Recently the Government of India announced ‘reforms’ to the Employees’ Provident Fund/ Employees’ Pension Scheme. I do not wish to go to deep into all of the changes but the two parts which have been widely criticized by the public include:
- Under the revised EPF rules, a worker who becomes unemployed cannot claim full final settlement before 12 months of continuous unemployment. Earlier, it was just 2 months.
- For EPS withdrawal, the employee has to wait 3 years for full pension withdrawal.
- 25% of your EPF will be locked up until retirement except under very limited circumstances.1
I mainly wish to discuss the macroeconomic effects of this and what EPF/EPS actually are.
EPF/EPS is a form of forced savings
EPF/EPS is a forced savings scheme, in that it is mandatory savings scheme. It is commonly touted as a retirement savings scheme, which is a bit misleading since the employee can voluntarily save for retirement if they choose. As for employer contribution, they can just pay the amount they put into the scheme as higher salary.
So, EPF/EPS is a forced savings scheme. The EPF/EPS scheme is intended to provide salaried workers a safety net if there is an emergency or retirement savings. While the former is understandable somewhat, I will show later that the latter is kind of silly.
Forced savings at macroeconomic level
I have talked about what EPF/EPS is. Now, let’s talk about forced savings in general. In his 1940 Pamphlet, ‘How to pay for the war’ 2 , J.M. Keynes talks about forced savings as a means to defer consumption. Why? He wrote this during World War II when the U.K. had to fight a war against the Nazis.
A war results in the capitalist economy being supply constrained as near full employment is achieved. This puts upwards pressure on prices (inflation) as capitalists and workers seek to increase their share of the pie. As Keynes mentions, during World War I value of money in the U.K. halved due to inflation and at the end of the war, real purchasing power of workers was 15% lower than at the start. This was because usually wages chase prices during the war as workers, more empowered under full employment can fight for higher wages whenever capitalists raise prices due to increases in costs.
Keynes says that in WWI, the ‘voluntary’ savings by the capitalists arising from inflation transferred £2.5 billion to the capitalist class. Keynesian policies on forced savings, rationing and wage/price controls resulted in WWII resulting in significantly less inflation and empowering the workers. The two decades after WWII is referred to as the golden age of capitalism.
Indian economy is demand constrained
Indian economy is at present demand constrained, there is a large pool of unemployed and underemployed who can be bought into work and existing capacity is underutilized due to a lack of aggregate demand.
Thus, forced savings aggravates the situation at the macro level by taking away even more purchasing power from the hands of the workers. The change in rules thus is a drag on economic growth.
Savings at individual level is virtuous but at the aggregate level it is a leakage that drains aggregate demand. This is known as paradox of thrift. This is why economic policies which stimulate aggregate demand are necessary to ensure output is sold and there is full employment.
However, the ease of withdrawal under the new rules in some cases can increase aggregate demand. It is more likely that on the net, the effect will be negative on aggregate demand.
Government of India is the sovereign and doesn’t need public savings to spend
It must be remembered that the Government of India is the sovereign issuer of the Indian Rupee and thus doesn’t need forced savings to fund its expenditure. I have discussed this in previous blogs such as “Old Pension Scheme is fiscally sustainable, always was, always will be.” and “Why I hate the term ‘taxpayer funds’”.
Government of India doesn’t need its own currency to spend, it spends first and taxes later. Commercial Banks are allowed by the Government to issue widely issued money and leverages state money (reserves at the RBI). The Rupee-denominated debt issued by the Central Government are risk-free and intended to maintain target interest rates, not to ‘borrow’ as the textbooks claim.
Unlike what the mainstream theory suggests, savings in the bank are not invested. Banks lend to whoever they see as creditworthy and profitable while keeping necessary reserves for clearing and legal requirements. It is in fact bank loans that create bank deposits, not the other way around. If you have ever taken a loan from the bank, you will see this, for example, if you take a loan of ₹100,000 from the bank, from bank’s perspective, they create a loan account in your name, this is asset of the bank and your liability. Similarly, your demand deposit is the bank’s liability and your asset. Your bank account is credited by 100k and your loan account is debited by 100k (this is from bank’s perspective, all the SMS and E-Mails you receive are from bank’s perspective). The bank’s net worth increases when you pay interest on loans. That’s their income and a major source of their profits and your loss.
So, you can see that banks don’t lend deposits, they create new accounts and add numbers by typing it in on the computer. When you pay back the entry is reversed and the account is eventually closed.
Where does bank get RBI Liabilities (cash) when you withdraw? The bank simply asks RBI for cash and pledges assets they have, solid ones like Government bonds (known as High Quality Liquid Assets or HQLA), in return they are lent cash (for some assets, there are haircuts). Similar happens when you transfer money from one bank to another, they use the reserve account they have at the RBI instead and everything is done electronically. If reserves are low, the banks go to the interbank market or in the worst case to the RBI who can always lend as the sovereign (lender of last resort).
So, you can see that savings don’t finance lending for commercial banks or the Government.
What about pensions?
As said in my previous3 blog.
“Pensions can be made universal so that private sector workers, too, can benefit. For example, any person who has worked for at least x years could be eligible for y% of their salary, indexed with inflation. Even those who have never worked or cannot work could still receive a smaller universal income for life.”
What about emergencies?
This can be a valid reason to have forced savings since it prevents workers from overspending and allow for the EPF to be used for emergencies. However, the Indian salariat are already deep in private sector debt.
EPF can be kept in place while injecting financial assets into the non-Government sector by the way of Government spending. To prevent financial issues of workers due to unemployment, a Job Guarantee can be instituted so that workers have a fallback job.
Conclusion
EPF/EPS reforms are a drag on growth and reduces liquidity of the workers in an economy characterized by weak aggregate demand.
That’s all.
- https://x.com/PIBFactCheck/status/1978394796889968791 ↩︎
- https://ia801508.us.archive.org/18/items/in.ernet.dli.2015.499597/2015.499597.HOW-TO_text.pdf ↩︎
- https://sidharthpsiva.in/index.php/2024/08/25/old-pension-scheme-is-fiscally-sustainable-always-was-always-will-be/ ↩︎