In 1976, management guru Peter Drucker (1909 – 2005) published a thought-provoking “vision for the future” entitled The Unseen Revolution: How Pension Fund Socialism Came to America. [1] In that book he looked at the implications of the then-growing trend for “defined benefit” pension plans owning a greater and greater share of corporate capital, and the social implications for that shift. Well, that didn’t happen. With the term “socialism” back on the ascendant in recent days, this post will look as some of the reasons why this version “petered out.”
Here was how Drucker saw the trend from the point of view of 1976, 42 years ago:
If “socialism” is defined as “ownership of the means of production by the workers”…then the United States is the first truly “Socialist” country.
Through their pension funds, employees of American business today own at least 25 percent of its equity capital, which is more than enough for control…[W]ell before the turn of the century, their holding should exceed around two-thirds of the equity capital…plus a major portion – perhaps 40 percent – of the debt capital.
In his book, Drucker foresaw huge societal changes, mostly good, in “the people,” owning their own employers, their “means of production,” via their pension plans. The major complication he saw was that these funds are managed indirectly through trustees, and that agency relationship would require a major re-think in this new ownership environment in order to best exert corporate control for the benefit of the “owners” of the pension plans.
Where we are now
In 1976, almost all major corporate pension plans were defined benefit plans, that is, retiring employees received a guaranteed annuity at retirement based on years of service and salary, adjusted for survivor options and other factors. Over the preceding decade these investment funds had indeed grown to encompass a big piece of the American equity market, shown in the top light-blue band in the graph below:
As you can see in this graph, defined benefit pension plan holdings grew as a percentage of corporate equity through the Reagan years, but leveled off, and then started to shrink, with greater growth then occurring instead in defined contribution plans, such as 401(k) and 403(b) plans, where the employee’s retirement annuity is a function of individual and employer contributions, plus self-directed, tax-sheltered individual retirement accounts (IRAs). [2]
So at least part of Drucker’s vision came true in terms of total pension-held equity. And note the steady decline of individual, taxable investment accounts as a percentage of total capital, offset by the steady rise of foreign capital going into American markets. Let’s look at some of these factors and why American workers are today even less invested in their own “means of production” than they were in 1976.
Factor #1 – The death of defined benefit pensions
The accounting idea behind defined benefit pensions is that, through “time value of money” mathematics, actuaries could predict how much money a company would have to put away each year to pay out a forecast level of annuities at some point in the future. In the way “time value” math works, a small investment during the inflationary, high bond-yield times of the 1970s would appear to fund most annuity needs 20 or 30 years out into the future.
But when inflation rates dropped, indeed crashed to near-zero after 2008, so did bond yields, and so companies, governments and educational institutions found that their required pension funding obligations had to double, triple, or more just to maintain already-promised future annuities. When employers balked at these high funding levels, aided by new regulator “flexibility” in the accounting rules for these funds, they reduced their contributions, putting sustainable future annuity levels at even deeper risk. And then “baby boomers” started retiring, with early retirements often encouraged to reduce stressed payrolls, and the drain from these funds began in earnest.
As a result, it is hard to find a healthy defined benefit plan pension today. Most employers have capped the plans, forcing employees into defined contribution plans, then they reduced their promised contributions into these plans, putting the onus on individual employees to fund their own retirement. This has been a recipe for disaster, as tens of millions of baby boomers are headed into retirement with very little saved in these plans.
Factor #2 – Top-heavy ownership of retirement plans
Even with the leveling off of defined benefit plans, the chart above does show an increase in total retirement plan investment as a percentage of owned capital. What the chart does not show, however, is that a smaller and smaller subset of Americans own a larger and larger percentage of retirement plan assets. As Patricia Cohen of the New York Times noted recently:
A whopping 84 percent of all stocks owned by Americans belong to the wealthiest 10 percent of households. And that includes everyone’s stakes in pension plans, 401(k)’s and individual retirement accounts, as well as trust funds, mutual funds and college savings programs like 529 plans. [3]
This is a reality that Republican have never figured out (or perhaps figured out too well). When you institute programs like individual retirement savings plans with generous income tax preferences, these are worth much more to the $200,000 per year business executive than to the $40,000 customer service worker. In times of rising income inequality, the bottom 80% of the labor market is poorly-equipped to defer 15% to 25% of their income for retirement, and they get little in tax savings in return. And their employers have been of little help here. [4]
Factor #3 – Passive investment in retirement plans
The first defined benefit pension plans were aggressively “actively managed,” either directly via investment advisers, or using the rising list of actively-managed mutual funds. The rise of the index fund, and consistent poor performance of many actively-managed funds in comparison to computer-managed index funds, moved many hundreds of billions of dollars into an interesting state of “management limbo.”
Managers of large pension funds often took seriously the weight of their investment power and exercised their votes, which was a crucial factor in Peter Drucker’s vision of “pension plan socialism.” In this vision, “enlightened” fund managers, perhaps even elected by the workers, would wield their ownership power in the best interests of their constituents.
That didn’t happen. Except for some university and church pension funds, it is difficult to find fund managers with a clear “pro-worker” bias today, indeed most vote with entrenched management virtually all of the time. And the humans managing the massive computer-traded index funds now making up a huge proportion of retirement funds show no “worker bias” at all.
Factor #4 – The bad Markov chain mathematics
Finally, Peter Drucker was seen as a “guru” in the field of corporate management, but a mathematician he was not. Projecting trends in a changing economy is a dangerous game. In a series of earlier posts, I looked at the math of Markov chains, which are a way for predicting how, for instance, consumers might shift their loyalties from one restaurant to another.
If you think of these different types of investment flows as “changing restaurants,” then you can see how trends always tend to peter out usually well before your hoped-for “control of the restaurant market” comes to fruition. When a good entrenched restaurant faces the marketing challenge of an upstart, it changes its marketing tack as well to create a dynamic market. The same thing has happened in the corporate capital markets.
Private equity, foreign investment, changing economic conditions, and simple trend exhaustion doomed Peter Drucker’s “pension plan socialism” before it got off the ground, especially in the United States. Some of us are able yet to retire on a combination of capped defined benefit pensions, 401(k) accounts and IRAs. But a huge number of people will retire with none of these, and with corporate control even more concentrated and unaccountable than ever before.
Notes:
- Drucker, Peter F. The Unseen Revolution: How Pension Fund Socialism Came to America. Heinemann, 1976, p. 1.
- Bryan, Bob. “Here’s Who Actually Owns the Stock Market.” Business Insider, 25 May 2016.
- Cohen, Patricia. “We All Have a Stake in the Stock Market, Right? Guess Again.” The New York Times, 8 Feb. 2018.
- Back in January I wrote a three-part series on the math of income inequality.