10/10/2012

By Michael Baxter


Nudge nudge, wink wink, know what I mean? Your pension, squire, is it a goer?

And so it is that the UK government has introduced regulations meaning that employees will automatically be enrolled into pension schemes, and for them not to take part, they have to consciously opt out.

The reform is not being introduced overnight. To begin with, the new scheme will only apply to companies employing 120,000 workers or more. But bit by bit, the scheme will be widened, so that by 2015 small businesses will have to take part.

According to the FT, it is estimated that 11 million Britons – or 40 per cent of the working population –­ are not saving enough to maintain living standards when they retire. (Can you believe that? This implies 60 per cent of the working population are saving enough. That is surely not true!)

There are snags with the scheme. For one thing the level of savings that employees will automatically start making will be tiny. Someone earning £20,000 a year will save just £2.37 a week.

Of course, the more you put in the more you get out, and workers setting aside £2.37 a week might think that one day a great windfall will be theirs, but in reality all they can really look forward to is either a retirement made of poverty, or working until they are very old indeed.

And while many argue that we all need to save more, it could be said: what’s the point? What’s the point when the rate of interest is so tiny, and stock market returns over the last 12 years have been so awful. After all the FTSE 100 still languishes some 1,000 points below its all-time high set on January 30 1999.

The truth is that the only way the UK will be able to meet the need of its baby boomer generations as they enter into their late 60s, is by extending their retirement age. Some may find that quite unappealing, but put the choice in these terms. The good news is that we are living longer, and are much healthier in our sixties and seventies than we used to be. Do you want to either: (a) work until you are in your seventies, or (b) see a return to what it used to be like, when the life expectancy was much lower?

But what is interesting about the pension reform is that it is based on the ideas of nudge economics.

There’s a book called Nudge, written by Richard Thaler and Cass Sunstein – and a very good book it is too.

Economic theory assumes we are rational. Maybe we are all inclined to think of ourselves as rational. Be honest now, when you go about your daily life, do you do the things you do because you are a sensible rational human being, or do you think you are little more than a collection of cells living in a world for which you were clearly not designed? Most of us probably think the former, but the truth is more likely to be the latter.

The book Nudge shows that sometimes we don’t do the things that are in our own interest. So until it was made compulsory to wear seat belts when we were driving, a lot of us didn’t. Or take the ATM. So you put your card in the that hole in the wall, ask for your money. Suppose the money comes out first, then the card. What then? Research shows a lot of people forgot about their card, and wandered off, leaving it behind. Then the banks, aware of the ideas of nudge, reversed the process, now the card comes out first, then the money. It is not often we forget about the cash, and just collect the card then go.

In short, we are nudged into not leaving our cash point card behind; we are nudged into putting a seat belt on when driving, and now we are nudged into saving for our pension.

Expect a lot more nudging to follow over the next few years.

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