of jobs in Morrisons given the performance of the company and its future plans?
In August 2012, the ECB president, Mario Draghi, said that the ECB would ‘do whatever it takes‘ to hold the single currency together and support the weaker economies, such as Greece, Portugal and Spain. At the same time, he announced the introduction of outright monetary purchases (OMTs), which would involve purchasing eurozone countries’ bonds in the secondary markets. There were no limits specified to such purchases, but they would be sterilised by the sale of other assets. In other words, they would not increase the eurozone money supply. But despite the fanfare when OMTs were announced, they have never been used.
Today, the eurozone economy is struggling to grow. The average annual growth rate across the eurozone is a mere 0.5%, albeit up from the negative rates up to 2013 Q3. GDP is still over 2% below the peak in 2008. Inflation is currently standing at 0.8%, well below the 2% target. The ECB’s interest rate (‘main refinancing operations rate’) is 0.25%.
The recovery is hindered by a strong euro. As the chart shows, the euro has been appreciating against the dollar. The euro exchange rate index has also been rising. This has made it harder for the eurozone countries to export.
So what can the ECB do to stimulate the eurozone economy? Other central banks, such as the Bank of England, the US Federal Reserve and the Bank of Japan have all had substantial programmes of quantitative easing. The ECB has not. Perhaps OMTs could be used without sterilisation. The problem here is that there are no eurozone bonds issued by the ECB and hence none that could be purchased, only the bonds of individual member countries. Buying bonds of weaker countries in the eurozone would be seen as favouring these countries and might create a moral hazard.
Reducing interest rates is hardly an option given that they are at virtually zero already. And expansionary fiscal policy in the weaker countries has been ruled out by having to stick to the bailout conditions for these countries, which require the pursuit of austerity policies.
One possibility would be to intervene in the foreign currency market by buying US and other countries’ bonds. This would drive down the euro and provide a stimulus to exports. This option is considered in the Jeffrey Frankel article.
Articles
Why the European Central Bank should buy American The Guardian, Jeffrey Frankel (13/3/14)
Draghi holds course in face of deflation threat Reuters, Paul Carrel and Leika Kihara (13/3/14)
ECB’s Draghi: Strong Euro Pulling Down Euro Zone Inflation Wall Street Journal, Christopher Lawton and Todd Buell (13/3/14)
Draghi Bolstering Guidance Seen as Convincing on Rates Bloomberg, Jeff Black and Andre Tartar (13/3/14)
ECB president Mario Draghi counters euro upswing Financial Times, Claire Jones (13/3/14)
Turning Japanese? Euro zone exporters must hope not Reuters, Neal Kimberley (14/3/14)
Prospect of ECB QE drives eurozone bond rally Financial Times, Laurence Mutkin (12/3/14)
Data
Statistical Data Warehouse ECB
Winter forecast 2014 – EU economy: recovery gaining ground European Commission: Economic and Financial Affairs DG
AMECO online European Commission: Economic and Financial Affairs DG
Questions
- Why is the ECB generally opposed to quantitative easing of the type used by other central banks?
- What is meant by ‘sterilisation’? Why does sterilisation prevent OMTs being classed as a form of quantitative easing?
- Would it be possible for OMTs to be used without sterilisation in such as way as to avoid a moral hazard for the highly indebted eurozone countries?
- Is the eurozone in danger of experiencing deflation?
- What are the dangers of deflation?
- Why does the ECB not cut its main refinancing rate below zero?
- If the ECB buys US bonds, what effect would this have on the euro/dollar exchange rate?
- Would purchasing US bonds affect the eurozone money supply? Explain.
- What other means are there of the ECB stimulating the eurozone economy? How effective would they be likely to be?
GDP figures are often a poor measure of a country’s economic well-being. By focusing on production, they may not capture the contribution of a range of social and environmental factors to people’s living standards, including the various negative and positive externalities from production and consumption themselves. A case in point is internet innovation: an issue considered in the first linked article below by the eminent economist, Joseph Stiglitz.
The effects of innovations that directly lead to an increase in output are relatively easy to measure. Many innovations, however, may allow those with power to consolidate that power, resulting in less competition and a possible decline in welfare. If, for example, companies such as Amazon, invest in online retailing and gain a first-mover advantage, they may be able to use this power to drive out competitors. In other words, innovations may not simply lower the cost of production and hence prices: they may even lead to an increase in prices.
Then there are innovations, such as faster broadband, that result in higher quality. While higher quality in one sphere may lead to higher output elsewhere, in many cases it is just improving the experience of consumers without being reflected in a way that can be easily measured.
Some innovations may be judged as socially harmful. Thus improved gaming functionality and realism may encourage people to spend more time online. The social and health implications of this may be considered as undesirable and resulting in a reduction in well-being. Of course, many gamers would disagree!
The point is that technological innovations often result in a change in tastes. These changes in tastes may involve negative externalities, themselves very hard to quantify. Consequently, 
resulting changes to GDP may be a very poor indicator of changes in social well-being.
The articles below consider some of these issues. The Stiglitz article gives an example of innovation in financial services. Although highly profitable for many working in the sector – at least until the crash of 2008/9 – according to the author, these innovations led to both lower GDP growth and a net contribution to social welfare that was negative.
The benefits of internet innovation are hard to spot in GDP statistics The Guardian, Joseph Stiglitz (10/3/14)
Economist argues for happiness over GDP Yale Daily News, Joyce Guo (19/2/14)
‘GDP: A Brief But Affectionate History’ by Diane Coyle and ‘The Leading Indicators: A Short History of the Numbers That Rule Our World’ by Zachary Karabell Washington Post, Tyler Cowen (21/2/14)
Emerging Markets: Income Returns To Innovation (GDP Per Capita Vs. Innovation Index) Seeking Alphz, Jon Harrison (4/3/14)
Questions
- What does GDP measure?
- What factors affecting the welfare of society are not measured in GDP?
- What alternative indicators are there to GDP as a measure of living standards?
- How would you set about measuring the effects on living standards of a technological revolution, such as the ability to access 4G on the move on laptops and smartphones (e.g. on trains)?
- How should the net benefits of installing more ATMs (cash machines) be calculated?
- Revisit the blog Time to leave GDP behind? and answer question 8.
- Referring to the Jon Harrison article, how would you construct an innovation index? How is innovation related too GDP per capita?
Footballers in the English Premier League are some of the most highly paid workers in the world. With unique talents and skills and hence a limited supply of labour, together with an insatiable appetite from the British public for football, we would expect to see high wages and a market ripe for investment, with high returns on offer. But, is this case?
The article below is by Linda Yueh, the Chief Business Correspondent for BBC News, and she has looked into the football, asking why on earth buy a football club? Despite the success of the English Premier League in drawing fans, TV and commercial revenues, many teams find it difficult to break even and investing in a team is unlikely to yield much of a return (if any!). Yet, we still see successful businesspeople, especially from abroad, purchasing English football teams.
Many club owners have hugely profitable ventures in other markets and historically only invest their money when they see an opportunity for a high return. But, not in the case of football. A return is unlikely and yet they still invest. So, with positive returns unlikely, what is it about this market that attracts investors? The article by Linda Yueh considers this question.
Article
Why on earth buy a football club? BBC News, Linda Yueh (27/2/14)
Report
Annual Review of Football Finance – Highlights Deloitte, Sports Business Group June 2013
Questions
- How can the returns to investment be measured?
- How can a company’s operating profit be calculated?
- Using a labour market diagram, explain why footballers are paid such a high wage.
- Is it monetary or non-monetary factors that seem to explain why businessmen invest in football clubs?
- Why are English football clubs typically unprofitable? Should they be?
- Which factors can explain the growing financial inequality between clubs in the Premier League and in the divisions below? Is there an argument for government involvement to regulate football?
When people retire, will they be tempted to blow their savings on foreign travel, a new car or other luxuries? And then, when their pension pot has dwindled and their health is failing, will they then be forced to rely on the state to fund their care?
