Blog: Economics in Action

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In November 2005, the independent Pensions Commission published its second report, setting out a series of recommendations for reform of the UK pension system. Drawing on recent research from the Centre for Market and Public Organisation (CMPO), University of Bristol, Sarah Smith discusses the Commissions proposals.

What is the pensions crisis all about?

Population ageing has put increasing strain on the UK pension system. Unlike many other OECD countries, there has not been the prospect of rapidly growing state spending on pensions. But past reforms have created their own problems, notably:

· a rise in means-testing (projected to apply to 70% of pensioners by 2050), bringing with it complexity and disincentives to private saving;

· a decline in the value of state pensions relative to earnings, without the anticipated increase in private provision;

· and gaps in state pension coverage, affecting especially women and those with caring responsibilities.

What solutions does the Pensions Commission propose?

In its first report, the Pensions Commission concluded that, with people living longer, there were some hard choices to be made between saving more, paying more in taxes, working longer or facing lower incomes in retirement.

The recommendations, contained in their second report, contain elements of all four. Their proposed solutions are to:

· create a firmer (non-means-tested) base to the pension system, comprising an earnings-indexed and (eventually) universal basic state pension and a flat-rate, contributory state second pension, which will, together, provide a pension of around 30% of average earnings.

· spread the cost of population ageing over future taxpayers and future pensioners by increasing state spending on pensions from 6.2% today to a projected 8.0% in 2050 and raising the state pension age, from 65 in 2020 to 68 by 2050. Effective retirement ages should also rise.

· phase out the earnings-related element of the state system, and in its place, introduce the National Pension Savings Scheme a funded, defined contribution pension into which employees would be automatically enrolled (with an opt-out option) and contribute 8% earnings (employers would be compelled to contribute 3% of this and the government would contribute 1%). Together with the basic and second pension, this would produce a pension of around 45% of average earnings.

Who would be the winners and losers from such reforms?

The overall winners and losers under such a system will depend on who bears the burden of the increase in state spending, but the changes are likely to be of most benefit in retirement to those on medium/high earnings who have some private savings. Their eligibility for means-tested benefits would have been reduced by those savings, but they will receive the full amount of a higher, non means-tested state pension.

Those who are on very low incomes during their working lives are unlikely to get a higher income from the state in retirement, but will see means-tested benefits largely replaced by a flat-rate pension. Given inequalities in life expectancy by social class, they will be harder hit by the increase in the state pension age. The Commission has suggested making generous means-tested benefits available from the current state pension age to ease the burden on this group.

Will the proposed solutions work?

The proposed changes are intended to reduce dependence on means-testing and fill the gaps in pension provision among those with caring responsibilities, increase the proportion of people with an additional, funded pension and achieve a fair and sustainable pension system in the face increasing longevity. But there are still a number of potentially unresolved issues, particularly in relation to future retirement ages.

The system remains complex. The transition arrangements will inevitably be complicated, but, even in the long-run, there will be a two-tier flat-rate pension system, which could have different entitlement criteria, indexation arrangements and starting ages. And while the extent of means-testing will be reduced, it could still apply to up to 40% of the pensioner population by 2050.

Auto-enrolment may fail to achieve its objective of achieving comprehensive coverage of additional pensions. There is a growing body of evidence from the United States and UK showing that companies who introduce auto-enrolment experience significant increases in participation in their pension schemes. The conclusion is that auto-enrolment is an effective mechanism to overcome individual inertia.

But the decision to change is often motivated by employers desire to raise participation, and may be accompanied by other measures, such as increased communication. The effect of government-imposed auto-enrolment could well be a lot smaller, particularly if there is employer resistance. The evidence shows that the employer match should raise participation assuming that employers don’t offer wage compensation in its place although it may reduce individual contributions among those who contribute already.

Raising the state pension age is unlikely to be sufficient (or, indeed, necessary) to raise the effective retirement age. Most people currently stop working before the state pension age and fewer than one in ten men stop working at 65 and draw only a state pension at this age. So changing the state pension age will have a limited, direct effect on retirement.

The high levels of non-employment among those with no qualifications in their 50s, suggests that the real challenge in extending working lives is not to encourage people to work beyond age 65, but to get them to stay employed at least up to age 60. Much of the focus of researchers and policy-makers in the past has been on unemployment among younger workers; what is needed now is greater understanding of the demand for, and productivity of, older workers.

Notes

Pensions Policy in the UK is a commentary piece by Sarah Smith of the Centre for Market and Public Organisation at the University of Bristol.

Related information

You can find other publications by from this research centre, related research and citations from IDEAS and you can search for more Internet resources on the topic of Pensions on SOSIG.

Economics in Action is a collaboration between the Royal Economic Society, the Economics Network of the Higher Education Academy and SOSIG, the Social Science Information Gateway. It forms part of the Why Study Economics initiative.

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Following on from the recent debates about education reform, Simon Burgess, Professor of Economics and Director of the Centre for Market and Public Organisation (CMPO), at the University of Bristol discusses school choice.

What should school reform be for?

· Raising standards is one obvious response. In England, this seems to be a particular problem at the lower end of the achievement scale, with large numbers of people leaving school with no qualifications.

· Another response is that it should be targeted at giving children from poorer families a better deal in the education system.

Either way, the focus of reform should be on lower-achieving pupils.

This is a matter of equal opportunities: policy should aim to reduce the link between a child’s family income and the quality of the school s/he attends. Currently, this link is all too apparent.

Where do disadvantaged children currently go to school?

Our research provides some new evidence on this. We take all state secondary school children in England, and look at children who live somewhere equidistant between a good school and an average or low-scoring school. We find that:

· Taking account of the children’s scores in key stage tests and their gender and ethnicity, children who are eligible for free school meals are around 40% less likely to go to the good school than are their better-off peers.

· So despite being the same distance from both schools and having the same test score history, something in the way the system works is creating a systematic tendency for poorer children to go to the less good school.

· Furthermore, if we look at children who live in essentially the same place (the same postcode) again comparing similar children, those from poorer families go to lower-performing schools.

· Of course, this is all on top of the fact that more affluent children are much more likely to live near good schools in the first place.

This evidence suggests that children from poorer families are not getting a good deal from the English school system.

How should school places be allocated?

Part of the hope for reformed school choice is that it is one way to reduce the importance of income in the allocation of school places. It certainly should produce an outcome less dependent on family circumstances compared with the alternatives:

· Selection: assigning children to schools on the basis of performance in a qualifying test (such as the 11+) opens a large role for a better-off family to pay for tutoring and so on.

· A good local school: a common alternative is neighbourhood schooling, the desired policy for many critics of school choice, where all children simply go to their nearest school. But this policy tends to produce highly segregated communities clustered around good schools, which makes it very difficult for children from poorer families to stand a chance of getting into a good school.

· Banding: this is another popular idea local rules force each school to take a certain fraction from different ability bands. While this may work well in small markets such as London LEAs, in large urban or mixed LEAs, it is likely that a child’s address will continue to play a substantial role in allocating school places.

· Ballots: the most radical policy would be to hold ballots for places in over-subscribed schools. This would obviously ensure that all applicants faced an equal chance of getting a place. The Select Committee recommended that this strategy be investigated.

Can competition raise standards?

Of course, the school choice agenda is broader than this: the central idea is that competitive pressures applied to schools that are vulnerable to losing more mobile pupils will raise standards everywhere.

There is strong evidence that this matters in the United States, but mixed evidence for England. If the reforms do have more effect on low-achieving pupils, then it could be the low-scoring schools that feel vulnerable to this pressure.

A new world of choice or a new kind of choice?

One big misconception in the current debate seems to be that we currently have a system where most children attend their nearest secondary school, and that the proposed reforms will move us into a new world of choice. This is not the case: the current system is largely one of choice, but with two major drawbacks:

· First, the capacity to exercise and implement choice differs between people choice is not available to all.

· Second, popular schools do not have sufficient flexibility to be able to expand. In this case choice reverses, and it is schools that do the choosing.

But school choice is feasible for most secondary school pupils in England, in the straightforward sense that they have more than one school near to where they live. In fact, over 80% have at least three schools within 5 kilometres.

Obviously, this varies over the country. In rural areas, the numbers are lower (but still around 40% have at least three schools within 5 kilometres) and in London, almost all pupils do. Put another way, three quarters of all secondary school pupils have at least three secondary schools within 4 kilometres of their home.

The evidence also suggests that we are a long way from a cosy world where most children attend their local school. In fact, only a half of all secondary school pupils in England attend their nearest school. One in two pupils are not going to their default school so we are already in a world with a lot of choice.

It is important to see that not all of this movement away from the local school is choice in the sense of consumer choice with a desired outcome. The school system has been more-or-less a closed system: roughly speaking, there are as many school places as children and each school can neither expand nor contract very rapidly (though there are excess places in some areas and schools can change size).

A useful analogy for the system is a modified game of musical chairs: there are enough chairs for everyone, but some are more desirable than others. The point is that one person’s choice of chair has implications for the places available to others. Unlike in most situations of consumer choice, choice by one person has spillover effects on others. The issue for reform is how things look when the game finishes which pupils are going to which schools.

What are the effects of our current, pre-reform system of partial choice?

Our research shows that areas of the country with greater school choice are also areas with stronger sorting of pupils. This takes account of the sorting of where people live. So over and above the fact that rich and poor tend to live in different places, we see that unequal choice tends to increase segregation in schools. This is true both in terms of ability sorting, and in terms of not producing an even social mix in schools.

Two things need to change to allow reformed choice to work better for disadvantaged pupils:

· First, much needs to be done to facilitate more active school choice by poorer families. This involves subsidising transport costs over a wider range, and providing informational support for the choices.

· Second, popular schools need greater flexibility to expand.

Will popular schools really expand?

The latter is perhaps the greatest issue. Once a popular school has to ration places, it seems likely that distance from the school will again be used to make the cut. So the aim of de-coupling family background from quality of school attended requires either ballots for places or a capacity and willingness to expand popular schools.

This greater freedom is part of what is embodied in trust status for schools. But the freedoms could also give greater scope for selection by ability, responding to incentives in the school system. This obviously works directly against a better deal for children from poorer families, and the Select Committee’s proposals to strengthen and monitor the code are very important.

But there may be another problem: giving popular schools the freedom to expand does not mean they will do so. To the extent that a school’s position in the league tables depends on the attainment of its intake, schools may be unwilling to increase and potentially to dilute the quality of their student body.

At the root of this is the question what makes a good school good? If it is mostly attributes that can be readily extended (such as leadership and ethos), then increasing entry should not be a major problem; if it is attributes inherent in the intake (such as the ability of peer groups) then this policy is more problematic.

Notes

Making school choice work for disadvantaged children is a commentary piece by Simon Burgess of the Centre for Market and Public Organisation at the University of Bristol.

Related information

You can find other publications by from this research centre, related research and citations from IDEAS and you can search for more Internet resources on the topic of Educational Policy on SOSIG.

Economics in Action is a collaboration between the Royal Economic Society, the Economics Network of the Higher Education Academy and SOSIG, the Social Science Information Gateway. It forms part of the Why Study Economics initiative.