James Barty is head of financial policy at Policy Exchange
The furore around Help to Buy is so typically British. We are fixated with the housing market in this country, which is why politicians are so keen to help people onto the housing ladder. This enthusiasm for housing in part stems from our inflationary past, in which rising house prices would convert a small deposit into a much bigger amount of equity by the time the property was sold. For many, that meant their home could be their retirement nest egg. A house that was big enough for the family could be sold once the kids left for a smaller one, with the difference being kept as a supplement to whatever pension they received. This is why older people are so unhappy with the current level of interest rates, as it eats into their income from that nest egg.
If the Bank of England is any good at meeting its inflation mandate, though, it is unlikely that housing will be such a stellar performer in the future. Indeed, the Financial Policy Committee has a specific mandate to rein in Help to Buy if the housing market looks like it is overheating. Yet even if housing is set to perform decently in the short run, any financial adviser worth his salt should tell you that putting the bulk of your investments in one asset is not a particularly good idea. If that one asset goes down, so does most of your wealth with it. And investing in UK property with a 95 per cent mortgage is a big gamble because the investment is leveraged. A 5 per cent fall in the price, and all the equity is wiped out.
In our view, it is much more important that the Government helps people to save than to buy. This is not least because, in economic arithmetic, the national savings of an economy is directly related to the level of investment in an economy. If saving is low then either investment is low or there is a deficit on the trade account. The UK historically has low saving, low investment and a trade deficit. In contrast, countries such as Germany and China have high savings, high investment and a trade surplus. The poor state of UK savings is illustrated by the fact that the average financial savings pot is just £5,000. That saving pot is some 70 per cent higher in Germany, and almost four times higher in China.
Low saving also means potentially larger demands on government as people get older. Public spending on pensions already is set to cost some seven per cent of GDP. Yet That is way short of what people will need to live on in retirement. Indeed, in a document we are shortly to publish on pensions, we calculate that a person on average earnings needs a pension pot of close to £250,000 if they are to meet the government’s targeted retirement income. Everyone who falls short of that targeted retirement income risks being a burden on the state. We simply cannot allow that to happen.
The government’s has rightly responded to this by introducing auto-enrolment in private sector pensions so that everyone has to be offered and enrolled into a pension, with a minimum 8 per cent contribution per annum funded jointly by individuals and companies. Pension saving should be the most attractive way to save because it is the most tax efficient way to save, because the government refunds the tax on your pension contributions. You can save up to £50,000 a year from your gross income (£40,000 from next year). Savings put into a house or even an ISA come out of your net income.
So government should continue to encourage people to save as much as possible into their pensions and, in particular, should explore ways to encourage people to save much more than the minimum. The DWP has talked about an automatic ratcheting up of contributions linked to rises in people’s incomes. We would like to see that implemented.
The same should be said for ISAs. We would like to see the government encourage more use of them and for the assets that could be invested in them to be expanded. At the moment, ISA’s are restricted to listed equities and a variety of funds. The government could and should be much more imaginative.
One area we would like to see included into ISA allowances would be funding for SMEs. We would like to see two markets develop. One would be for banks to sell off SME loans, which individuals could buy as part of a fund. This would allow banks to get these loans off of their balance sheet and enable them to do more new lending. The second would see the development of large equity funds, which people could buy and put into their ISAs. The objective of these funds would be to provide longer term equity capital to SMEs. Being in a fund the risk would be spread over a large number of SMEs.
Both types of investment should offer much higher return than people are currently getting on their cash ISAs and incidentally be much safer than either Peer to Peer lending or crowdfunding, which require exposure to individual companies. And they would also represent ideal investments for the extra money we want to see invested in pension funds. If we really want to rebalance our economy we have to save more, and encourage our SME’s to grow more rapidly. We think that both can be done at the same time.
Policy Exchange will issue a major report on pensions later this year.