PFI - pension fund initiative?

Pension Fund Capitalism
June 22, 2001

One of the most lively debates in the City of London over the past few months has surrounded the recommendations in the Myners report on institutional investment, published with chancellor Gordon Brown's 2001 budget. Paul Myners, the head of Gartmore, a major fund management house, was asked to review decision-making by investment managers. He interpreted his brief broadly, though the original stimulus behind the commission was a belief in the Treasury that the largest institutional investors shunned venture capital.

Myners showed that, by comparison with the United States, major institutions invest a relatively small proportion of their portfolios in small firms and venture capital funds, and perhaps - though not certainly - a smaller proportion than might be justified by the observed returns on different classes of investment over time. (Though it is fair to say that there is more institutional venture capital in the United Kingdom than anywhere in continental Europe.) Myners advances a number of behavioural hypotheses as to why this phenomenon is observed. He notes the influence of performance benchmarks and points to the great influence of a small number of investment consultants, who tend to promote normative behaviour in their, largely risk-averse, clients.

Unfortunately, the debate on his stimulating report has tended so far to focus almost exclusively on one recommendation: that the practice of "softing", whereby broking commissions are partly rebated to the client through the provision of research and other services, should be outlawed. This modest proposal has polarised City opinion and has replaced the single currency as the controversy of choice in the watering holes of EC4. To some, this would bring about the end of civilised life; to others, it is a long overdue reform that will bring welcome transparency to the marketplace.

As a result, many of the other useful points made by Myners, especially about the influences on decision-making in large funds, have been obscured. There has been far less debate, for example, about his proposals to ensure the professionalism of pension fund trustees. That is unfortunate, as Myners has a lot to say about the issues (or some of them) that pre-occupy Gordon Clark and his economic geography colleagues at Oxford.

In Pension Fund Capitalism , Clark has bitten off an enormous subject (later I will discuss the extent to which he has chewed and digested it). He begins with some trenchant observations about the influences on publicly funded investment programmes. The argument is neatly summed up in the title of chapter two, "The retreat of the state".

"The postwar consensus that legitimised state intervention in market capitalism is in tatters," he argues. "The state is in retreat on many fronts, from providing the most obvious forms of infrastructure like bridges, roads etc, through to the less obvious forms of urban development, including employment, housing etc." He maps this trend against a second phenomenon, the massive growth of private-sector pension funds, whose "stupendous size and importance" have eclipsed all other forms of private saving, and transformed the nature and structure of global financial markets.

There is no doubt about the two trends he observes. But Clark's explanations will not convince everyone. He places heavy emphasis on what he describes as "the cold-hearted voter problem", which he defines as the tendency for middle-class voters "not to support state expenditures except in areas that directly affect their wellbeing". He points to "the fragmentation of the electorate into rival groups of public good consumers, all of which seek to maximise their share of existing resources, while discounting the claims of those perceived to be net costs to the state".

Clark takes it as axiomatic that there is no discernible difference between the Labour and Conservative parties on the question of the role of the state in the provision of public infrastructure and public services. Indeed, his argument proceeds at a level of lofty abstraction, far above the cut and thrust of political debate. There is but one passing reference to Blair, T., and the designation Brown, G. does not appear in the index. I suspect that voters in the recent general election did perceive some difference of approach between the two parties, and chose the one whose public spending plans are conceived on a grand scale, even though those who voted for them may not be crystal clear on how, and by whom, these plans will in due course be funded.

So the first leg of Clark's argument may not be as robust as he would like to think. And it is worth pointing out that this is a mid-Atlantic view of the world. In Just Capitalism , recently published by Macmillan, Adair Turner has powerfully debunked the view that there is some inevitability about the dominance of an Anglo-American strain of capitalism. He points out that other economies, with almost equally successful records of economic growth, have quite different views on the appropriate size of the state. Looking at the US, the UK, Japan, France and Germany, public spending varies from about 30 per cent to a little over 50 per cent of gross domestic product, without obviously superior results in terms of per capital prosperity at one end of the spectrum or the other.

But it is fair to say that most of Pension Fund Capitalism is about the second leg of the thesis - that the direction of pension fund investment will become increasingly important in determining the nature of economic growth in the US and the UK. To illuminate this, Clark seeks better to understand the nature of decision-making in the major funds, and especially to ascertain how they evaluate investment opportunities outside the two major asset clauses of traded equities and bonds, which continue to dominate pension fund portfolios on both sides of the Atlantic. Is it possible, he asks, that pension funds will take up the slack and compensate for reductions in public funding of economic development, especially in less-favoured areas?

How does he approach this question? Here your lay reviewer must enter a caveat. Any emptor of Clark's book should be aware that he or she crosses a methodological minefield. The introduction makes much of the fact that the analysis is heavily reliant on "the choreography of close dialogue" and that this is a highly controversial technique. I think, though as a layman cannot be sure, that "the choreography of close dialogue" can be roughly translated as "asking people why they behave as they do". In other words, Clark has talked to the fund managers.

It is a little surprising, then, that he has not found out more than he has. He poses a series of interesting questions about the nature of decision-making and the construction of what he calls "alternative investment products". Yet the answers are not as clear as they might be. The British reader, in particular, will find that a great deal of the analysis is built round a small number of case studies drawn from the US. There is an extended discussion of a project in West Virginia, where the state's Investment Management Board was required to invest in bonds issued by the prisons authority. And we hear a lot about Economically Targeted Investments, an initiative promoted by US trade unions, among others, that ran into the sands of Republican Congressional opposition in 1995.

But the private finance initiative, which was promoted by the past two British governments, is relegated to a couple of uninformative footnotes. Any study that purports to examine the scope for private-sector funding of public infrastructure must surely address the PFI, with all its contradictions and complexities, head on.

Perhaps because the initiatives he discusses have so far borne so little fruit, Clark's conclusions are modest and disappointing. He believes that "there are good reasons to support pension fund investment in economic development". But he notes that there is "a basic unresolved issue". Trustees, in Clark's view, have to balance their role as agents of pension plan beneficiaries with their role as what he terms "agents of society". Their disposition of huge investment resources, displacing public investment, ought - he thinks - to make them adopt a broad view of their role in economic and infrastructure development. Yet the regulation of pension funds take little account of this potential broader role.

As a result, he concludes, "the governance of pension funds and the regulation in relation to social interests will be of profound importance over the coming century". If Clark's thesis about the further retreat of the state from financial public infrastructure is correct, he may be right. But if the middle classes are such cold-hearted voters as he asserts, it is hard to see why they should be so much more generous in their role as pension fund beneficiaries. Indeed, there is evidence that voters are just as protective of their pension entitlements as they are of their current incomes.

One final, somewhat disobliging point. Whatever the limitations of this book, the kind of work Clark and his colleagues are undertaking is potentially of interest not just to economic geographers, but also to a wider community in government and in the financial markets. It is a pity, then, that Pension Fund Capitalism is written in a style calculated to repel boarders. Almost every assertion is referenced to a source, sometimes to a laughable degree. The bold observation that "West Virginia is a relatively small and poor state" is referred to CQ's State Fact Finder in the Congressional Quarterly . Similar footling references clog the text throughout.

And the prose style: well, words fail me - as they clearly do Clark. There must, in the bowels of the OUP, be some jargon-buster who could turn this into English comprehensible to a wider audience. If not, perhaps a pension fund could sponsor one, as a contribution to the common weal. This cold-hearted reader would be eternally grateful.

Sir Howard Davies is chairman, Financial Services Authority.

Pension Fund Capitalism

Author - Gordon L. Clark
ISBN - 0 19 924048 5 and 924047 7
Publisher - Oxford University Press
Price - £17.99
Pages - 342

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