The chancellor Rachel Reeves’ announcement of a far-going review into Britain’s pension fund system has the potential to rival Gordon Brown’s creation of an independent Bank of England in economic importance.

Unbelievably, less than 2% of the £2.5tn of pension fund assets run by over 30,000 – often very small – pension funds are invested in British companies, either on the public markets or as unquoted start-ups and scale-ups. It is a disgrace, serving neither the economy nor pensioners: root and branch reform, as I argue in my new book, This Time No Mistakes, is a precondition for higher growth.

The review makes good the limited ambition of last week’s pension bill. First and foremost, Britain needs fewer and much larger funds than the smorgasbord of tiny, ­underperforming funds whose trustees guard their independence so jealously that property market nimbyism looks tame. It is only very large funds, ideally over £100bn, that can diversify risk sufficiently to be able to invest more in the full range of productive assets, ­including those in the UK, to raise returns, boost the economy and lift pensions.

Two important targets are identified. First, to explore ways to pool risk and consolidate the multiplicity of fast-growing but often minuscule defined contribution schemes and second, how to turbocharge the glacial consolidation of local government pension funds. That could bring £1tn into productive investment. As important is the further £1.4tn sterilised in closed defined benefit pension schemes.

They need a guarantee (or “underpin”) to persuade trustees to release £225bn of stagnating surpluses and for another 2,000 very small, closed defined-benefit schemes to agree to be merged into the highly successful Pension Protection Fund.

Do all this, and Britain will at last have the investment pools to turn round its decaying stock market – and trigger an investment boom.

• Will Hutton writes for the Observer and is co-chair of the Purposeful Company