Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 9 - Evidence - Afternoon meeting
CALGARY, Wednesday, February 18, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 1:00 p.m. to continue its study of the governance provisions contained in the Canada Pension Plan Investment Board Act (previously Bill C-2).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: I would welcome Professor Tupper to our committee, Perhaps you could proceed with your opening remarks and then we will have some questions. Do you have copies of your opening comments?
Professor Allan Tupper, Department of Political Science, University of Alberta: No, they will be forwarded.
The Chairman: We will make notes as we go along.
Mr. Tupper: Thank you very much for inviting me here today.
I would speak to the sole item in which I am even remotely competent, accountability in governance provisions. I would like to pretend that I can speak to financial matters in the way my colleague can, but I would not fool you for long.
I think the accountability provisions are rooted in very old -- which is not necessarily bad <#0107> and very unimaginative ideas. As well, they are rooted in several questionable premises. I believe there is a need for reform of these accountability provisions, and that, I think, could be done fairly readily. I have some suggestions in that regard.
The ideas about the governance of this body are, essentially, those that have historically governed public corporations: "Crown corporations", as we call them in Canada. The concept is that these ought to be independent bodies, insulated from the forces of democratic politics if they are to do their jobs correctly. These ideas were essentially derived in the United Kingdom at the turn of the century as governments in that country and in others expanded into financial and entrepreneurial functions. The basic logic is that the board will operate at considerable distance from public influence and even control of the government.
The influence which Canadians as citizens can impact on this board is to alter, through their representatives, the legislation and the regulations and, in particular, the appointment procedures in a set of after-the-fact accountability procedures. It is a fairly standard and, to repeat, I think a somewhat unimaginative approach to this. Let me make this point as clearly as possible: I believe the basic premise of it all has to be challenged. The premise is the farther away such a body is from the forces of democratic politics, the better able it is to discharge its responsibilities.
That is the premise that governed the accountability structure for the Alberta Heritage Savings Trust Fund. In outlining the contents of that legislation, former premier Peter Lougheed made it very clear that he believed that the greater the degree of public discussion of that trust fund's investments, the poorer would be the rate of return. I am not sure that is necessarily the case. Not only do we have the Alberta experience with the trust fund and the management of such funds within the public sector, we also have the more compelling case of Quebec and the Caisse de dépôt.
I will comment briefly on the legislation. The framework for control allows for the possibility of debate in the appointment procedures for the directors. Since you are obviously aware of those procedures, I will not repeat them.
In no particular order of importance, I would make the following points about the directors and how they are appointed. According to your terms of reference, this is a concern of the committee.
It is not clear to me at all in this case why regional representation is of particular importance in the structure of this board. You might find that curious coming from a student of Canadian politics. I would point out that "region" and "province" are no longer synonymous. In fact that is always a bone of contention with the province you will visit next. I do not understand the assumption that is being made. Is it that the investment philosophies of Canadians vary significantly by region? I am also not sure whether the regional representation dimension of this is completely incongruent with the statutory obligation to consult the provinces.
I have no greater wisdom than anybody else as to why this "magic number" was chosen for the term of appointment. I would suggest, instead of three years renewable, a term of six years non-renewable. With such security of tenure a person would have an opportunity to get his or her feet wet. However, the term is not so long that a member would become stale or that there would be the perception that the body is becoming an oligarchy of some sort.
There is also, in the appointment procedures, an advisory committee which, as I understand it from my reading of the text, is to be federal and provincial in composition. I do not understand the logic of that. I would not know why a federal-provincial makeup should, necessarily, be the driving force. Obviously in this case, we would want Canadians from all parts of the country, but I would expand that section to read, "distinguished Canadians from all walks of life should be considered for appointment to the board." I do not see any reason why the terminology could not be broadened. If you broaden those criteria, it would preclude the inevitable intergovernmental tensions regarding the appointment process.
Although this would be unusual in federal appointments, I would suggest that it would be good to have the potential candidates' names, with their consent, made public at some point prior to appointment. However, that would be at variance with many other appointment procedures and would constitute, obviously, a fairly substantial change.
The legislation provides that the board must comprise enough directors, I take it, of proven financial ability. How such an ability is manifest and who makes that determination is unclear. I am uncertain as to the precise criteria. Financial acumen is only one form of experience. Perhaps that section could be expanded to broaden the range of skills and experience that might be brought to bear. I do not think it would take tremendous imagination to do so.
Being naive about matters concerning large amounts of money, I would assume that a person's proven financial experience would imply that he or she is involved in, or has been quite recently involved in, substantial financial dealings. However, I suppose the greater that involvement, the greater the potential for conflict of interests. I am not sure how that would be managed at all, but if the notion is related to recent experience in these matters, that might pose problems.
The last point is one that worries me the least, but I believe it worries my colleague a lot, and that is the question of partisanship. As a political scientist, I do not know what else can be said about that. It is not a concept that terrorizes me or causes me to lose sleep. The concern over excessive partisanship arises when there is no sense of merit at all in the appointment. If people get overly panicky about this and start precluding anyone who has ever been active in a political party, I think that would be ridiculous. You have to bear in mind the normal safeguards of a democratic society as they relate to patronage and excessive partisanship. There must be a mechanism for broad and informed public debate, such that the person's life qualifications would be measured against the qualifications required for membership on the board. I do not know what else to say about that.
With regard to public accountability and governance, the act provides a set of after-the-fact accountabilities, and they are exclusively after the fact. I believe it goes too far in limiting the accountability mechanisms, and that they need to be broadened. There is a need, in other words, for greater involvement by the Parliament of Canada in the scrutiny of the investment board, given the amount of money involved and the importance of its activities to Canadians.
This board is rooted, as I said, in the classic assumption that: the farther away from democratic politics, the better. I am not sure that is right. I see no reason why the board's report should not be referred to Parliament. It surprised me considerably to note that the report would not go to Parliament for discussion. I would presume that an annual report would go along with the normal public hearings of the board members and senior management of the investment board.
The Chairman: It is our understanding that the annual report is tabled by the government.
Mr. Tupper: I missed that in the legislation. Do you know which section that is?
The Chairman: No, but we have been told that by officials, and I believe that to be correct. Please continue.
Mr. Tupper: I believe it is section 51. My apologies. I see that there is provision for a mandatory three-year review. That responds to my concerns.
The Alberta Heritage Trust Fund is reviewed annually by a select committee of the legislature. That has been successful in debating some of the purposes and successes of that fund.
I believe there should be more emphasis in the act on ensuring that all possible mechanisms are explored by the board for communicating to the public at large by way of the Internet and all the mechanisms of modern electronic democracy to ensure that the information is as widely distributed as possible. As well, it should be written in as clear a set of terms as possible, particularly the information that the legislation stipulates concerning the financial criteria.
To sum up: I think it important that the governance procedures be aired more broadly. As presently constituted, I believe the act is too restrictive regarding public input and discussion. It is very important that the experience of the act be probed fairly regularly by Parliament. Much of the wind has been taken out of my sails with the knowledge that an annual report will be placed before Parliament.
Professor Randal Morck, Faculty of Business, University of Alberta: Thank you very much for inviting me to make this presentation before you.
I think some basic flaws have crept into the legislation which was introduced by the House of Commons, and that there is a real opportunity here for the Senate to deal with that.
I have some experience of dealing with corporate pension plans. I would like to outline what sorts of problems corporate pension plans have run into in the way they are administered and in the way their boards of trustees operate. I will then compare that with the situation regarding public sector pension funds.
Originally, corporate pension plans were pay-as-you-go plans like the Canada Pension Plan. However, a problem would arise when a company declared bankruptcy and nobody would pay the retirees. Governments in various western countries began legislating the requirement of corporations which set up pension funds to estimate their future liabilities, and to ensure that there were adequate assets in those funds to cover the liabilities. This was not done for public sector pension plans because governments were not supposed to be able to declare bankruptcy, and so it did not seem necessary.
The CPP is not bankrupt. It could be retained intact in several ways. However, it has two major problems. One is related to demography. The mere presence of a pension plan like the CPP encourages people to have fewer children. There seems to be some economic evidence to that effect. When different countries put uniform pension coverage into place, we find that birth rates drop shortly afterwards. Maybe it is a coincidence.
The second problem relates to communication with older people. My member of Parliament has to attend political meetings in his riding, and they are usually widely attended by old people who are cranky, ask questions, and have lots of time to write letters. Given those sorts of meetings, I can understand why politicians, over the years, have tended to be very generous in the sorts of funding that they give to senior citizens relative to the amount of money that is available from the taxes that working people pay.
The CPP could be retained intact in three ways. One way would involve a major tax hike. That, I think, is out of the question. Another way would be to adopt a policy that is being considered in some countries.That policy is to use immigration policy to adjust the demographics, that is, you bring in lots of 20-year-olds, and then the pension plan keeps working the way it always did. A third way -- and it is being discussed in Germany with amazing seriousness -- is the idea on having a tax on couples who do not have babies on the grounds that it is their fault the pension plan is in trouble and so they should have to pay for it. I do not think any of those measures would be appropriate for Canada, but I do think there are some legitimate reasons for changing to a funded system.
The first is we want to avoid tax increases. The second is a funded system does create a big pool of capital, and that makes money available to corporations for investment. The third is that it keeps politicians, who are inspired by these political meetings to be generous to senior citizens, at arm's length, and I politely disagree with my colleague about the importance of that.
When corporations switched from unfunded plans to funded plans, they initially all switched to defined benefit plans, that is, a plan where the corporation puts together a pool of assets and then promises the employees a fixed amount of money every year when they retire that depends on the final year's salary and the number of years into which the employee contributed to the fund. The big advantage of doing that was employees felt it was safe. That is: "I know that when I retire I will have a pension that is equal to X times my final year's salary plus Y times the number of years I have contributed to the fund and I can figure out what that number is and I know it."
The disadvantage to defined benefit plans in the corporate sector was that they ran into huge corporate governance problems. First of all, pension fund professionals love defined benefit plans because there is very little accountability and there is a huge opportunity for favour trading. For instance, in corporate studies we found that, if a corporation performs badly and the managers get into trouble at a shareholders' meeting, the pension funds of other corporations would support the management of that firm and avoid the situation of them being ousted by the shareholders. In return, the management of that firm will tell their pension fund to support the managers of the other firm. There is a kind of favour trading. There is evidence that this has happened.
The second problem is that the apparent safety of a defined benefit plan is not real. Every time there is a union-management negotiation, the benefit structure can be revisited.This also happens in the public sector. I am a member of the faculty advisory committee for our University of Alberta faculty pension plan, and when we had a funding short fall, the pension benefits were simply reduced to match the amount of money that was available. It is not really clear that this defined benefit system gives you a great deal of safety.
The third governance problem with defined benefit plans is that it allows for wealth transfers from politically weak constituencies to politically powerful ones. We have seen, in corporations, that younger workers pay in more than they get out, that there can be skews in terms of wealth transfers from men to women or women to men, depending on how the benefits are set up. That is one set of problems.
The second set of problems stems from the first, and that is, when we looked at how corporate pension plans performed -- that is, you compare their performance to other investment funds such as the SNP 500 index or the TSE 300 -- we found that corporate pension funds perform abominably. In general, over time, they have gotten very low returns relative to randomly chosen portfolios. The governance problem is important because it has real monetary consequences in terms of the pension plans not generating the returns they should generate.
Why do defined benefit private sector plans perform so badly? Some colleagues of mine, Andrei Shleifer at Harvard and Rob Vishny at the University of Chicago, with whom I have done some papers on this topic, looked at how a pension fund manager is re-appointed. As it works now, the trustee decides to allocate a certain amount of money to various pension fund managers. A couple of years later, the performance of the pension fund managers is reviewed and a decision is made whether to reappoint or not. They found that trustees want good excuses, not good performance. If the pension fund manager has not performed well, but can come up with an excuse as to why that happened and explain why it will not happen again, he will probably be re-appointed. That gives rise to some window dressing of pension funds. We have found strong statistical evidence that this is pervasive. What happens is, if a pension fund is doing really poorly for the quarter before the report is made to the trustees, the pension fund managers will quickly sell all of the stocks whose value has declined and buy a bunch of stocks whose value has increased. For example, they might sell Bethlehem steel stocks and buy Netscape stocks and say, "Well, we were loaded up with Netscape in our portfolio, so we got that right, it is just that some of our other stocks did not do quite as well." Of course, the stocks that declined in performance are out of the picture, so they do not show up in the report. The pension fund manager is buying high and selling low.
The second major problem relates to how pension fund managers are paid. They are paid a percentage of the assets under management. That means they are not very concerned about how the assets perform because they will still receive one per cent of $76 billion, or whatever it is you are giving to these managers, which is a lot of money. Just before his arrest, Mike Milken was about set up a fund where he would get a percentage of the income the fund generated rather than a percentage of the assets. That generated a fire storm of controversy in the managed investment fund business. People were absolutely shocked that anybody would think of doing such a thing. Fortunately, he went to jail before he had time to put it into practise.
Of course, there is also the issue of who owns any surplus. Suppose the pension fund assets do better than expected and there ends up being more money in the pension fund than expected.
The Chairman: That is not a concern in the case of the CPP yet.
Mr. Morck: Not yet.
That raises the question: Does the government keep the money, or does it belong to the people who paid it in and should their benefits be increased? That is something corporations have had to deal with. It has been very controversial.
The other problem in corporate pension plans relates to the fact that the actuarial assumptions that are made to determine what it means for the plan to be funded can be easily "twiddled". I am reminded of the joke about asking a physicist: "What is two plus two?" and he will say, "four"; but if you ask an accountant: "What is two plus two?" he will say, "What do you want it to be?" You choose what you think the rate of wage increase will be for your beneficiaries. You choose the discount rate. You choose your assumptions about mortality, morbidity. You can make the number be almost anything you want it to be. Corporations in the U.S. have gone under and, although it looked as if their pension plans were funded, when we looked at the actual obligations that the pension funds had, we found they were not funded at all. That is another problem with defined benefit private sector pension plans.
Moving to the public sector, there has been one very influential study of public sector pension plans in the U.S., which was done by Roberta Romano, a law professor at Yale Law School and probably the leading expert on public sector pension plans in the United States.
She looked at public sector defined benefit pension plans to assess whether they underperformed in the market in the same way that private sector defined benefit pension plans did. She found a rather surprising result: that public sector pension plans underperformed private sector pension plans which underperformed randomly chosen portfolios of stock. She started to ask why public sector defined benefit pension plans do even worse than the already abysmal performance of private sector defined benefit pension plans. She began to look at which plans performed the worst, and which plans did less badly. She found that the plans that did the worst were those that were either required or encouraged to invest in local initiative projects. For example, I might say, "I would really like the CPP to invest in this meat packing plant in my riding in Northern Saskatchewan. I am sure it will be a great investment, and it will create jobs". You must understand that I have to be politically careful here.
Senator Tkachuk: We have one of those in Saskatoon as well.
Mr. Morck: My colleague mentioned the Heritage Fund. If you want to buy some gravel roads in Northern Alberta, I believe we have a fund that could sell them to you.
Senator Kenny: I thought it was sand for golf course traps?
Mr. Morck: I think there is some of that too.
There are additional problems with defined benefit plans, one of them being related to the appointment of the boards of directors. Often these are people who view their appointments, primarily, as patronage positions. I have talked to people who are on the board of trustees for the Heritage Fund, people who work for the teachers' pension fund, and to people who work for private sector pension funds in the United States, and I was amazed to learn about the gifts they get from potential pension fund managers. Pension fund managers may take trustees of pension funds out to dinner at the most expensive restaurants thinking that, if they spend a couple of hundred dollars on a nice meal, they will get a contract to manage a billion dollars and be able to deduct their fee of one per cent from it every year. From that point of view, it looks like a pretty good deal for them. They might even offer them free vacations, or the sorts of things drug companies give physicians. That sort of inducement tends to skew decisions in such a way that they may be suboptimal.
In the private sector, corporate pension plans, one after another, have been moving to a third formula by which pension plans can be structured, and that is something called a "defined contribution plan". In a defined contribution plan, every beneficiary has his or her own account. The money that is put into that account by the firm is owned by the individual. That person can, in some cases, decide between two or three different fund managers that are approved by the pension fund to manage that money. In some cases, it is left wide open. The person can ask any of a list of several hundred managers to manage the fund, but basically the decisions are taken away from the trustees and given to the beneficiaries.
The advantage of this is that there is a clear, direct ownership of assets by each beneficiary, and if the investment earned a return of minus three per cent last year when the market went up ten percent, then the beneficiary can demand answers. The beneficiaries hire and fire managers themselves by moving out of a badly performing fund into a well performing fund. Poor performance is visible immediately and the trustees have only an oversight view. It is not a difficult job, but it is also not a powerful job, and the temptation for patronage and other problems is removed. The disadvantage of this is that it appears less safe because the beneficiaries cannot count on receiving a certain amount per year at retirement. That will depend on the growth of the plan.
One way that has been proposed for remedying this by Jim Paturba, who is a professor of economics at MIT, is that the provincial governments or the federal government could make a new form of investment available. That would be a traded annuity. For instance, I would pay $10,000 today, and for that, I would get an investment that would pay me nothing until I retire, but after I retire, it would pay me $150 a month. If I decided that I needed to have $900 a month guaranteed or $1,800 a month guaranteed, then I know how many of those annuities I have to buy. I can buy them from the Alberta government or the Bank of Nova Scotia or whoever chooses to issue them, and they will be priced the way bonds, stocks or any other financial instrument is priced.
We have the CPP proposed reform which has raised certain governance problems. How do you get around that and improve the governance of the CPP within the framework that has been set up? Option one, I think, is to have constitutionally independent trustees. That deals with the issue of distancing people from government. The problem is I do not believe that is possible. The trustees will be appointed by government no matter what and, therefore, will be reflecting political considerations. To some extent, I agree with my colleague that it is better to have that out in the open than it is to have it appearing as if it is at arm's length when it is not.
A second option is to assign trustees a very strong and powerful fiduciary duty to act for beneficiaries, along the lines that we already have for private sector defined benefit pension plans. The problem is that works poorly in the private sector. We know these plans perform very poorly despite the very strong fiduciary duties that are assigned to their managers. We can do it, but I am not optimistic that it would work well.
A third option that is sometimes proposed is to mandate passive investment, indexing. One problem with this is that it is opposed vehemently by investment professionals, partly for selfish reasons and partly for genuine reasons. The selfish reasons are that, once you have passive investments, there is very little for managers to do, and consequently it is difficult for them to justify receiving two per cent or one per cent of a billion dollars every year for putting stocks in the TSE 300. The more genuine reason is that a passive portfolio should include things like venture capital investments and real estate, and those are areas where there is still discretion. My passive portfolio should be 20 per cent real estate, but what real estate do I buy? I still have opportunities to buy that meat packing plant in Saskatoon that you were worried about. It is not really clear that this removes political pressure.
Another problem is that we have found the prices of stocks do jump when they are included in indexes. They suddenly become something that these people who are forced to index can buy. It will create political pressures in terms of who is in the index and who is not. Suddenly it is worth a lot of money for me if I can get my firm included in the TSE 300 index.
Senator Kelleher: Ask Bre-X.
Mr. Morck: Options one, two and three create problems.
The fourth option that has been tried in corporate plans is to set up detailed investment rules. The pension fund cannot invest in derivatives. It can only invest in bonds that have triple B ratings or better. There could be a maze of these detailed rules. The problem with that is that the rules quickly go out of date. Some junk bonds have turned out to be very good investments. Derivatives can reduce risk, not increase it, if you use them properly. It is not really clear that that is a good way to go either.
My fifth option is that the CPP should try to be as much like a defined contribution plan as possible, so that beneficiaries can identify their money and watch it. There are several ways this could be accomplished. The first is that, from the outset, there should be individual accounts. Each beneficiary should be able to point to a little pile of money and say, "That is my money, and sure you can lump it all together and have it in a big fund that is managed and so on, but I know that is my money and I know how much my money has earned."
The second way is that you might allow competition between different pools of money and allow investors to decide in which pool they want their money to be. One pool could be run by the government. Another could be let out to private investors. Yet another pool could be indexed. Let investors move their money from one to another. You can set up competition within the Canada Pension Plan in that way.
Third, governments and private firms as well could offer the sorts of annuities that I have talked about where you pay X dollars now and in return you get Y dollars per year from the time you retire until the time you die. That would allow people to trade away the risk that their portfolios might not do very well. They could buy guaranteed monthly payments for their retirement, and they would know how much they would have to pay for them.
Fourth, defined contribution plans for public sector pension funds have gotten a slightly bad reputation from association with some countries that have radically switched to them. For instance, Chile switched instantly from an unfunded plan to a defined contribution plan. If we considered doing that in Canada, it would skyrocket the federal debt and do all sorts of terrible things. An instantaneous switch would be unwise. However, I think Canada could make a gradual switch. People who have spent all of their lives with the current system should get what the current system promises. People who are just entering the system now could pay into a defined contribution plan of the sort that I have outlined. People who are part way through the system could get part of their retirement benefits from the old system according to a graduated formula based on how much they contributed over how many years and part of their benefits from the new system based on what they contribute from now forward.
That, to me, seems like the best way to put the CPP on a long-term, sound footing.
The Chairman: I have one question on your last point. I do not see how that would deal with the financial problem. Let me explain why. Essentially, what you are saying is you pick some day, say tomorrow, and any future benefits that are accrued will come out of a defined benefit contribution plan and contributions made after tomorrow will be held in the name of an individual. What I think you are missing in your proposal is consideration of the rest of the group. The rest of the group have not had contributions made in their name. Those pensions have to be met, and a significant portion of the 9.9 per cent contribution rate, in fact, is going toward paying benefits to other people. To make your system work, of the 9.9 per cent, 7.2 per cent would have to go to older people, and the remaining 2.7 per cent would have to go to your defined contribution plan. Most of what you contribute today will not go to you, even under the best of circumstances. It is just the mathematics of the current problem.
Mr. Morck: The current problem exists partly because of the way it is framed. For instance, nobody mentions that the Canadian Armed Forces has a huge unfunded liability but, nonetheless, the Canadian government has a whole series of payments that we know will have to be made to military bases, to soldiers, and so on in the future. We calculate the present value of that. Nobody has talked about the issue of setting up a fund to finance the army, so we do not worry about it.
I think the problem is that the Canadian government, in setting up the CPP, was basically taking a payroll tax, using it to fund a benefit, and trying to describe it as a pool of money when it was not a pool of money.
The Chairman: As did every other democracy. They all had the same problem.
Mr. Morck: I agree.You have these existing obligations, and I think that the way to meet them is to recognize that they are obligations of the government, not of the Canada Pension Plan system. The government has various ways of raising money, some of which are more fair, some of which are less fair.
The Chairman: Do we agree "fair" is a subjective word and a very value-laden word?
Mr. Morck: Yes, we do. One of the most regressive ways of raising money is a payroll tax. It is also one of the most economically destructive ways, because it discourages work. You are proposing that we use a payroll tax to raise money for the government to cover these liabilities, rather than an income tax, a GST, a consumption tax, or whatever. It is not clear to me that it really makes sense to insist on maintaining this connection, which never really was there in a real economic sense.
The Chairman: Your comments have moved us off into another area.
Mr. Morck: I understand that.
Senator Meighen: Our witnesses before lunch wondered whether confusion had grown up because of the way the legislation is drafted -- confusion between this investment board and perhaps what is more properly termed a "board of trustees". They said that there did not seem to be much concentration on the liability, which is something you are saying, and that there is lots about management in that sense. Where is the knowledge about the liability that the management of assets is supposed to meet? There should be some standard for this investment board. Do you have any comments on that?
Mr. Morck: There is a huge amount of flexibility in this. In one study we looked at the accounting assumptions made by different corporations, and we found that the assumptions were skewed to make the pension liability look big for corporations that had lots of revenue that they wanted to stuff into tax-free pension funds. We found that the assumptions were skewed to make the liabilities look small for companies that had fiscal problems. I think we can expect the same thing to happen with the government. The assumptions will probably be twisted in such a way to make the liability look as small as possible during a time when the government has a fiscal stringency situation.
Senator Meighen: If the liability is relatively small then, obviously, that would influence the assets?
Mr. Morck: Right. It means you do not have to put as many assets into the fund, but if you calculate the liability a different way, you need more.
Senator Meighen: Would it also mean you do not have to worry as much about growth because you do not have to produce?
Mr. Morck: That opens the possibility of that meat packing plant again.
Mr. Tupper: What is the problem with that meat packing plant? I want to come back to that.
Senator Meighen: In the first three years, it is supposed to just roll over provincial bonds. That will not get us very far. Presumably, if the mix does not include a meat packing plant, it will have to include something that has the opportunity for substantial growth and that is determined by what liabilities you are trying to meet.
Mr. Morck: That is absolutely true. You clearly need to have public oversight of what assumptions are being made. They should also be made public so that accountants can pour through them and decide whether or not they are being fudged in one way or another. I think transparency is the best way to deal with that.
I would like to return to the Chairman's question about how you deal with the existing deficit. If you insist on dealing with the existing deficit to the Canada Pension Plan out of the Canada Pension Plan, you would have to slow the transition to a defined contribution plan. Over the transition period of, say, 20 years, you would slowly switch people into the defined contribution plan from the defined benefit plan. In that way, you could tax the contributors over the next 20 years to slowly pay off the additional money you would need. You certainly could do it that way. It is not the most economically sensible way or the least economically damaging way, but it could be done.
Senator Meighen: There is no hidden agenda here. Would you agree with the statement that what we should strive for is to choose the best qualified people, and impose upon them the smallest degree of restriction and let those good people do a good job?
Mr. Morck: Yes. Combined with a fairly high degree of accountability, I think that makes sense. You cannot hamstring people with dozens of rules about what they can and cannot invest in. That would only encourage political lobbying on what those rules should be, and the rules would end up favouring some constituencies and not others. The whole purpose would then be frustrated. Give people freedom, but also make them accountable.
Senator Meighen: The failures, which will inevitably occur, are just part of the job of good investing.
Mr. Morck: Right. If you had several funds instead of one fund, with people deciding which fund to put their money into, one fund's failure would not bankrupt the whole system. That is why this idea of diversification of the fund into different compartments is very important. It is a mater of localizing the failure. It would only be people who chose to invest in that particular fund who would get into trouble because of a failure. The people who chose these other options that we set forth for them in their defined contribution accounts would not have that problem. You have a problem with the defined benefit portion of the fund if you continue running that, but hopefully over 20 years or so that would disappear and the fund would then be on a long-term stable path.
Senator Meighen: Just for the record, could I take it as a given that you would like to see the investment policy such that the 20-per-cent restriction did not apply to the Canada Pension Plan?
Mr. Morck: Do you mean the 20-per-cent restriction on foreign investment?
Senator Meighen: Yes.
Mr. Morck: Yes. A couple of years ago, I was asked to give input to Industry Canada on this issue and, at that point, I argued very strongly that this does not make sense, that what we are preventing Canadians from doing is getting a higher return and lower risk by investing wherever they want. We are keeping them from the temptations of excess wealth, I suppose.
Senator Meighen: Most people seem to agree that it is time to move away from the 20-per-cent restriction, either totally or increasing it, as this committee has suggested, by two per cent a year over five years, up to 30 per cent, but the argument has been put forward that, in the present context, given the weakness of our dollar, that might, by causing more money to go out of the country, increase the pressure on the dollar. It seems to me that that is not something which is likely to be a major contributing factor to the strength or weakness of the loonie, but I would like to have your comment.
Mr. Morck: I agree with you. I do not feel that that is a major factor in setting the value of the dollar. I think you can make an argument that it might go the other way. Part of the problem now is that Canadian companies are, perhaps, not as competitive as they should be because they have a pool of capital they can only invest in Canadian companies. If that capital could go elsewhere, it might force Canadian companies to smarten up, and that might increase our productivity and raise the value of the loonie.
Senator Kenny: Professor Morck, perhaps I did not understand your defined contribution proposal as clearly as I might have, but it struck me as being a proposal that would have exceedingly high administrative costs and that the administrative burden, if you will, would be enough to negate the value of individuals watching over their own little nest egg.
My other concerns relates to who would be left out because this sounds very much like individual RRSPs. What about those folks who fall between the cracks? How would they be taken care of in this proposal?
Mr. Morck: On the first question of administrative costs, a couple of studies are relevant to this. One study was of the Chilean pension plan system where it was found that the administrative costs were very high compared to a very simple pay-as-you-go plan or compared to a one-fund defined benefit plan. Another study was done by Olivia Mitchell in the United States. She looked at defined contribution corporate plans versus defined benefit corporate plans, and again found higher administrative costs with the defined contribution plans. You have identified a very real concern and it is part of a real trade-off. I think we need to look at the issue as a comparison of costs and benefits. You have correctly identified the high cost of my proposal. The question is: Do the benefits justify it?
As to the question of who falls through the cracks, that is a difficult one. The problem might be solved -- and this is in the long-term where the entire country would have switched to a defined contribution plan -- by having the government simply assign money to an account for every Canadian in some minimal amount, and then employers could top that off or it might not apply to people who have higher incomes. There are ways of dealing with this.
Senator Kenny: In terms of your concern regarding corporate governance, you talked about how the minister has to plant the seed first. Have you given any thought to the minister establishing a foundation, if you will, or a larger board that would, in fact, be self-perpetuating after that? The model I am thinking of would be one where they would almost be proxy shareholders, if you like. They, in turn, would re-elect boards on their own and would recreate themselves without government interference. Have you considered a model of that sort?
Mr. Morck: Yes, I have. In fact, it is interesting you use the word "proxy shareholders" because another suggestion has been that beneficiaries could vote on who would be on such a board. You would not want to have a full election for this kind of thing, but you could have a mail-in ballot where a board would be elected in the way you are proposing. I think that should be considered.
Senator Kenny: Turning, if I may, Mr. Chairman, to Professor Tupper and your first comment about not understanding the rationale for regional representation, I suspect no one around this table sees any economic reason for that, but we all see the political fallout of not having regional representation and the acrimony that would exist if the board were made up entirely of people from, say, P.E.I. I am assuming that your comment was not one that you wanted us to focus on very much.
Mr. Tupper: Yes and no. I think that there are certain areas in Canadian politics that require regional representation, but sometimes we should ask tougher questions about that being an inescapable fact of life. We ought to have some justification for that being one of the few criteria that is included here. Once in a while you have to make some sort of argument about what you are bringing to the table on the basis of where you happen to reside. If there is some strong evidence that it is required, I am for balanced representation.
Let us consider this board in the context of the board of the Canada Foundation for Innovation. I think you have to look at the two of them as relatively coincident government structures. The notion of an independent board is independent in one sense only, and that is in its relationship to direct governmental authority. It is not value independent. This notion that, because you have 12 expert financial advisors running this all is perfect, cannot be relied upon because they just operate according to textbooks and theories. They have no values, no premises. That is my point. I think virtually everything that can be said strengthens the case for greater political involvement. I would like to see an obligation that there be a directive power from, say, the Minister of Finance. There are many other comments you could make about who you want to have on that board.
Senator Kenny: Would you briefly recap for the committee why you believe political involvement would be of value on the board, and why you believe that it should be an essential component of the board? I think your response might lead to more interesting questions from the committee.
Mr. Tupper: I think there ought to be a balance between the sorts of expertise and wisdom that an independent board could bring and what can be brought from all other sectors. I am sure the sum total of the evidence you have collected in your hearings would be pretty strong evidence of that. Once this board is up and running, it should not become a self-governing oligarchy, and the way to prevent that by having public discussion. My thinking is no more complex than that. It is a value premise, as I said earlier, about patronage and so on. I do not lose sleep about these matters. In the 1990's, it is not exactly commonplace. I neither feared nor disliked democratic politics. That is my logic.
Senator Kenny: I would like you to elaborate, if you would, on the value of the democratic process and how useful it is to have political appointees on these boards.
Mr. Tupper: They will be political appointees by definition. My point is that there simply ought to be people who have considerable life experience on the board, and political involvement might result in a manifestation of certain skills that they might bring to the board.
Senator Kenny: Having a certain political philosophy does not negate the fact that they have useful life experiences.
Mr. Tupper: Absolutely; nor does the suggestion that if we "insulate" this board from the politician it means that those who are appointed do not have very clear philosophies that we should know about.
Senator Kenny: It is "in the closet" in the first case, and it is "out of the closet" in the second case.
Mr. Tupper: We must not forget that very few Canadians have the kind of pension plans that we all have, which are a defined benefit. I am referring to university professors, civil servants, or people with positions of influence. The vast majority of Canadians have what this will be, period.
Senator Tkachuk: The idea that the appointments to the board would be political deeply concerns us, whether they are political in the sense of having a partisan flavour or whether they are political by what they have in their head, that is, they may believe they should invest in items that are "green" only, environmentally correct. That is a political point of view that the people of Canada will not know about until the OC is passed and they are on the board, but by then, of course, it will be too late. With the understanding that the process is political, we have to then find a system to open it up, make it transparent and make it answerable to somebody, because now it is answerable to no one.
On the question of the report that is to be tabled in the House of Commons under the CPP legislation, my understanding is that there will be no reference to committee. It will merely be tabled along with the other 500 reports that are constantly tabled in the House of Commons. That means the government, indeed, the minister will have little input.
The Chairman: I am not sure of the procedure in the House of Commons, but I know that, under the Rules of the Senate, we can refer reports to committee. We have done that many times.
Senator Tkachuk: We are examining two aspects of this: ways to make the process more accountable and more transparent. One is different from the other. We should consider trying to find means by which the board will appear before a committee of Parliament so that people feel they have some input, and confidence that their concerns are being met.
Mr. Morck, as a CPP contributor I would have a choice of funds in which to invest. How would that balance with the fact that everybody will get the same amount of cash at the end of the day in any event?
Mr. Morck: Everybody would get the same minimum amount of cash, so a certain percentage of the contributions would be invested in a particular fund. You would have no choice about it. You could tax that fund to deal with the demographic problem but, on the margin, say on 20 per cent, people could allocate between funds and that would slowly grow over time. Then, if I wanted to put my money in a green fund, I could do it, and I would face the consequences if that fund were a poor investment. In that way, you can have public input into the decision making of the fund without having to deal with the party politics system of government.
I think the issue that Senator Kenny raised earlier, the idea that you could have a separate board that would either perpetuate itself or that would be directly elected by the beneficiaries, by the people of Canada, separate from the way Parliament is elected, might make sense. I might like the Liberal Party's or the Conservative Party's policies on immigration and taxation, but I might not like the way they run the pension fund. I might them to follow a different philosophy in that regard. When we elect a party, we elect a basket of opinions. It may be that the way a pension fund is managed is sufficiently unrelated to other policies of a government that people ought to make separate decisions regarding a pension fund.
Senator Kelleher: While section 51 does, in fact, require the minister to table the report, nothing further may be done with it, because tabling is all that is required. I know this from personal experience. As a minister, I had to file a number of reports and, I can assure you, I hoped to God no one would do anything with them.
Senator Tkachuk: You were never disappointed, were you?
Senator Kelleher: No. They were never referred.
The Chairman: It is not totally dissimilar to academic papers.
Senator Kelleher: I would not want to comment on that, due to the fact that we have two respected professors with us. I think the concern expressed by Professor Tupper still exists.
Mr. Tupper: I see no problem with saying that it ought to be reviewed by a committee of Parliament. I think this is important enough for a joint committee of the Senate and House of Commons to review annually.It could also conduct a five-year review of the philosophy and that sort of thing.
The Chairman: I would just make the observation that, historically, joint committees have not worked very well.
Mr. Tupper: I an aware of that.
The Chairman: The difference is there continuity in Senate committees in that people serve on those committees for a long period of time. That is not the case in the committees of the House of Commons. Consequently, our experience has been with what I would call "business-type" issues, as opposed to social policy questions. Most of the people in this room have been on this committee for a long time. We deal with complicated subject matters which take some time to master.
Mr. Tupper: The logic of suggesting a joint committee was to combine the shorter-term impulses with the longer-term memory.
The Chairman: The membership is always two to one in favour of the House of Commons.
Senator St. Germain: I apologize for getting back late but, from what I heard, I was impressed by your presentation.
Mr. Tupper, my concern relates to the question of credibility and the current public cynicism. If members of this board are paid the salaries that were mentioned yesterday, an appointment to this board could end up being a better sinecure than a Senate appointment. We do not know what board members will be paid. The per diems could be an astronomical amount.
There is very evident public cynicism about any type of political appointment. I was hoping we could find a method, other than a Governor in Council appointment, to select members of this board. If we could do that, people would have some confidence that this Liberal government had selected people who would operate at arm's length from the government but who would be accountable, and there would be transparency. I know many people in the business community who want to have nothing to do with politics. They are apolitical. They want to do what is right for the country and they want to get on with business and make money. There is nothing wrong with that.
I do not think the method that has been chosen gives the necessary transparency. You may or may not agree with me.
Mr. Tupper:I agree with you. To the degree that public opinion can genuinely measure this, the public opinion polling on this question of citizen cynicism and distrust of public institutions is declining considerably. If you examine what has happened during the course of the 20th century in that regard, you will see that public cynicism is essentially a function of economic downturn -- the weaker the economy, the greater the levels of citizen cynicism. That being said, there are certainly considerable anxieties among Canadians about these matters, but I think that is changing.
I was trying to argue that it would be appropriate to have some advance discussion regarding the appointments to the board. You only hear about them after the fact, even if they are excellent. In the various constitutional renewal processes we have seen, there has always been a discussion about key federal appointments being ratified in some way prior to their being made, essentially by the Senate or by the House of Commons. I made the point that there is probably a strong case for public discussion prior to appointments being made. That, of course, would be subject to the permission of the candidates. However, if they did not agree to that, you probably would not want them on the board. That is my opinion, and it may be at variance with yours.
I presume that all major appointments would be brought in line. There is nothing I can see, despite the amount of money involved, that distinguishes this body from many others, all of which have tremendous importance for Canadians. If we can get around that, we could get a better sense at least of the short list of people who would be appropriate. However, I have no other suggestions other than Randall's suggestion of election, and I do not see a compelling democratic case for that. The quality of the appointments will be very important, but I do not think that the criteria are broad enough. I think the criteria in the act are very limiting, and that they ought to be expanded. If I read the legislation correctly there is to be an advisory committee, but the minister is under no obligation to accept anything it says. However, if the report were made public, then the pressure would be on the Minister of Finance to ask why certain people where chosen to be members of the board.
The Chairman: Thank you, gentlemen, for taking the time to assist our committee.
The committee adjourned.