Britain’s trillion pound shortcut to financial repression

The UK has a lot of government debt, the servicing of which very visibly costs money. With the debt-to-GDP up at around 100 per cent, and long gilt yields bobbing around 5 per cent, the fiscal challenge is non-trivial. This has made the Institute for Fiscal Studies sad.

The usefulness of a simple debt-to-GDP ratio is a question for another time, and it’s only fair to note that UK national debt has been far higher than 100 per cent before, yet the world kept spinning. What’s more important for now is that to reduce the debt-to-GDP ratio you need:

👩‍🏫 Your starting debt ratio . . . 
👨‍🏫 multiplied by . . . 
👩‍🏫 real interest rate (r) minus real economic growth (g) . . . 
👨‍🏫 and the result needs to be smaller than . . . 
👩‍🏫 your primary budget surplus.

This is a lot easier to pull off if your starting debt ratio is low (nope), your economic growth rate is high (again, no), or you’re running a big primary surplus (feels like a pattern’s emerging here). Meddling around to artificially depress real interest rates is known as financial repression. This, in large part, is how the national debt was slashed after World War II. The Treasury certainly has a motive to give it a go.

Could financial repression help the Exchequer out this time? Putting aside the not insignificant body of opinion that has been arguing that financial repression has been rampant for the last fifteen years (albeit unsuccessfully, if debt reduction was the goal), the big paper of Jackson Hole reckons this is far from feasible.

Sadly, pensions nerds don’t get invited to fancy central bank retreats. So no-one was there to point out that this (r-g) thing misses the state’s biggest contractual financial liabilities. Whole of Government Accounts show the *really* big contractual financial liabilities don’t sit in the gilt market, but rather with public sector occupational pension schemes. Maybe someone should check on those too? Just a thought.

The latest bean count as to the value of public service pension promises to nurses, teachers, tax inspectors, soldiers and coppers (and their colleagues) was around £2.2tn. The latest bean count as to the value of financial assets backing these promises was around zero/zilch/nada.

With a clear motive to shrink liabilities on the part of the Treasury, could that massive dark blue chunk sitting off-balance sheet be in play?

First up, it’s worth clarifying that the actual amount payable to nurses, teachers etc is somewhat more than £2.2th. That figure is just the present value of those promises, discounted back using a sort of mash-up of corporate bond and inflation-linked gilt yields in March 2021. As a present value, the number jumps around a bit.

Second, while it will take months (if not years) to get the actual figures for 2023, rising bond yields look likely to have wiped maybe north of £1tn from the total public liability, making the UK government maybe the biggest mark-to-market winner of rising bond yields in the world.

Does wiping a cool trillion pounds from the public sector liability count as financial repression? Afraid not. The terminal value of pension promises is reduced in neither nominal nor real terms by rising bond yields, so whilst an impressive reduction in government liabilities, we’re really talking about an accounting impression rather than financial repression. It’s a yields up/prices down thing.

To see whether there is the opportunity for financial repression of the vast off-balance sheet liabilities we’re going to have to dig into . . . 

The SCAPE of the nation

If you’re a normal person with IRL friends and everything, you probably haven’t heard of SCAPE. Here’s the government having a go at explaining it:

To ensure that the public sector provides pension benefits in a sustainable way, it is important that the expected long-term costs of pension promises are recognised and that these are taken into account when promises are being made. This is done at periodic actuarial valuations where employer contribution rates are set. In unfunded public service pension schemes employer contribution rates are determined using a process called ‘Superannuation Contributions Adjusted for Past Experience’ (SCAPE). As part of SCAPE, a discount rate is applied to each scheme’s expected future pension payments, which extend decades into the future, so that the cost of pension promises being built up can be expressed as a present-day cost. This discount rate is called the SCAPE discount rate and is set by HM Treasury using a prescribed methodology.

A couple of important bits of information there to pick out. First, the SCAPE discount rate — in the context of an unfunded scheme — can be thought of as a promised rate of return to members on their contributions. The lower the rate, the lower the effective cost of borrow to the Treasury (that sits behind public service pensions as guarantor).

Crucially, it isn’t the same discount rate used by the Whole of Government Accounts to estimate the present value of liabilities. That would be far too straightforward. Instead, as recommended by Lord Hutton’s Independent Public Service Pensions Commission in 2011, it is the Office of Budget Responsibility’s assessment as to long-term nominal economic growth (parsed into a number that’s CPI + x per cent).

Second, SCAPE is used to establish employer contributions. The lower the rate, the higher the employer contribution.

Think about it like this: if you need to get to a hypothetical 100, a lower notional rate of return on any virtual nuts you squirrel away means you need to squirrel away more virtual nuts to get there. And in this tortured analogy, it’s public sector employers — places like schools, hospitals, local police forces etc — who need to source virtual nuts. Or rather, buy the virtual nuts with actual money.

Anyway, the SCAPE rate matters A LOT to public sector employers. Little wiggles in the SCAPE can throw employer contributions all over the shop. So tweaks to SCAPE can have serious implications for departmental spending.

If this all sounds a bit abstract, let’s look at how this impacts schools. Teachers in the UK are eligible for defined benefit pensions. For every year that they work they accrue a pension worth 1/57ths of their career average earnings.

How much does this cost schools? Schools have to pony up 23.6 per cent of salary, and the teachers themselves chip in a further c.9.6 per cent of salary (which is deducted from their pay cheque). Barnett Waddingham, the actuarial consultant, reckons that a reduction in the SCAPE rate of 0.7 per cent will likely have the effect of increasing employer contributions to teachers’ pensions to well north of 30 per cent of salary. To put this in pounds and pence, such a move could maybe take employer contributions from c.£7bn to c.£10bn next fiscal year.

Where do all these contributions go? In this example it goes to the Teachers’ Pension Scheme. The scheme takes the money and spits it straight out (and more) to retired teachers, tapping HM Treasury for the shortfall. If the government were a private sector firm, they wouldn’t be allowed to do this and would have to back these promises/claims with assets. And for reasons that we don’t quite understand, folks working for local authorities, the Bank of England, as well as Members of Parliament, get asset-backed schemes despite working in the public sector. But government set the rules and the rules say this is all legit. So most public sector workers’ pension schemes are backed only by a promise from HM Treasury (which, tbf, is a pretty great promise)

The chart below shows OBR projections for the largest schemes stretching out to fiscal year 2027/8. Big numbers, but they are still based off the old SCAPE rate. November’s forecast will see employer contributions jump and we reckon this could push public service pensions from being a use of cash to a source of Treasury funding.

Given this set up, is there an opportunity to engage in some financial repression?


Government has been, and continues to be, effectively borrowing vast sums from public sector workers, with the promise to repay them many many years hence at a completely made-up off-market rate designed by boffins sponsored by the Treasury. The scale of these borrowings dwarf the size of the (traditionally recognised) national debt. If this isn’t a prime opportunity for massaging the books we don’t know what is.

Right, so we have a motive (liability reduction), and an opportunity (made-up off-market discount rate). Is there any evidence of financial repression using public sector pensions?

Short answer: no. Long answer: maybe the opposite?

The long answer

For the past decade or so the market rate for inflation-linked term borrowing has been meaningfully negative. Bond market investors were literally paying the government to take their money. But Treasury has been borrowing from public sector workers at the SCAPE rate, which has been very far from negative. Any opportunity to financially repress via public service pension schemes looks to have been squandered (much to the personal benefit of nurses, teachers, soldiers etc).

One reason why this opportunity has been squandered is that the Office for Budget Responsibility – on whose long-run estimates for nominal economic growth the SCAPE rate is attached – really is operationally independent. The OBR has downgraded its long-run outlook a number of times since 2011; each of these downgrades has led to SCAPE discount rate cuts, forcing employers to pay higher contributions for their staff’s pension. Sometimes the Treasury has compensated spending departments for the increased staff costs that SCAPE reductions deliver. Sometimes they haven’t. According to the IFS, that last tweak to SCAPE back in 2018 forced employer contributions higher to the tune of around £6bn per annum

Following the most recent downgrade of the OBR’s long-run estimates for UK growth, the SCAPE discount rate will come down again from April 2024, meaning that employers will have to find huge sums to pay for the higher contributions that result. We reckon the cost could be maybe £12bn.

If this looks a like a forthcoming public sector budget car crash, don’t panic. The Treasury has committed to top up departmental budgets to the tune of the amount needed to make good increased employment costs, where employment costs are centrally funded. All of this ‘new money’ will of course be sucked straight back into Treasury coffers by way of public service pension schemes, so no new actual money. And schemes will be probably thrown into looking cashflow positive.

This is a very long, very technical post. Well done for getting this far. What are the takeaways?

First, public sector workers, past and present, are the Treasury’s biggest creditors, though the value of their claims will likely shrink by a trillion pounds once the bean-counters catch up with higher bond yields. This feels like it should be a big deal, but probably isn’t.

Second, the chancellor is likely to stand up and (credibly) promise an increase in departmental spending to the tune of £60 billion over the next five years. But while departmental spending will increase by this amount, this won’t actually mean any fresh money. So if the chancellor chooses to make out that this increase in spending is a big deal, point and laugh. With the market rate moving rapidly towards the SCAPE rate, it just aligns the cost of pension provision more closely with the market, and in any case leads to no new resources.

Third, the cool kids of Jackson Hole can sleep easy in the knowledge that despite ignoring the elephant on the public sector balance sheet in their analysis of debt sustainability, they haven’t missed a huge back-door that has been actively used for financial repression. If anything, the closer we look, the more convinced we are that the UK government has been engaging in whatever we might call the opposite of financial repression.


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