Australian Spotlight -- May 2024

Ageing populations can be a real drag. A drag on government finances, debt, and economic growth. Many countries with fast ageing populations look to the future with foreboding. Australia however is doing better than most. Thanks to government foresight in the 1980s, Australia has one of the largest retirement savings pools in the world - currently worth over USD 2.4 trillion.  And with big money comes some big advantages for the Australian economy.

Australia’s strong pension position

In 2023, Australia’s pension funds ranked 5th in the world by overall size and 4th as a percentage of GDP (see table below). These are strong results considering the little battler downunder only has the 12th largest economy and 55th largest population.

Further, when you look under the hood to see how Australia’s pension funds are funded, you can see that Australia stands alone. Nearly all its pension funds are defined contribution (88%) (see RHS of the chart below), which being an accumulation fund makes it generally more financially secure than an employers’ “promised payments” defined benefit scheme.

In addition, Australian pension funds are better primed for growth. Of the 7 largest pension funds, it by far has the highest exposure to equities at 51% (see LHS of the chart below).

It is thus not surprising that Australia’s pension funds were the fastest growing between 2002 and 2022 - more than double the growth of 2nd placed Canada (see chart below).

The economic advantages of Australia’s position

Big pension funds are great for Australian workers when they retire but it is also great for the Australian economy. Let’s explore why below:

1. Less government debt

The relatively large size of Australia’s pension funds and their funding and returns growth means the Australian government has a smaller public-pension burden compared to other countries. This is true now and will be even more so in the future as populations age in Australia and around the developed world. This can be seen in the chart below which shows Australia’s public-pension spending as a percentage of GDP decreasing over time while it steadily increases for the UK and ultimately increases for the US.

Source: Bloomberg

A lower public pension burden is a boon for Australia’s future public debt levels, which like other developed countries will come under increasing pressure from an ageing population and associated social services over the course of this century.

Australia already has a lower public debt to GDP ratio than the US and UK and the difference is projected to grow to 2029 and beyond (see chart below).

Higher public debt means higher interest payments which means governments can spend less on public investments that can help an economy grow. Too much debt can also land an economy into a debt and currency crisis. Wouldn’t you rather be Australia than Argentina?

2. Large pools of savings available for public and other investments

Australia’s pension funds have become big equity investors in Australia and on the world stage. They are large pools of compulsory savings looking for a productive home. They are increasingly investing in private assets which includes real estate, private companies,  and public infrastructure such as toll roads and airports. For example, 30% of Sydney Airport is owned by three Australian pension funds. This means Australia has more funds available to invest in its future capacity and productivity. 

3. Wealthier retirees equals wealthier nation

All else being equal, wealthier retirees spend more than poorer retirees. They may buy a Lexus rather than a Toyota and eat out more than cook at home. At the very least, their grandchildren will spend the extra wealth! This means that the success of Australia’s pension funds should translate into higher economic growth than otherwise would be the case.

How Australia’s retirement system works

Around 88% of Australian pension funds (and rising) are defined contribution funds called “superannuation schemes” or “super” for short. Superannuation is derived from the word “superannuate” which means to retire due to old age or ill health. It also means to declare something obsolete! How rude! The remaining 12% of funds are defined benefit schemes.

The superannuation funds are trust funds managed for the benefit of their members. The largest type of superannuation funds are “industry funds” originally established by trade unions (38.3%). The next largest type is “Self-Managed Super Funds” (29%), followed by retail funds (22.7%), public sector funds (8.1%), and corporate funds (1.8%) - see chart below.

The industry funds have tended to perform better than the other types. Researchers ascribe this to the fact that industry funds are focused on the long-term benefit of their members.

Superannuation is funded by mandatory payments by employers and voluntary payments by employees. Employers must pay 11% of their employees’ gross income into superannuation. This is increasing to 11.5% in July 2024 and 12.5% in July 2025. Employees are incentivised to make their contributions by tax concessions. At retirement, beneficiaries can receive their superannuation assets as a lump sum or as regular payments.

Below superannuation is the Age Pension safety net provided by the government (the public pension). It is provided in part or in full for those who do not earn sufficient income through their superannuation.

How did Australia get here

Getting employers and employees to pay more for their retirement is not easy. Changes to the provision of public pensions can bring people to the streets like few other issues. Even Russians took to the streets in 2018 when President Putin proposed pension reforms.

Australia’s first superannuation schemes began in the 1800s but even up to the 1970s, it was a fringe benefit for a small number of lucky workers.

Australia’s superannuation as we know it today was the result of policy proposals from the 1970s and a pivotal point in Australia’s recent economic history.

The Labor government won the federal election in 1983 as the country was struggling with the ongoing inflationary impacts of the OPEC oil shocks and red-hot wage increases demanded by the strong trade unions.

The new government was able to cut a deal with both the trade unions and employers to stop wages chasing after prices (“The Accords”). Part of the trade off for both employers and the trade unions was the introduction of superannuation as a basic employment condition for workers.

Initially the government could not force employers to pay a set percentage into superannuation but after years of negotiations and arbitration cases, the government introduced the Superannuation Guarantee Scheme in 1992 which mandated that employers pay 3% of gross salary into superannuation. Today it is 11% and will become 12% by 2025.  

Final thoughts

We all want our parents, aunts and uncles to be looked after as they retire. We also have retirement dreams of our own! But for many countries with big public pensions systems and ageing populations, individual retirement dreams are becoming a collective nightmare!

Australia’s system is not perfect, with lower income workers still likely to be falling through to the public pension public safety net. Women who have children and take a career break also suffer. However, Australia is doing much better than most and it will have huge future economic payoffs for its economy. So why wouldn’t you want to retire in the warm weather and beautiful beaches of Australia?