Britain is about to suffer a massive collision with reality

This dates me, I know, but when I first became a financial journalist, it was a well-established principle that the bulk of your savings would automatically be vested in UK equities.

This was justified on the basis that it would insulate your pension from exchange rate risk, and from the presumed natural instability of overseas markets.

The notion came from an era of comfortable assumption that British companies, and the political system under which they operated, were innately superior to their foreign counterparts.

But then came globalisation, and with it the revelation that other markets tended to perform as well, if not better. Pension funds switched en masse from a UK-centric to a global equities approach to investment.

This might have been OK if everyone else had done the same thing. What UK markets lost in terms of domestic savings as a source of capital for domestic firms, they would have gained from the inflows of foreign capital.

But this didn’t happen. Instead, foreign pension money has largely stuck to the old approach.

Compounding the deficiency further was the perceived need for liability matching as pension funds matured. The big legacy funds largely switched out of equities altogether, and into government bonds.

This suited the Government, which had the luxury of a big, guaranteed source of demand for borrowing to spend on current consumption. But it has been pure poison for becalmed UK equity markets.

It’s too late now. That ship has long since sailed. The big defined benefit pension schemes have done their asset reallocation, and they are not about to reverse it.

Well, not entirely sailed, as Charles Hall, head of research at Peel Hunt, points out. Higher interest rates have returned many of these funds to surplus, which in turn means they could run, should they choose to do so, a slightly more aggressive, higher risk investment strategy. But don’t hold your breath.

This is an industry with a long track record of doing the wrong thing at the wrong time. The latest craze for buyouts – often to overseas insurers and sovereign wealth funds – is a case in point and closes off even this potential lifeline to UK equity markets. Once bought out, the fund’s obligation to pensioners is capped, and any upside belongs to the insurer.

But it is not too late for new-style defined contribution pension saving, nor is it too late for retail investors, for whom UK equity markets have become so thoroughly unloved that they actually begin to represent very good value.

I wrote on Saturday about the political paralysis that surrounds any serious attempt to tackle the UK’s multiple economic weaknesses, and highlighted one glaring deficiency in particular – one of the worst savings rates in the OECD. This in turn stunts investment in the future, and lowers long-term growth.

In public policy, we routinely favour consumption over savings and investment; in doing so, we mortgage our future in order to support our current lifestyles.

Eventually, there will be a reckoning, a massive collision with reality which will see living standards and international standing substantially diminish. That point may come sooner than we would like.

But we have to remain optimistic, and consider what might be done in the meantime to at least partially correct the problem. Politically, it’s bound to be extremely difficult, because any attempt to force up Britain’s savings rate will necessarily eat into disposable incomes, leaving less money to spend on other things. But it is not impossible.

In a submission to the Chancellor late last year, the Capital Markets Investment Taskforce put the nature of the challenge succinctly. “As with the decline in retail investing in the UK, the decline in UK pension funds investing in the future of UK business has been …stark and contrary to the situation in other G7 countries, despite the pensions industry benefiting from over £60bn worth of taxpayer support.

“The data in aggregate suggests that, whilst the decline in retail investment has been 50pc, the decline in pension investment in the UK equity markets has been even more pronounced: falling from 53pc to 6pc of total assets over the last 25 years (a collapse of 89pc).

“This equates to a withdrawal of £1.9 trillion from UK equity markets over that period, a sizeable amount of which is now invested in the homegrown businesses of other countries. Equity markets exist to finance the economy they are founded in. Many jurisdictions across the world have a strong domestic investor base that invests in its own economy and is incentivised to do so”. But not in Britain.

To be fair on Jeremy Hunt, the Chancellor, he wholly gets the problem, and is desperate to do something about it. The Mansion House reforms and plans for an all British Isa are a reasonable start, but they don’t go nearly far enough, and in themselves are unlikely to make a sizeable difference.

Hunt understandably shrinks away from the idea of outright coercion, but it is as plain as a pikestaff that something has to be done to shift the dial and get the country saving to invest in the UK’s future once more.

The National Employment Savings Trust (Nest) is as good a place to start as any. This sets out to provide a bare minimum of workplace pension saving by auto-enrolling employees into the scheme unless they actively opt out. Since its launch in 2008, it has been relatively successful, with 12.5 million members at the last count and £33bn of funds under management.

In the scale of global savings, this is still nevertheless tiny. As things stand, no more than 8pc of income needs to be contributed – half by the employee and half by the employer – which is not enough either to provide a reasonable pension in retirement or to make much of a difference to the overall savings rate. In an ideal world, it would be progressively increased to around 20pc of income.

Something also needs to be done about asset allocation. Of the fund’s top 10 equity investments, not a single one is even European, let alone British. Hey ho.

This article is an extract from The Telegraph’s Economic Intelligence newsletter. Sign up here to get exclusive insight from two of the UK’s leading economic commentators – Ambrose Evans-Pritchard and Jeremy Warner – delivered direct to your inbox every Tuesday.