By Nirvikar Singh
India is set to grow consistently at about 7%, which is enough to double GDP every decade. That is exceptional compared to historical averages, but short of East Asian miracle growth rates. To achieve those growth rates, and meet aspirations of reaching advanced country income levels, India has to grow faster. That, in turn, requires some combination of higher rates of investment and greater growth impacts of investment expenditures. The latter may require more innovation, both technological and institutional, which presents specific challenges. More investment requires more domestic saving, especially in a world where foreign capital is becoming more cautious in its deployment, as evidenced by falling foreign direct investment (FDI) levels.
Thinking about saving, particularly household saving, turns attention to the government’s recently announced plan to reconfigure the National Pension Scheme (NPS). The NPS was formulated over two decades ago, in response to the projected explosion in government pension liabilities, identified in the late 1990s. The Old Pension Scheme (OPS) promised fixed benefits, with no contribution from employees. It was therefore a form of (very generous) deferred compensation, implemented as forced long-term savings for employees, but not reflected in current budgets. Its exemption from taxes amplified its generosity. Households could also save in other ways, mostly through various savings accounts that offered fixed interest rates, where the household saving was invested in government bonds or life insurance policies that promised annuity payments.
The NPS replaced the OPS, making several changes to the design. Employees now had to contribute towards their future benefits, with the government matching these contributions. Thus, a current savings element was made more explicit in the NPS, rather than being notional and not clearly defined. The NPS also expanded the range of options for investing these explicit savings, in an India that now had modern financial asset markets. Most important of all, the NPS shifted from the defined-benefit system of the OPS to a defined-contribution system. This meant that the returns to the contributions were no longer guaranteed, but depended on the performance of the assets in which the contributions were invested.
The NPS was implemented slowly, and in a somewhat piecemeal and incomplete fashion. It dealt with the looming fiscal disaster of the unsustainable OPS, but it also meant that the deferred compensation it offered was less generous and more uncertain, leading to unhappy employees — especially since those hired earlier under the OPS continued to be covered by their more favourable scheme. Recently, some states have bowed to pressure from their employees, and begun reverting to the OPS, which is constitutionally their prerogative but threatens to bring back the threat of fiscal disaster, which would ultimately be the Union government’s responsibility to handle. The Centre has responded with a new Unified Pension Scheme (UPS), which is supposed to exist alongside the NPS. It retains the matching contributions, albeit with a higher government match. But it shifts back to defined benefits, and has generous indexation provisions. These features can also create fiscal problems down the road, if not as severely as the OPS.
Many details of the UPS are unclear, including aspects of its design and implementation. It is clearly a political response to a political problem that emanates from India’s economic structure, where government jobs are valuable because good jobs are scarce, and holders of those jobs have disproportionate power as an interest group, as well as India’s federal structure which is baked into the Constitution. The UPS is clearly a short-term response to an immediate political issue. But this can be an occasion to recall some of the thinking behind the original NPS plan, which was meant to lay the foundations of a pension and savings system that could serve a much larger proportion of the population than the small slice that has government jobs.
Sustainable systems for long-run savings require good options for investing those savings, across a range of assets with different risk-return characteristics, good low-cost options for choosing among institutions and managers who will guide households in their choices, a great deal of education and information transparency to enable households to make choices, and careful regulation for protecting small investors. None of this is easy. Well-off households, whether they are employed by the government, by private corporations, or run their own businesses, already have many more savings options than they did two decades ago. The challenge is to extend these opportunities to a larger proportion of the population, in a manner that keeps their institutional costs and risks down in an appropriate manner. Employer contributions and tax breaks are another component of designing systems that incentivise long-run savings, as well as enabling those savings to be channelled to productive uses.
Ultimately, pensions are just one form of long-run savings, and the real need for government policy is to take a comprehensive look at the institutional landscape for such savings (including financial products such as life insurance), to incentivise them without promoting dissaving elsewhere in the economy, and to channel these savings into growth-enhancing investment, as opposed to going disproportionately into assets such as real estate and gold. It is almost a decade since the report of the committee on household finances, headed by Tarun Ramadorai, which provided a comprehensive analysis of these issues, including pensions, insurance, and financial assets in general. With India’s household savings having declined to a five-year low, returning to this approach ought to be a priority for policymakers.
The author is a professor of economics at the University of California, Santa Cruz.
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