In defence of financial coercion

By Edward Hadas
March 26, 2014

Last week the British government gave a new freedom to its citizens, or at least to a relatively privileged group of them. No longer will pensioners with defined contribution retirement plans be forced to invest their accumulated funds in an annuity. The old requirement was a form of financial coercion: government rules which influence behaviour.

For the pensioners in question, the new arrangement may feel like liberation. They will no longer be enslaved to a product which offers meagre yields. For the rest of Britain, though, financial freedom has probably been reduced. All taxpayers will end up paying more for the medical bills of some pensioners, those who would have had an annuity income but who might now be forced to turn to the state if they run out of money when they need expensive care.

The elimination of one sort of coercion for some people brings a new coercion for others. The pattern is typical, and not merely in finance. Freedom is usually tied to constraint. If I am free to play loud music, my neighbour is forced to endure a racket. If I am free to charge as much as I want for a product that is in short supply, the rich are free to buy but poorer people are forced to do without.

In complicated modern economies, this financial coercion is inevitable. Banks and other institutions which collect and disperse money cannot operate well without trusting customers. These intermediaries are so big and distant that customers will not trust them without strong regulatory and legal protection. So the freedom of banks to decide about their capital structures and lending practices is justly restricted for the sake of protecting the value of the funds deposited in the banks. Indeed, more of that sort of financial coercion a few years ago would have saved the global economy a great deal of trouble.

The financial system will always be designed to promote some mix of social goods. In well-organised societies those goods start with prosperity and security. In more corrupt arrangements, the interests of particular groups – bankers, lenders or borrowers – are favoured. In all cases, some activities are well rewarded and others are discouraged or punished. Financial coercions can bring greater freedoms overall or can improve life in some other ways.

The British annuity problem is a reminder that in rich countries savers are currently the most coerced group. Annuities were unattractive because bond yields are held down by central banks. In the UK, insurance regulators add to the pressure by forcing providers to buy long-term government bonds, assets which are supposed to be safe and which definitely have low yields.

Many economists argue that this particular repression has promoted greater goods: faster GDP growth and lower unemployment. Even if the policies are actually working as planned, savers have a right to moan, after being squeezed for most of the last decade.

Not that the coercion of savers is always bad. It is one of the key aspects of Chinese financial policy, which has worked exceptionally well. Capped interest rates, unfair and relatively small equity markets and capital controls punished savers, but their sacrifice helped fund a vast general increase in prosperity. Growth would have been slower if higher interest payments had reduced the amount of money available for investment.

The right policy question about financial coercion is not whether to have any – it will always be there. The right question is which coercions are best right now.

The debate should be guided by a simple principle. Financial coercion, and even some types of financial injustice, should be tolerated for the sake of a more prosperous and just economy. The principle also helps justify some debt forgiveness. While it is generally good to honour debt contracts, it is always better to cancel debts which lead to misery for borrowers or to unmerited and excessive enrichment for lenders.

Right now, saver-punishing interest rates are considered the best way to deal with overly indebted developed economies. The new British annuity rules, which go along with higher yielding “pensioner bonds” from the government, amount to only a tiny step in the opposite direction.

The current arrangement is an uneasy compromise. Both government and private borrowers are expected to make good on their debts, but low interest rates lighten their burden. The chosen mix of coercions has a serious problem: it will reduce the level of debts at a painfully slow pace.

Policymakers have an alternative – cancelling some debts and increasing interest rates. That would change the coercions on savers: from low interest rates for a very long time, to higher rates but losses on the principal of their loans. Such a shift in coercion would probably lead to greater and more evenly distributed prosperity.

7 comments

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Coercion is not intrinsically good, but rather a relative good in comparison to anarchy and destruction. What would be best is that individuals who make up the collective population exercise a presence of mind and strong discipline of behavior that such win/lose coercions by politicians are not needed. Coercions are only good in the same sense that it is good that a soldier who has gangrene amputates a limb. Better yet is to avoid actions which compel the soldier to go to war. When coercion is needed then the society is sick. Tragic that coercions are now the default attempt by governments to ‘restart the economy’ but time and again they lead nowhere as will Britain’s attempt to get pensioners to spend it up (and leave the dying medical bills for the next politician in power). I feel the answer lies in localizing such coercions, to the province, city, suburb levels – when the coercer must live the effect of his own coercions then it no longer a faceless decision, but one from which he (or she) will seek a win/win outcome.

Posted by BidnisMan | Report as abusive

The problem with your final suggestion (debt forgiveness and rate hikes) is the other effects of these (bankruptcy of lenders and stagnation of lending). It is for this reason that it is my belief than any win/lose coercion has such a little net effect on any economy that you need not bother (economically speaking, politically these can be quite beneficial to politicians). Look to history – and you will see many countries who have substantially similar coercions performing at the polar opposites of the success spectrum. My country, for instance, has a financial services and tax system substantially the same as the US, UK and other top tier countries – yet we have less than 10% gdp per capita of these countries, massive unemployment and general infrastructure decay. Why? It is because we don’t have the entrepreneurial mindset of the American, the globalized investment thinking of the British nor the will to learn to engineer like the Japanese. We do, however, spend most of our time arguing about who should benefit in the next governmental coercion intervention.

Posted by BidnisMan | Report as abusive

This new policy will be good for the wealthy and well-informed, a key constituency for the Conservative Party. For the poor, this will mean more of what they suffered in the 1990′s: gigantic scams by large and “respectable” “financial institutions”, like “endowment mortgages” etc.

Posted by matthewslyman | Report as abusive

@BidnesMan,

“My country…has a financial services and tax system substantially the same as the US, UK and other top tier countries – yet we have less than 10% gdp per capita of these countries, massive unemployment and general infrastructure decay. Why? It is because we don’t have the entrepreneurial mindset of the American, the globalized investment thinking of the British nor the will to learn to engineer like the Japanese.”

I would instead suggest that it is because you are part of “Socialist Europe” whose lavish benefits cannot be financially sustained by associated economic activity over time. One way or another the piper must be paid.

Posted by OneOfTheSheep | Report as abusive

Mr. Hadas,

Another duly thought out and well stated piece. Well done!

Posted by OneOfTheSheep | Report as abusive

@OneOfTheSheep

None of “Socialist Europe” countries has per capita gdp as low as 10% of the British one.

Posted by yurakm | Report as abusive

@OneOfTheSheep – I am not in Europe and my country is 100% capitalist. Both capitalism and socialism are just different methods of win/lose. I am on the side of win in my country but it does not mean I don’t look for something better.

Posted by BidnisMan | Report as abusive