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Enrico Letta’s European 401(k) policy is ambitious but necessary | Opinion pieces

Letter from the editor May 2024

This is part of a grand vision to add a fifth element to the internal market – the freedom of research, innovation and education – in addition to the four freedoms of movement of people, goods, services and capital. These have been crucial to the internal market since its creation in the 1980s.

Letta recognizes Europe’s commitment to long-term investments – private savings are leaking to the US because there are opportunities there – and he recognizes the need for a more attractive investment ecosystem in the EU.

His proposal for an EU grant for deep tech to leverage areas such as quantum computing, AI and biotech goes to the heart of Europe’s problem with tech startups. Europe produces many innovative startups, but has no equivalent of the NASDAQ if they want to be listed. Ideas, people and capital migrate to the US. Like many other things in the report, this recommendation is very ambitious.

At the very least, Europe has the advantage of a huge amount of household savings (about 33 trillion euros). But much of this is inefficiently invested in low-interest bank deposits (even though these accounts may now offer decent risk-free returns).

And poor demographics mean Europe’s population is aging rapidly; much of the continent’s vast savings stock may be implicitly earmarked for pensions. Either way, it will likely belong to older and more risk-averse individuals. Many EU countries hardly have a long-term savings culture, with few tax incentives.

The EU has long pondered how to better channel long-term savings into productive investments, spawning vehicles such as the European Long-Term Investment Fund (ELTIF) and the flawed but well-intentioned Pan-European Personal Pension Product (PEPP). Letta now proposes to upgrade the PEPP so that it can act as an auto-enrolment vehicle, and to provide tax benefits to the ELTIF.

Despite a wealth of global experience with auto-enrolment, few EU countries offer it. Poland may have the best EU policy model. It has seen steady growth in its PPK auto-enrollment plans, which reached a new milestone of PLN 25 billion (€5.8 billion) in assets under management last month.

However, the size of Poland’s labor force has provided much of the tailwind for policy, rather than any enthusiasm for long-term savings, and opt-out rates remain high.

Letta’s auto-enrollment policy faces serious headwinds and its 2025 implementation target is far too optimistic.

Decent tax incentives will be needed to make such a policy attractive. And it will not be possible to change European citizens’ risk aversion and preferences for bank deposits or bond funds overnight.

Both the European elections, in which the extreme right could gain ground, and the composition of the new European Commission, could influence the direction of travel. And then comes the consideration of how the Commission would implement such a policy.

If this sees the light of day, significant policy refinement on the ground will be needed to ensure success. These include the precise composition of the standard funds and tax incentives, as well as the rules for early withdrawal of lump sums and the rules surrounding the payout phase. Contribution rates are likely to be controversial and employers will undoubtedly resist mandatory contributions on their part.

Compensation will also spark a lively debate. Policymakers should learn from the PEPP reimbursement cap, which is widely considered too low to make the product commercially viable. But compensation caps should not be set in stone and should be reduced over time as the size of the funds allows.

Letta’s avoidance of the term ‘pensions’ is notable and politically sensible: the proposal focuses on long-term savings rather than pensions, presumably to avoid objections to interference in social policy, which is the prerogative of EU member states.

In reality, Letta’s auto-enrollment idea will need a significant coalition of support and any real political weight before it can possibly get off the ground – let alone 2025. Even if it is implemented, unenthusiastic policymakers in the national capitals bring it to a standstill.

Three other Letta recommendations – harmonizing national interpretations of Solvency II to give insurers greater freedom to invest in productive capital, reforming public-private partnerships and further facilitating bank securitization – are likely to make profits easier deliver.

Liam Kennedy, editor
[email protected]