Transform Our Pension Funds Into Sovereign Wealth Funds?
This essay is part of the Prosperity’s Path series. In a time of geopolitical instability and a shifting world order, the challenges facing Canada's economy have only gotten more visible, numerous and intense. This series brings solutions.
When the 2008 financial crisis struck, the Bank of Canada followed other central banks in flooding the economy with money, by slashing interest rates and buying government debt. This juiced the economy with borrowed money. But it did nothing to boost its long-term productivity. This effectively took future income and redistributed it to the present.
When wealth races ahead in this manner, something I call the Icarus effect sets in. Initially, rising wealth raises a country’s growth rate by, among other things, creating a larger pool of capital to support investment. But past a certain threshold, wealth becomes a dead weight.
A greater share of investment tends to go to real estate, which sucks income into paying rents – not just on homes but on commercial real estate as well, which raises fixed costs and so can hurt competitiveness. Money gets sucked into stocks as well, but it tends to steer clear of start-ups and innovators and more toward established, conservative but dividend-paying companies. That slows the rate of new business formation and depresses labour productivity. It also undermines regime stability, as young people, who are disproportionately affected, turn against democratic capitalism.
So, if the problem is that the country has enriched itself by redistributing income from the future to the present, the solution is to reverse some of that, ensuring future generations enjoy the same benefits that today’s receive.
The good thing is that we seem to be going in this direction. The past week Prime Minister Mark Carney announced a sovereign wealth fund to invest in nation-building projects and generate returns, “creating even greater opportunities for future generations.”
On April 27, Prime Minister Mark Carney announced the creation of the Canada Strong Fund, Canada's first sovereign wealth fund.
But Mr. Carney did not go far enough. The fund would have only $25-billion initially. Norway’s sovereign wealth fund, to which Mr. Carney compared Canada’s, has US$1.7-trillion in assets.
There is a next step that governments must take, and that is to expand the mandate of Canada’s pension funds so that they invest more domestically. These funds should effectively become sovereign wealth funds as well.
These institutions manage $2-trillion in assets and have long time horizons. They are big enough, patient enough to make a difference. And they should. Pension funds are, after all, the very embodiment of protecting the future, of deferring income today to spend tomorrow. It’s just that this “future,” and whose future it is, has so far been defined too narrowly.
This idea is admittedly controversial. Two years ago, a group of executives wrote to then-finance minister Chrystia Freeland, calling for the government to “amend the rules governing pension funds to encourage them to invest in Canada.” The initiative stirred considerable pushback, not least from the pension industry itself, which said it would hurt returns. In my own modest contribution to the debate, I doubted the merit of a national-development mandate.
Half of the Canada Pension Plan's holdings are invested in the U.S. economy, an odd mismatch at a time when Canada is trying to lessen its American exposure and fortify its economic sovereignty.
But the world has changed an awful lot since that original debate. After all, Canada did not then face an existential crisis, and the case for a national-development mandate has turned into a national-survival one. Economic sovereignty is what will enable Canada to stand up to a hostile United States, Prime Minister Mark Carney has said. And as former prime minister Stephen Harper said in February, “We must make any sacrifice necessary to preserve the independence and the unity of this blessed land.”
Almost all Canadian pension funds have a purely fiduciary model. Take the biggest of them all, the Canada Pension Plan. As the CPP states, “Our mandate is clear: to invest the assets of the CPP Fund with a view to achieving a maximum rate of return without undue risk of loss.”
But an exception already exists: the Caisse de dépôt et placement du Québec, which has a dual mandate of also contributing to Quebec’s economic development. Notably, this has not proved controversial. Despite the criticism that anything but a purely fiduciary mandate is irresponsible, the Caisse’s returns are in line with other Maple Eight funds. Why not give all funds a similar mandate – and more?
Singapore’s Central Provident Plan provides an illustration of how this can work. Singapore used its pension scheme to accelerate national development by steering toward housing, education and the growth of the local stock market (by allowing members to withdraw some funds to invest in local securities). The results speak for themselves. Measured in per capita income, Singapore was in 1960 poorer than Argentina. Today, it’s richer than Canada.
The specific mechanics might differ greatly – for one, Singaporeans must pay a whopping 20 per cent of their salaries into CPF. But the general idea is worthy of emulation. Canada’s pension system can play a similarly vital role in reallocating resources back into the Canadian economy, steering investment toward emergent businesses with a long-term future and also engaging in a multiyear investment program to build houses, especially at the underserved low end of the market. As happened in Singapore, the reduced cost of housing would free up money for working people, which could then be allocated toward other purposes.
Singapore has seen success using its Central Provident Plan pension scheme to accelerate national development by steering toward housing, education and the growth of the local stock market.
Moreover, while that purely fiduciary requirement has led funds to invest in what they view as stable assets with generous dividends, it has arguably come at the expense not only of the Canadian economy, but of future generations.
For instance, many funds invest heavily in fossil fuels. That neglects the impact carbon emissions will have on future generations and carries an opportunity cost – that money could have gone into other investments. The funds are heavily invested in the U.S. economy – half of CPP’s holdings, for example. That is an odd mismatch at a time when Canada is trying to lessen its American exposure.
An expanded mandate is a way for the funds to fix those issues.
Canada has one of the world’s largest pension funds. As a tool to help steer the country through this moment of difficult transition, and thereby preserve the independence of which Mr. Harper spoke, it could prove extremely potent.
Most Canadian pension funds have a purely fiduciary model, but Quebec’s pension fund manager, the Caisse de dépôt et placement du Québec, has a dual mandate of also contributing to the province’s economic development.
The Caisse’s example notwithstanding, even if an expanded mandate hurts returns, it is a worthy sacrifice. If Canada is to grow its wealth in the long term, and if it’s to build a more dynamic, competitive and diversified economy, over the short term it will need to reduce its wealth. Although wealth is good, since it’s the accumulation of past income surpluses, the problem is that today much of Canada’s wealth is actually the opposite and a drag on growth.
Most importantly, there’s an argument to be made that young people already made their sacrifices for their country and now it’s the turn of their elders.
When the pandemic hit, lockdowns hurt young people’s education, job prospects and mental health, but they were asked to make the sacrifice to protect the vulnerable elderly from COVID-19. They gave a lot. Let them now be assured of a future in a sovereign and prosperous country with the sacrifice that can be made today.
Oh God! I fundamentally disagree with pretty much everything John Rapley states in his comment, so why am I posting it here?
He's not totally out to lunch. La Caisse has a dual mandate and is delivering solid long-term returns, but I loathe the argument that if La Caisse has a dual mandate, every other major Maple Eight pension fund should too.
Total rubbish! CPP Investments has its own mandate and laws that define its objectives and risk-taking.
All of Canada's Maple Eight invest more than enough in Canada and if Carney governments finally privatizes airports and other major assets, they will invest more domestically.
But let's stop pretending Canada's pension funds will "save our economy" by investing more domestically.
There are intelligent arguments to invest more wisely in Canada, and then there are silly ones like this one.
Dual mandates are hard; they require great governance and are fraught with risks, like political interference and corruption.
When things go right, you look like a superstar, but when things turn south, you look like a complete fool.
I've seen plenty of organizations suffer major setbacks investing in Canada. I saw the BDC lose its shirt in venture capital during the 2008 GFC.
Invest more in venture capital, not dividend-paying stocks from stable businesses.
Really? That's what we want our pension funds to do: to invest more in Canadian venture capital?
Not me, I see a recipe for disaster with this strategy.
Invest in large infrastructure projects, fine, but in venture capital, tread extremely carefully.
Why? 99 times out of 100, you're going to lose your shirt.
Notice how Rapley doesn't talk about the insane regulations that have destroyed business formation in Canada.
No, it's the pension funds' fault for not investing more in venture capital.
Give me a break!
What other nonsense? Oh yeah, how dare CPP Investments invest in oil and gas companies and put 50% of its assets in the US?
Well, thank god John Rapley isn't in charge of asset allocation at CPP Investments.
Lastly, he writes:
Most importantly, there’s an argument to be made that young people already made their sacrifices for their country and now it’s the turn of their elders.
Seniors on a fixed income who paid into the CPP all their lives are in no position to make sacrifices, nor should they be asked to.
The job of every pension fund in Canada is to make sure all members -- young and old -- are taken care of when they retire. Full stop.
Dual mandates sound cool but in practice they can be hell, especially if the governance is all wrong and governments continuously interfere in the investment process.
We all deserve better, a lot better, and we need to trust the fiduciaries of our large pension funds.
I don't know where this Canada Strong Fund is headed. As I wrote, I have my doubts but want it to succeed.
I think our government is on the right track if it privatizing airports and other large infrastructure assets.
That all remains to be seen.
But changing the mandate of our large national pension funds to emulate La Caisse or Singapore’s Central Provident Plan?
No thanks, I think we are on the right path and Trump Derangement Syndrome is leading some commentators into recommending the wrong long-term path.
Below, Prime Minister Mark Carney introduced a sovereign wealth fund for Canada to bolster national projects, create jobs and grow taxpayer money — but it's not a sovereign wealth fund in the traditional sense. Andrew Chang explains the stark differences between the Canada Strong Fund and other countries' sovereign wealth funds, and what we know so far about how it will work.
Comments
Post a Comment