The Economics and Politics of the CPF

[What follows is the excerpt of an exchange I had with someone regarding the CPF. My opinions are purely my personal comments and should be read in the light that I do not have empirical data and am only able to speculate about how the CPF is managed.]

Q: Whats your opinion about CPF 2.5 % and 4 % per annum? Are the returns fair for the avg singaporeans? I thought CPF as an institution ($60 bn, correct me if i'm wrong), should have economies of scale when engaging with investment banks and hence better returns if it were to engage with Vanguard or Merrill Lynch.

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I think the real question for CPF should always be about economic/financial viability and nothing to do with politics. Investment is something we can calculate/evaluate that is why i love it, can we evaluate politics?

A:The Ministry of Finance (MoF) manages and controls the CPF. It takes in monies/deposits from Singaporeans on the liabilities side while investing the proceeds on the assets side.

On the assets side, Temasek and GIC, which are owned by the ministry of finance, manage the reserves and investments of the MoF.

Now, the challenge for the ministry of finance is to give Singaporeans a reasonable return on their CPF monies, at the same time guaranteeing that
A. it will be there for their retirement, and also guaranteeing that
B. it will be available for housing and medisave,
as and when it is needed for those purposes.

The crux is, how much return should Singaporeans get on their CPF savings, while still being able to retain benefits (A.) and (B.)

Your contention is that it should be possible for the government to give a higher return than a 4% fixed rate. After all, if you were just managing your own retirement money, you would just put your savings into an index fund and let it sit for 30yrs and you would expect to earn about 9% per annum. So, why can't the government do this, since because of its size it has a large bargaining power and it can rope in world class investment expertise from around the world?

My argument is that, yes, it may be possible for the government to give higher rates, but with several caveats.

a. Size is the enemy of returns. Even the Sage of Omaha, Warren Buffett, has admitted that the mountain of capital he has to deploy eats away at his returns. On an individual's scale, you may be managing your retirement money of $1 million. However, this is a very different problem compared to managing assets of $60b. The MoF/CPF cannot simply stick all its assets into an index fund like you can. We have to note that from the government's point of view it is taking responsibility for the entire country and the problems are quite different on a macro scale rather than the micro scale of the individual.

b. Many Singaporeans intend to use their CPF for housing and Medisave. This adds a liquidity challenge to the investment issue and the government may only be able to deal with this by devoting a significant portion to shorter-term marketable liquid securities which give a much lower return than equities. At the same time, higher returns tend to be made in long term investments such as corporate acquisitions, real estate, and equities which will be much more volatile and illiquid than fixed-income securities. Therefore, in order to provide the liquidity and certainty (benefits A. and B. as discussed above), the Ministry of finance may not be able to devote a large portion of CPF monies into higher yielding investments, therefore the tradeoff is that Singaporeans have to accept lower returns on their CPF monies than if they were managing their retirement themselves.

Since we do not have empirical information about the size of the CPF and the inflows and outflows of CPF monies and the investments of the MoF, we can only speculate whether or not 4% is a reasonable number.

This covers the economics and finance of the CPF issue.

The politics of the CPF, however, is just as important.

Central to the CPF is the idea that Singaporeans should automatically abdicate their rights (and responsibilities) to manage their own retirement money, to the government. This is enshrined in the fact that CPF is compulsory for all Singaporeans.

If Singaporeans accept the compulsory nature of the CPF and take no political action to the contrary, then they have to also accept whatever it is that the government gives them. After all, if you don't want to take responsibility for your own retirement, then you have no say in determining the return on your retirement monies. In other words, if you let the govt manage your money, then you have to accept whatever the govt gives you, 4% or not.

And, if the govt is able to invest the money at 15% (thru its investment arm like Temasek) but it only gives you 4% per annum, it may be earning the spread of 11%. You may be unhappy with the fact that the government is getting in a sense a low interest 'loan' to make its investments, but the fact is that Singaporeans as a whole keep quiet and do nothing to change the status quo.

Now, you might say, many people do not have time to look after their savings investments and are willing to let someone else who knows what they are doing, manage it for them.

How about those who have the time to manage their investments? Perhaps an option is to make the CPF an optional scheme. For those who want to opt into CPF, the government will be responsible. For those who want to opt out, they will have to be responsible for their own retirement. But this is a political issue.

Or perhaps, we could retain the compulsory nature of the CPF, but instead of forcing Singaporeans to contribute 20% of their salaries, they should only be required to contribute less, like maybe 10%. This is a number that is closer to other countries' pension funds, like the Canada Pension Plan. This, again, is a political issue.

We could even ask another question and say, I'm not sure that the CPF is giving me as much money as I should be getting. I think the government should be more transparent about the CPF and the returns it is getting so we can figure out if we deserve more. But transparency is a political issue.

The issue about how much returns can the government give on our CPF monies is a economic issue. But the question, should CPF be compulsory and/or should we have the freedom to manage more of our retirement monies and give less to the CPF, is a political one. The question whether the govt should be transparent with their books, is a political one.

And as long as the politics of the CPF remains as it currently is, there is no point arguing that the government should be giving more than 4%. Because as long as Singaporeans abdicate their rights to manage their own retirement money, the returns on the CPF are not for the people to decide, it is for the government to decide.

I think the real issue ultimately boils down to whether the people want to be spoon fed and let the govt take the responsibility for their retirement, or they want to take responsibility into their own hands. i.e. without solving the political issues of the CPF, it means very little to debate over the economic ones.