#270 Inception

UPS vs NPS, Strategic Autonomy from a Cognitive Lens, and Reading Recommendations

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India Policy Watch #1: Back To The Future

Insights on current policy issues in India
— RSJ

We had the old pension scheme (OPS) for government employees. Then, in 2004, we introduced the new pension scheme (NPS). Now, in 2024, we have a newer pension scheme sprung on us out of the blue that goes by the boring name Unified Pension Scheme (UPS). I mean, where has the acronym-spinning machinery of this government gone? The Samyukt Maha-viksit Bharat Vyavastha (Sambhav) was waiting to be taken. Central government employees who are now covered under NPS can continue with it or switch to UPS with a retrospective effect. The only restriction is once an employee has chosen the UPS, it is irreversible. They cannot go back on their choice. From a policy-making evolution perspective, we have moved from a bad scheme (OPS) to an ideal scheme (NPS) to a mediocre one (UPS) over a 20-year period. There are lessons to be learnt here.  

The NPS legislation and implementation had bipartisan support when it was implemented and seemed to have widespread adoption both among government and private sector employees. The total assets under management (AUM) among various pension fund managers (PFMs) who are empanelled by the PFRDA (the sectoral regulator) is about ₹12 lakh crore (trillion) now. This was around ₹3 lakh crore back in 2019. Clearly, more Indians were taking their retirement seriously, and the PFMs were doing a good job in raising awareness and managing the corpus. A strong equity market helped as well. Also, if you compare the returns delivered by these PFMs over the last decade, on average, they have beaten the index and outperformed the EPFO fund that the government manages. So, here was a scheme that had everything going for it - a sound economic logic when it was conceptualised, good performance on an objective set of parameters and strong subscription adoption. 

So, what was the need for a rethink?

We have written about pension schemes and their costs in the context of defence personnel who were exempt from moving to NPS and still get covered under the OPS along with members of the judiciary and legislature. But a short primer about pension schemes might be in order here.

The old pension scheme (OPS) for government employees followed the most rudimentary principles whose origins can be traced back to Bismarck, the progenitor of the idea of pensions, and the development of the German welfare system in the late 19th century. The Government of India Act of 1935 provided for 50 per cent of the last drawn salary of the government employee during active service to be given as a pension after retirement. This is what the OPS remained, broadly speaking, with the additional feature of being adjusted for inflation or “dearness” every six months for the pensioners. There was no separate fund that the government had to build up every year to meet this future liability.

The simple idea was you just debit the exchequer every year with an additional pension that becomes due to the retired employees. It is what is called a “pay as you go” (PAYG) model. By early 2000, it was becoming clear that this model wasn’t sustainable. Retired people were living longer, more people were retiring because of the expansion of state capacity that happened in the 60s and 70s and the inflation was running high. Simple math showed these trends would continue for the next few decades, and things would worsen when the population peaked and started declining. Experiences of other countries and companies (the big American motor companies) also showed an unfunded pension scheme that guaranteed an inflation-adjusted amount for life would bankrupt you. You would have to keep taxing future generations or cutting on investments vital for your economic progress to support a retired class of government employees. The government employees, obviously, never complained. Those who should have complained, like the non-government employees, didn’t comprehend the fiscal burden of such schemes or were yet to be born to know better. The pension outgo as a percentage of net revenue receipts was already around 6 per cent in the early 2000s, and it was clear that unless this model was changed, it would be over 25 per cent in a couple of decades. 

Based on extensive consultations, the new pension scheme (NPS) introduced in 2004 changed the model from a fixed pension scheme to a defined contribution scheme. Employees would contribute 10 per cent of their monthly salary (plus DA), and the government would add another 10 per cent as its contribution (changed to 14 per cent in 2014). This corpus goes to a pension fund run by various Pension Funds Managers (PFMs) that are regulated by the PFRDA. Employees can choose various funds with different exposure levels to debt and equity depending on their risk appetite, and the PFMs will stick to that mandate. The PFRDA also made sure that the guidelines around fund management are quite strict, which allows for very limited degrees of freedom for the fund manager to take risky bets. The fund management guidelines were drawn from global standards on pension fund management in developed markets where protection of the corpus against downside risk is a paramount objective. So, the retirement corpus of an employee builds up passively during their working life with returns that typically beat inflation (and often the index). At the time of retirement, the employee could withdraw 60 per cent of this corpus if they liked to, while the remaining 40 per cent would go into an annuity fund that would deliver a monthly pension to them. Again, the annuity fund guidelines were arrived at with prudence and strict regulatory oversight to minimise downside risks.

As I mentioned, this was as good a policy reform as possible. The future pension payments were funded in the present by the employee and the government; professionals managed the funds in a competitive market where their performance on returns was transparent, and the government wouldn’t have to spend 25 per cent of their net revenue receipts on less than one crore citizens (that’s the total strength of government employees today). The future generations won’t have to pay taxes to fund a retired citizen base. Also, importantly, the government would be freed of this cost, which could enable it to provide social security for workers in the unorganised and farm sectors that account for almost 90 per cent of the labour force.

So, why was the government forced to change a good scheme that seemed to be performing well on almost every metric? Three things seem to have gotten in the way. 

First, in 2004, the emphasis was getting all new entrants into government service to enrol into the NPS. This would mean they had a good 30-35 years of service left to build a corpus and get a good return from the PFM who would have managed the fund across business cycles. This corpus would then get annuitised to a healthy monthly pension when they retired. However, there were others who joined the government services laterally, for instance, teachers and short-commission positions in paramilitary and police. They enrolled into NPS at an older age (say, in their 40s) or they retired early, and it is these cohorts who started experiencing the NPS outcomes in the last 3-4 years. Many of these could only contribute to the NPS fund for about 10-15 years. Not enough time for a build-up of a corpus, especially if they chose a conservative fund management option that could compare with a guaranteed 50 per cent of the last drawn salary that they would have got in OPS. These were the first cohort of people who started complaining about the NPS. This could have been anticipated and a transition pathway from OPS to NPS could have been worked to take care of this cohort. The problem of having this segment unhappy with NPS is this is the first ‘proof of pudding’. When those who are still a decade or more away from retirement see what this first cohort of NPS retirees are getting as pensions, it shakes their conviction in the product regardless of what kind of returns they are sitting on and what the numbers foretell them about their pension.

Second, there is the allure of a ‘guaranteed return’ among risk-averse investors. This is especially true if the true cost of the guarantee is not to be borne by them but by another set of taxpayers in another generation. A ‘guarantee’ given today is better than a higher return which is probabilistic in future, is possibly the mindset of an average government employee in India. Again, this aspect of communication was possibly missed, so the first threat to a good future return meant there was a desire to return to the safety of a guarantee.

Lastly, there is the old policy problem of ‘concentrated benefits - diffused costs’ here. In most large states in India, the wage and pension expense of the government is now over 40 per cent of the net revenue receipts, while the total government employees in the state would be less than 2-3 per cent of the state. This lopsided statistic should have meant anyone protesting in favour of OPS would have faced a strong backlash from the majority that aren’t state government employees. But that’s not how the politics of mobilisation works. The benefits are concentrated among a minority who find it easy to mobilise and act as a pressure group that could influence elections. The costs of returning to OPS are spread over a large population base that cannot be animated to protest against OPS.

Back in 2021, the opposition, led by Congress, wasn’t exactly brimming with ideas on pinning this government down. While clutching at every available straw, it caught on to the rumblings about NPS in Rajasthan and made an issue of it. It found some traction on this, and soon, reversal to OPS became a policy plank for most opposition-run state governments. Despite all the evidence that showed the budgets of these state governments will go haywire in future, they went back to OPS. Post the 2024 verdict and another four state elections around the corner, the Modi government seems to have blinked with the announcement of UPS.

It isn’t exactly going back to OPS, but it is halfway there. The guaranteed pension is back on the table at 50 per cent of the last drawn salary for those who have worked for more than 25 years and a proportionate benefit to those who have worked between 10-25 years. Also, back are inflation indexation, family pension and a minimum pension. What’s left from NPS is the scheme's funding, which will be done on an ongoing basis through monthly contributions from the employee and the government.

How will the numbers work for all the costs of these guarantees? The government has increased its share of contribution to 18.5 per cent in UPS from 14 per cent in NPS. The employee contribution will remain unaltered at 10 per cent. The pension corpus will be divided into two funds—an individual pension fund with a 10 per cent employee contribution and a matching 10 per cent government contribution, and two, a separate pool corpus with the remaining 8.5 per cent government contribution alone.

The way I see it is that the 20 per cent pool will continue to be managed by the PFMs based on the choice of how employees want their funds to be managed. The 8.5 per cent pool looks to me like a ‘contingency fund’ that the government will manage to deliver the ‘guarantee’. That is, if the PFMs don’t deliver on the corpus they manage and the benchmark annuity turns out to be lower than the assured annuity, the government will meet the shortfall from the contingency fund.

I guess the government has done its numbers and, based on actuarial tables and inflation assumptions, concluded that 8.5 per cent will be sufficient to assure the guarantee. The other way to look at this is that the employee under UPS will have 20 per cent of his salary going to a market-linked fund instead of 24 per cent under NPS but will get a guarantee for ‘losing’ this option. The guarantee comes to him from a passive central pool funded by the government contribution of an additional 4.5 per cent (18.5 per cent minus 14 per cent) apart from the 4 per cent that’s left. Any guarantee that’s in the future requires very active management of asset-liability matching mechanism and then hope for all the assumptions like lifespan, total government employees to be hired in future, inflation and equity market performance to go as per plan. These are way too many variables to manage and most guarantees become a burden unless their cost is priced into the product. In UPS, that cost is bundled into citizens' taxes in the future. It is less onerous than reverting to OPS, but it will be onerous nevertheless. The government expects the UPS option will prevent states from going down the OPS route and provide a counter to the opposition promise on reverting to OPS. That check by itself is a significant positive. I guess the government will also gently nudge its employees to choose the NPS option now that they have somewhat blunted the demand for a guaranteed pension through UPS. 

It is one thing for the opposition to set the agenda after being in the political wilderness for years. It is quite another when the agenda is economically unsound and yet the government concedes ground to it. Perhaps the political winds are changing direction faster than we imagine.  

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India Policy Watch #2: Autonomy is Cognitive, not Strategic

Insights on current policy issues in India
— Pranay Kotasthane

The evergreen debate surrounding India’s strategic autonomy came to the fore once again over the past two weeks. On the one hand, a section of the Indian strategic community continues to believe that the regime turnover in Bangladesh was orchestrated by the United States. Meanwhile, on 23rd August, the Indian PM was in Kyiv, offering a prayer in memory of children who were killed in a Russian attack a few months ago. India’s Raksha Mantri met the US Defence Secretary on the same day to discuss defence-tech collaboration.

For those who use strategic autonomy as a code for keeping distance from the West, these events left them dumbfounded.

Just a few days later, speaking at the launch of a new book at the Vivekananda International Foundation, India’s External Affairs Minister was even more categorical, stating that:

“Today the US relationship is, both for strategic purposes and economic purposes, in many ways an invaluable relationship for us. Where the US is concerned, I would accept the history. I mean I’m not in denial… we have had a series of challenges with the United States in the 50s, 60s, 70s, 80s. The challenge for us is when we think of multipolarity and strategic autonomy, because of that history, we posit ourselves against the United States.

Now the reality of the world today is something very different. That if we look where the primary sources of presssure are, they are no longer in the United States. So as the world has changed, our understanding of the US has changed, and by the way, US understanding of us has changed too.

And therefore I would argue, that the US is today indispensable for our multipolarity today. That if we need the decision-making space and freedom, we need the countries in whose interest it is that we have those margins on our side.

And I would also say that the apprehensions are based on history; I don’t dispute the history. But I think when we look at the US, we are looking at convergences. No one sensible in policymaking would say there is full congruence with the United States. US by its very nature and India by its nature will have interests that will diverge. If we understand the expectations from this relationship—it is not about alliance, it is not about congruence—it is about convergence, it is about overlapping interests, it is about working together on issues, and areas, and theatres that suit us. And you can see that. There are regions and issues on which we profoundly agree with the US and clearly on some we don’t, in full public display…

The book says that “we need to accurately guage and leverage the US’ compulsions to seek a better relationship with India”, and this bit I don’t agree with “and wait till the relative power is less tilted in the favour of United States”.

Now I don’t have a problem with the end objective, but I have the problem with the word “wait”. I don’t think in this world, we can cold-start a relationship at some point when it’s convenient for us. We saw the opportunity, and the record of the last twenty years bears out that the choices that were made were the right ones. If you look at our strategic position today, a lot of it is derived from that.” [EAM S Jaishakar]

This statement is perhaps the clearest explanation of India’s stance with respect to the US.

As we have written before, strategic autonomy is analytically a useless concept. Every nation-state tries to be autonomous to the extent that its power allows. Given the uncertainty of the world order, alliances are largely seen as constraints, not enablers; no nation-state wants to be locked in one. Small states like Maldives and Nepal have also tried their hand at strategic autonomy while dealing with bigger powers like India and China. So, it’s only natural that a power like India will also exercise its autonomy. Strategic autonomy is a low bar. In fact, doggedly batting for distancing from the West is itself a violation of India’s strategic autonomy because it reduces our leverage with all sides.

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While autonomy in the strategic sphere seems self-evident, it seems quite underappreciated in the cognitive domain. That’s where I turn to next.

This week, the US presidential election discussed taxes on unrealised capital gains. Ravikiran Rao on X astutely remarked that premature imitation would follow, and Indians would start talking about a similar tax in about six months’ time without considering the vast difference in the two countries’ economic and income-level situations. In other words, regardless of our strategic autonomy, we are cognitively aligned with Americans (with a phase shift). This lack of cognitive autonomy in the Information Age should be our real concern.

Relatedly, Robin Hanson tweeted another study indicating how adolescents' lack of independent thinking plays out. An empirical Psychological Science paper from 2020 investigated how people revise their donation decisions after learning about the donations of others. It found that:

“adolescence is a period of social reorientation, during which social concerns (e.g., to fit in or learn from other people) might crowd out other factors such as monetary concerns.”

In other words, while teenage is generally associated with an urge to “be different”, what really happens is that individuals end up copying behaviours, actions, and lines of thinking. Once again, there is an unseen loss of cognitive autonomy.

Taking this idea one step further, my senior colleague Nitin Pai argues that cognitive autonomy is a basic human right that’s all the more important in the Information Age. He explains:

“The reason social media platforms have so much political power is that can influence what individuals and entire societies believe. More than general artificial intelligence enslaving us, we should be more concerned about some humans using artificial intelligence to accumulate power over others: Power that is undeserved, unaccountable and unchallengeable. So protecting the mind from being influenced without its consent, and without societal safeguards, should be our first step.” [Nitin Pai]

Thus, at a time when nation-states, influencers, activists, and corporations all engage in networked information warfare, protecting what the author Susie Alegre calls the “freedom to think” might be our biggest challenge.

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Thus, I submit that we must also interpret strategic autonomy from a cognitive lens. It specifically means the following:

• A recognition that distancing ourselves from the West for historical reasons can never be the overarching objective. As long as it suits our medium-term interests, cooperation should follow.

• A realisation that there will be compromises. Just because one event makes India concede more to its partner does not mean that its strategic autonomy has declined. As long as this concession can increase power, it ultimately increases India’s “freedom to think and act” independently.

• An appreciation that India should be willing to take up issues that are seen as aligned with the West, even if their politics make them disband their positions. For example, another Trump presidency might well lead the US to decry globalisation, immigration, and climate change mitigation. But as long as these issues are in our interests, India should be willing to champion them. The idea alone matters, not its place of origin.

• An acknowledgement that a one-sided overdependence on any one nation-state in defence, technological, and economic domains means a loss of autonomy.

These interpretations are what the strategic autonomists desire, but they end up taking the easy route of engaging in an anti-West diatribe. This obsession is itself a loss of cognitive autonomy.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Podcast] If you are yet to catch up on the pensions debate, start with this Puliyabaazi from 2021 with Renuka Sane.

   पेंशन के मायने. Why the Fuss over Government Pensions?

2. [Paper] This excellent paper answers the question: “Who lends to the Indian State?”. The mechanism for government borrowing isn’t what you think it is.

3. [Article] China's Indian mango exports are more than India's Indian mango exports.

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