September 29, 2004

Are There Reasons to Be in Favor of Social Security Privatization?

Duncan Black writes:

Eschaton: The Case for "Privatizing" Part of Social Security: Actually, I don't think there is one. What would be the point? If you think reducing payroll taxes and/or guaranteed benefits in a way which adds up is a good idea then go ahead and advocate that policy. But, what possible good argument is there for a policy roughly like the ones which are floated by the Bushies (without details of course), which would cut payroll taxes by 2 percentage points, cut guaranteed future benefits, and then mandate that you save/invest that 2 percentage points of income. What's with the mandatory savings? If you want to cut benefits, fine. If you want to having all kinds of tax free savings instruments, which we already do, fine. But why force people to save? The only point of doing so is to ensure that people have a reasonable income base when they're of retirement age, but once you take the "insurance" part out of retirement insurance, then a mandatory saving/investment program doesn't achieve that.

I disagree. There are five reasons to be in favor of Social Security privatization. They are:

  1. There are large-scale financial market failures which cause the equity premium to be *way* too high: the stock market does a lousy job at mobilizing society's risk-bearing capacity as applied to investment. Privatizing Social Security and mandating that such accounts be invested in stocks rather than holding the public Social Security Trust Fund in Treasury bonds is a powerful way to try to repair this market failure by boosting demand for equities

  2. Too many households are myopic: they do not save enough. Households resist increases in Social Security taxes--they see no link between the taxes and their future benefits. But if Social Security were privatized so that households saw their Social Security contributions as their own, in the future there would be much less objection to upping the contribution rate--and so creating a real and more effective forced saving program to raise the national savings rate.
  3. Prefunding Social Security is moral: it is unfair to make tomorrow's young bear the entire burden of financing the retirement of the baby-boom generation. But prefunding requires raising Social Security contributions and building up huge assets in the Social Security Trust Fund--enough assets to give the Managing Trustee of the Trust Fund effective voting control over corporate America. The Managing Trustee is the Secretary of the Treasury. Do we want the Secretary of the Treasury casting the deciding votes in every election for corporate boards of directors? No. Hence privatization is a necessary first step to create the possibility of doing the moral thing--making the boomers build up the assets needed so that they can shoulder a greater share of the burden of financing their own retirement.

  4. We need to raise our national savings rate. But if we just raise Social Security taxes, Congress will treat these taxes as general revenue and spend them. Only by funneling Social Security contributions into some vehicle that Congressional representatives cannot interpret as a resource available to fund current spending can we raise the national savings rate. And private accounts are the best vehicle we can find to (a) accumulate contributions without (b) allowing Congressional representatives to seize them as resources available to fund current federal spending.
  5. At present, your Social Security benefits are yours only by grace of Congress: Congress could cut them if it wished. But if your privatized Social Security account were *yours*, then it would be yours not by grace of Congress but by right of property: courts would stand ready to defend it against any casual attempt to cut or confiscate it.

The problem is that I cannot see any of these as a reason for George W. Bush to be in favor of Social Security privatization. (It does seem likely to me that (1) and (3) are Marty Feldstein's and Andrew Samwick's reasons for being strong advocates of privatization, and that (4) is Kent Smetters's reason for being a strong advocate of privatization. But their reasons aren't the administration's reasons, and hence whatever plan a second Bush administration might ultimately propose would be unlikely to be crafted to achieve goals (1), (3), or (4).

Why are other groups inside a second Bush administration likely to be in favor of Social Security privatization? What's in it for them? I can see three possibilities:

  • Enormous fees for the mutual fund industry...

  • Huge capital gains for current investors as stock prices rise in anticipation of the enormous flow of stock purchases by private accounts...

  • Over time as the contribution rate to private accounts is upped and the resources to pay for the still public system fall, the finances of the public system get worse and worse as the relatively young place less and less reliance on it and more and more on their private accounts. Eventually the balance of political support tips--and the public system's benefits can be slashed and then the public system itself shut down.

I don't think the Bush administration itself knows why it is in favor of Social Security privatization. It only knows that it is.

Nevertheless, I accept Duncan Black's big point: most of the good arguments for privatization are simply not accessible to people on the right: they are inconsistent with their view of the world.

Posted by DeLong at September 29, 2004 08:17 PM | TrackBack
Comments

The ultimate reason to privatize Social Security is because it's actualrially unsound. Insurance takes in money and invests it; benefits come from return on investment. SSA takes in money, all of which Congress spends on stuff; benefits come from current receipts, hence the comparison to Ponzi schemes (or Enron).

Could someone state explicitly why the good arguments for privatization are inaccessible to GOP perceptions of reality? What exactly is this alleged GOP worldview?

Posted by: Alan K. Henderson at September 29, 2004 08:44 PM

Wouldn't it be a nice idea to guarantee a good chunk of money - a basic Social Security check of some decent amount - and then give people the opporunity to get a lot more? In other words, wouldn't it be a nice idea to have private accounts on top of Social Security? I like to think of it as making sure everyone has a bowl of ice cream but giving them the opporunity for toppings. In fact, in his memoirs, Bob Rubin said something like, "Create private accounts if you want, but assure the basic guarantee of the system."

From what I gather, the Bush administration does something like this. I have yet to read through the entire CBO report on this, but it seems that by indexing the funds to prices instead of wages, a large part of the problem goes away. People are always going to get something. Yet is it enough? I can't imagine that it is, although perhaps it will increase over time, once the Baby Boomers are all gone, and I will find this out once I finish the report. For argument's sake, let's assume that this is not the case, like I assume. The system as we know it would not be in place. A lot of it depends on the risk involved, of course, but unless I am missing something, low risk financial options are not going to reap huge rewards.

As for why the Bush administration is for it, perhaps Daniel Altman in his book (which, damn me, I am still in the middle of) "Neoconomy" hit on something: it's all part of a broader scheme to reduce any taxes on investment and things like that and only tax work.

And while the Bush administration's plan can be characterized as bad, dishonest, or both, I am not hearing much from the Kerry camp, which annoys me to no end.

Posted by: Brian at September 29, 2004 08:47 PM

Here's the reason to be against privatization: Most Americans don't know enough about investing to invest money wisely. They don't even know enough to handle their 401K plans. How can we expect them to be good stewards of this money?

And if people manage to lose all or most of their privatized Social Security nest eggs, what will happen to them then? Will we have to give them welfare money to keep them from living on the street?

The point is: If it's really their money, then they can really lose it on their own, right? And what happens then? Am I missing something here?

Posted by: Vicki Meagher at September 29, 2004 08:48 PM

I think there is one more reason to be in favor of Social Security privatization, and that is one that *is* accessible to the right: like other forms of savings, it is a means to build up family capital that can then be passed on to the next generation. Such capital build-ups will then allow the next generation to do things like provide for their own futures, buy homes, pay for college, etc.

Social Security doesn't do that --- parents can't leave the surplus in their account to their heirs.

Posted by: dm at September 29, 2004 08:50 PM

My post, which was being typed at the same moment as Vicki's, should partially answer her big concern. Social Security is a welfare program disguised as an insurance program. Privatization means that people will have actual nest eggs, which isn't the case now.

On top of all that, SSA can survive only as long as each successive generation is bigger than the previous. (Another commonality with pyramid schemes.) The Baby Boom kept it alive, and the Baby Bust will bust it - or force the government to sharply raise the age of benefits eligibility.

Posted by: Alan K. Henderson at September 29, 2004 09:04 PM

I thought that 3 was already accomplished by the Greenspan Commission in '83. Except that 4 has already spent it.

And why is it any more 'unfair' to make the Post Boomers bear the entire burden of support for the Boomers when the Boomers have been bearing the entire burden of support for current retirees. The system is, after all, an intergenerational support system. The first beneficiaries of this system paid squat back in the '30s. The first of the boomers are about to retire...

Does the system really want more savings and less spending from the working class? What about the damage from removing these consumer dollars from the system. And the damage this does to the families with maxed out credit cards and ARMs?

And this discussion does not get to the issue of the cost of the transition from one system to another...

Posted by: Otto at September 29, 2004 09:05 PM

It seems to me that (3), (4), and (5), or close variants, are not only accessible on the right but have in fact been major pillars of Cato's privatization arguments for many years.

Posted by: Jacob T. Levy at September 29, 2004 09:13 PM

Brad - eager to hear what Tyler Coven has to say re: your especially cogent analysis. Still, you do not answer the shortfall question for those who are currently receiving or soon to receive public SSA when the income to the program is reduced. Can there be any solution but a substantial infusion of public dough - or an immediate reduction of benefits?

Posted by: Martin at September 29, 2004 09:18 PM

Brad. Disagree totally with your analysis.

1. If the stock market is so lousy at "mobilizing society's risk bearing capacity...", then why give it more resources to continue this misallocation? This is like giving a drunk a free drink. There is also the old Street adage that says they can supply stocks to meet ANY level of demand. Have you forgotten the internet bubble already?
2. True. But in an era of declining real wages are you suprised? If you want to "raise the savings rate" why not just abolish all taxes on incomes above $500,000/yr? Given the higher propensity to save by the rich, think of the savings! Oh. Wait. The Bush administration is already doing that.
3. Baloney. A pay as you go system is perfectly moral. Besides, when the boomers die off there will be this puny (less numerous) generation of selfish "X'ers" to share the unimaginable wealth cause, as we all know, Republican policies will induce annual GNP growth of upwards of 10 per cent per annum. So what's the problem?
4. I thought this was a market economy. Are these the same folks who decry intervention everywhere else. Furthermore, if everybody saves more you might wind up with lower GNP growth. You are an economist aren't you? You have heard of the "paradox of thrift" have you not?
5. Pure poppycock. This is scaremongering of the lowest order. On the other hand, you've never heard of "eminent domain" I guess. Not likely you say? About as likely as Congress just suddenly ending the program. Get real.

The Bush administration may not know "why" they advocate privatization. Take my advice, don't give them any more bad ones. I'm positive they will have no problem finding their own wretched rationales. They haven't failed us yet in this regard on ANY issue you wish to discuss.

Posted by: bobbyp at September 29, 2004 09:19 PM

I am not comfortable with the premises that either the stock market is inefficient or that any amount can be invested in it. The high returns earned in the U.S. stock markets in the 20th century may simply reflect our good luck; Japanese and German investors did not do nearly as well, 1926-1960, as U.S. investors did, for obvious reasons. And, forcing a fixed amount into the stock market, to the extent that that amount exceeds the available opportunities for profitable investment, will simply result in the loss of the "surplus" funds.
The one sensible thing we could to do, to improve capital market efficiency would be to increase the inflation rate slightly; a modest inflation rate ensures that investments with a minimal, positive net present value will be made. (Ideally, ALL investments with a positive present value ought to be made.)

Reality is that only the present moment exists, and if a larger part of the population is out of the labor force, the existing labor force must bear the burden, like it or not. Hoping that additional capital will somehow substitute, as a source of income, is charming, but misleading. "Pay as you go" is a fact of nature, which cannot be avoided. The accumulation of Treasury securities in the Trust Fund will serve to channel general revenue to supplement social security tax revenue in the years when the boomers are drawing heavily. That is a sensible, planned measure to ease future tax burdens.
The idea that corporate dividend payments and buybacks may be diverted with the same ease and certainty as the government's debt service is interesting, but speculative. To the extent that future SS funding depended on the sale of stocks into a market, in which a smaller, middle-aged cohort was investing, suggests that p/e ratios would be as depressed in 2030, as they have been inflated in the 1990's, by having a larger cohort pour in its increasing saving.
Those expecting high returns from stocks may well be disappointed at the critical moment. Moreover, any fully privatized system loses the tontine effect, of having the contributions of the early deceased added to the common pool.

Posted by: Bruce Wilder at September 29, 2004 09:20 PM

Re: "It seems to me that (3), (4), and (5), or close variants, are not only accessible on the right but have in fact been major pillars of Cato's privatization arguments for many years."

Only (5)--and I don't think it's been a major part of Cato's arguments. Cato people who use (3) and (4) are then vulnerable to the critique, "why force people to save? Why not simply cut their Social Security taxes?" And the answers to that are inaccessible to the right because they require a deep distrust of markets...

Posted by: Brad DeLong at September 29, 2004 09:27 PM

I think the best reason for privatizing social security is to make our debts look bigger, so that they'll act as a cudgel to beat us into being more responsible financially. Nothing very much real is changed by it, though, except through the indirect, "****, our debts look huge" psychological/political effect. I actually support this argument. If you like it, though, it's probably wise to find other reasons to support it, because if you support it and get it passed on those grounds, it might negate its own effect because people might say "well, just as advocates said, not very much real has changed, so our debts aren't really any bigger compared to before, because we have counterbalancing assets. They just look bigger."

Posted by: Julian Elson at September 29, 2004 09:40 PM

Don't ALL Social Security privatization programs destroy the "security" function of social security? If people control their nest eggs, even without stupidity some will just have bad investment luck. And some will get flimflammed by con men. And we'll be back to where we started.

Posted by: zizka / John Emerson at September 29, 2004 09:55 PM

As Brian mentioned upthread, indexing SS benefits to price instead of wages pretty much eliminates the problem, especially if we raise the income caps on FICA taxes.

When people talk about the impending bankruptcy of Social Security and Medicare, everyone talks about SS reforms because its the easy one to fix. Medicare is the real problem and no one has a good answer.

Posted by: beowulf at September 29, 2004 09:58 PM

My response to Dr. DeLong's points will be somewhat personal, but here goes:

1. "...mandating that such accounts be invested in stocks rather than ... Treasury bonds..." Speaking for myself, I really don't have the time or the energy to put into market research so that I can get to the point where I'm as comfortable with the risk/return equation on stocks as I am on T-bonds. I suspect that rather a lot of people have less time, less energy, and less capacity for it than I do. Flooding the market with investors who have a low capacity for research is just inviting endless recurrences of the Enron meltdown.

2. "Too many households are myopic: they do not save enough. Households resist increases in Social Security taxes..." Do you know for a fact that households resist increases in Social Security taxes? I can't remember anyone even suggesting such a move since 1983, when taxes were in fact raised. It's not obvious to me that a "myopic" household that does not see its future benefits related to its present taxes will feel any differently about being forced to give up disposable income to a mandatory savings plan.

3. "It is unfair to make tomorrow's young bear the entire burden of financing the retirement of the baby boom generation." Isn't it rather too late for the boomers to build up assets in their own savings accounts? If so, aren't tomorrow's young inevitably going to finance the retirement of the boomers, either through Social Security or through other taxes? Anyway, why is it unfair? Isn't that the intergenerational contract that most societies accept (the boomers raise the GenX'ers, then the GenX'ers take care of the boomers a few decades later)?

4. "We need to raise our national savings rate." So why not continue to raise the contribution limits on IRAs and other forms of private retirement savings? You get increased savings generated by people who decide that they can afford it, and the Social Security safety net for everyone.

5. "Congress could cut them if it wished." That is true. The only argument I can muster against that is that I have confidence in the reluctance of Congress to tamper with the benefits of an overwhelmingly popular program unless they have an immensely good reason to do so.

Posted by: PT at September 29, 2004 10:03 PM

I'm planning on investing in penny stocks myself.

Woohoo! Either I'll get rich, or the security aspect of it all will save me.

Posted by: jerry at September 29, 2004 10:09 PM

Brad writes: Do we want the Secretary of the Treasury casting the deciding votes in every election for corporate boards of directors? No.

And why not, pray tell? One of the biggest problems of US economy is that executives and board members of the public US companies became a closed self-perpetuating group outside of public control. Even the largest investment funds (like CalPERS) are powerless to influence the boards. If the state (via SSA) had at least one seat on the board of each S&P 500 corporation, they would be exposed to the public and Congressional scrutiny and we would have less corporate crime.

Posted by: a at September 29, 2004 11:19 PM

a says, "...we would have less corporate crime."

What causes you to believe that? Have you not read of the troubles Tom Delay and his buddies are in? Being employed by the federal government doesn't confer honesty.

Posted by: Linkmeister at September 29, 2004 11:30 PM

Posted by Linkmeister: What causes you to believe that? Have you not read of the troubles Tom Delay and his buddies are in? Being employed by the federal government doesn't confer honesty.

No, but the assistant undersecretary of Treasury sitting on the Haliburton board can be dragged to Congress and asked how he is performing his function of safeguarding the public assets. If he takes the Fifth, he is fired. Think tobacco case and lets be clear: our political system, with all crimes and misdemeanors of the current Republican leadership, is democratic and open for public input - much more trustworthy than the board of any public company.

Posted by: a at September 29, 2004 11:44 PM

bewoulf,

Somebody mentioned that Kerry's plan would reduce costs for Medicare, too. I have to research that, but do you think that would be the case, and if so, why? Anyone else can chime in as well.

Posted by: Brian at September 29, 2004 11:53 PM

(1) is wrong unless it relies on a Glassman-style mistake argument. If there's a genuine market failure you can't fix it by forcing people to act as if the missing market were there. You have to supply the relevant services.

This means going for the Clinton plan (keep social security but invest in equity) rather than privatisation.

Posted by: John at September 30, 2004 03:27 AM

Since 1983, American workers have been providing a surplus to Social Security to prepare for the demographic shift that will occur as the baby boom generation retires and a smaller generation is left to care for them. Baby boomers have have most responsible in preparing Social security for the future. To threaten the benefits of baby boomers on the eve of retirement is thoroughly immoral.

The problem with privatizing Social Security is above all the cost that will further threaten promised benefits. Alan Greenspan and Republicans promised that Social Security benefits could be honored easily even with tax cuts, now the refrain differs. Well, the promises have been made and payroll taxes collected to provide for the baby boom generation. Keep the promises.

Posted by: anne at September 30, 2004 04:33 AM

An additional weakness to (5): the 'sanctity' of ownership of private accounts is far from certain. It'd be easy, IMHO, to set up things with trigger clauses stuck in the middle of 1,000 page bills, which future courts could use to declare that there is no true ownership.

Posted by: Barry at September 30, 2004 05:10 AM

Again, how do we pay for privatization? How do we cope with a structural budget deficit, retiring baby boomers and need to honor promises to them for both Medicare and Social Security? How much money do we set aside for private accounts? Where would a trillion dollars come from for such accounts? Remember, we are looking at more tax cuts to come. At the least the Alternative Minimum Tax must and will be set aside before it severaly damages middle income households.

Posted by: anne at September 30, 2004 05:25 AM

I hate to say this, but the main reason to be against social security privatization is that Republicans support it--they would be the ones implementing it if they could. Get ready for compensatory payments from the government when some people's accounts go bust.

I'm totally unconvinced that private accounts would cause people to save more, especially when the moral hazard of government bailout is present (and it will be).

Posted by: Marshall at September 30, 2004 06:54 AM

The Social Security trust fund should be abolished. Current benefits should be paid out of general revenue.

A forced savings plan similar to that for federal employees, through the Thrift Savings Plan should be mandated. Employees should be required to save 5% of their salary, with an employer match. The federal thrift Savings Board could manage the plan.

Posted by: Arthur Arfa at September 30, 2004 06:54 AM

Paying for privitization is nothing more than pointing to the elephant in the room that there is no money there now.

I can't fathom what Brad means when he asserts that the reasons for privitizing social security are not accessible to the right. Ownership of assets is better than vague government promise. This is a matter of property rights, which people on the right perfectly well understand.

That the moral thing to do is finance one's own retirement is an observation of the right. Saying that those who make this argument are subject to the argument of what justification for forced savings is akin to arguing that home ownership is irreconcilable for those on the left because it doesn't advance socialism. If someone chooses not to save, that is not a failure of the market. The concept is not that the market fails by not forcing you to save, but that the government will fail by not forcing you to pay the consequences regardless of your choices. Privitization is better from a right wing perspective along almost every vector than pay as you go. You have a property right, you don't just vote yourself more benefits at someone else's expense, real savings is increased, social security taxes get deducted from general revenues, it is a shelter against demographic risk, and so on.

It is not ideal, but it is better than what we have. It is the difference between being forced to save (which treats you like a child) and forcing others to pay for your retirement.

Posted by: Jason Ligon at September 30, 2004 06:55 AM

You lost me at "must go into equities."

Let's ignore that all the calculations of the "equity premium" don't adjust for the cap on bond yields that was in effect until the late 1960s.

But we cannot ignore (1) that the legendary 9-11% "yield" includes a Dividend that is both disproportionate (compared to the current market) and that ignores the tax consequences of that dividend; (2) the impact on tax-free (read: Municipal) securities of making equities essentially a tax-free investment (last estimate I saw was somewhere around 0.25% on the bonds--which means many will lose in Property and State taxes what they might gain in stock investment); and (3) that All That Money will (as noted above) drive DOWN the Market's return, because it will not be invested for value, but rather because one needs to invest.

So the "equity premium" (which appears to be fairly well gone as is) will be replaced by investors having to treat stocks as virtually "risk-free" by virtue of their preferential treatment.

Posted by: Ken Houghton at September 30, 2004 06:57 AM

Our host makes an arguement I don't understand:

Prefunding Social Security is moral: it is unfair to make tomorrow's young bear the entire burden of financing the retirement of the baby-boom generation. But prefunding requires raising Social Security contributions and building up huge assets in the Social Security Trust Fund--enough assets to give the Managing Trustee of the Trust Fund effective voting control over corporate America. The Managing Trustee is the Secretary of the Treasury. Do we want the Secretary of the Treasury casting the deciding votes in every election for corporate boards of directors? No. Hence privatization is a necessary first step to create the possibility of doing the moral thing--making the boomers build up the assets needed so that they can shoulder a greater share of the burden of financing their own retirement.

It seems to me that an individual can save for retirement by buying deferred claims on production. I don't see how a society can do this. Current consumption comes from current production; there is no place else. We can use foreign production, financed by borrowing as long as they will lend, but that has a limit. (Where? I wish I knew.)

So, if future consumption, that is, Social Security benefits, are prefunded, when the time comes to collect the result will be inflation, drop in asset prices, or both. (And I'm sorry for the structure of the last sentence.)

To put it another way, the idea of SS is to provide a bundle of goods and services. If that bundle is a fairly small proportion of current production it can be provided with small sacrifice. If it's a larger part, coming up with it becomes painful. I don't see how financing arrangements make much difference.

OTOH, I'm sure Professor deLong is just as capable of this reasoning as I am. Would someone enlighten me as to what I am missing? TIA

Posted by: Jonathan Goldberg at September 30, 2004 07:19 AM

Good post (though I would have merged 3 and 4: both are variants of the "hide the money from the politicians" argument), but you missed 2 other points:
1)As Kent Smetters argues, people with zero wealth are implicitly forced to direct all their savings into Social Security, and thus cannot diversify into stocks. Private accounts would allow them to adjust their investments to suit their taste for risk. (People with wealth could rebalance their portfolios, so their effective exposure to equities would be unchanged).
2) Private accounts implicitly index retirement benefits to life expectancy. Under most plans, the balance would be annuitized at an actuarially fair rate. As life expectancy at annuitization age increases, the annuitized benefit for any given account balance decline. Poof! Instant longevity indexing. Of course, this could be done without private accounts, but one could argue that privatization would be the only way it would be politically feasible.

Posted by: Anonymous at September 30, 2004 07:27 AM

Does anyone else find it ironic that the self-described conservatives are pushing for government ownership of a healthy chunk of heretofore private American enterprise? Alas, they want to do this in the way that affords the least of the benefits of ownership--being minority shareholders.

Have the stock market scandals of the past 15 years occurred on some other plane of existence?

Posted by: Tim Francis-Wright at September 30, 2004 07:29 AM

Wouldn't Point One Create a Bubble Market, much decried in the 1990's?

Point Two ignores the huge transition costs required to create these "private accounts" and it also ignores the non-ROI functions of SS...Survivors insurance, disability insurance and COLA adjustments.

Point Three ignores the influence of Wall Street and "private" corporations on our electoral process and the ultimate amoral nature of the corporation which only wants PROFIT and COMPENSATION FOR IT'S CEOS AND EXECUTIVE STAFFS.

Point Four again ignores the transition costs

Point Five ignores that you wouldn't own anything worth having. I'm reminded of Groucho Marx "I wouldn't belong to any club that would have me" I wouldn't want anything in the way of private accounts that the government is willing to give me.

Posted by: Oleary at September 30, 2004 07:44 AM

There is actually a little experiment going on right now in a kind of "privatization" of federal government-run pension assets. In 2001, the Railroad Retirement and Survivors' Improvement Act (Public Law 107-90) created a private investment board to oversee investment of the Railroad Retirement trust fund in private stocks and bonds. Previously the Railroad Retirement Trust Fund was, like the Social Security Trust Fund, limited by statute to investment in Treasury securities. See section 105 of the law; here is the URL for the text of the law on the THOMAS Congressional website (HTML version):

http://thomas.loc.gov/cgi-bin/query/C?c107:./temp/~c10758T5pF

Railroad Retirement is the New Deal-era government-run retirement program for railroad workers, which takes the place of Social Security for those railroad workers eligible to participate. It is of course much smaller than the Social Security program, so some of the issues Brad points to in Social Security privatization - like being so big that it might impact nationwide corporate governance - wouldn't arise. But it still may be an interesting test case.

I am familiar with this legislation as a tax lawyer, but have not followed the investment privatization aspect of it. I wish economists and others would follow up on this recent first step in the direction of private investment of federal government pension assets, and see how it has played out so far. Is there any evidence of politically motivated investment or shareholder voting decisions? The Railroad Retirement Board, rrb.gov, is the federal agency that operates the system.

Posted by: Richard Riley at September 30, 2004 07:54 AM

Christ on a bike! If you don't mind my saying so, Brad, these reasons range from "weak" to "mad".

1. The stock market is not a material source of funds for investment. There is no reason to suppose that it would become one simply if one threw a load of money at the stock market.

2. Aside from the fact that this is social engineering far more radical than the French working hours legislation, savings are fungible. It could easily go the other way; that households do not currently count SS as part of their savings and would reduce other savings if they began to do so.

3. This is insanity of a level which requires a very great degree of intelligence to achieve. In primitive societies in the Kalahari, they are aware that the duty of the young to support the old is a moral duty. This moral duty even made it into the Ten Commandments. It takes years of education to get someone to the point where they believe that it is "immoral" to believe that the old have a claim on the young for no better reason than that they gave birth to them and raised them.

4. In general, projections of catastrophe which have as one of their premises that people will do obviously crazy things, are built on sand.

5. The Labour government's first action on coming to power in 1997 was to pass a law which effectively represented a 10% windfall tax on private pension funds (they removed the tax credit on dividends). The courts didn't make a squeak.

I've never understood how anyone can end up believing that small risk pools are better than big ones, or that equities make a better matching asset for certain future liabilities than bonds. I note idly that in the USA it would be illegal to run a life annuity company on the basis suggested for Social Security; in the UK it is legal, and ask any Equitable Life policyholder how well that turned out.

Posted by: dsquared at September 30, 2004 07:58 AM

Terrible argument in point 1. On the assumption that the equity premium is too high ("we don't believe in markets"), we force a particular segment of society to commit resources to getting prices where we think they should be.

Paternalistic argument in point 2. Households (make that "people") are myopic, a polite way of saying stupid ("we don't believe in incentives, intertemporal discounting, or rationality even in a bounded form"). Didn't I learn in 101 that the best thing anybody could have in order to boost their own welfare is control over how their own resources are spent? That's the standard argument against non-cash forms of public assistance. Recipients can do better at making spending decisions than policy makers. Surely, that holds across time.

Point 3 is easy enough to get around legislatively, if that's what we want to do.

Point 4 is a structural issue, which was at least partially addressed with REAL paygo rules. A return to such rules seems vastly superior to beggaring the Social Security fund to keep congressional (and presidential) mitts off the money. Indeed, only part of the Social Security fund is made safe from politicians if only part of the fund is privatized.

Point 5 substitutes "would" where "could" might be more appropriate. Courts "could" stand ready to defend our right of property, though I agree they very probably would.

Alan H.

It is a bit of a stretch to say that the present SS system means people don't have to have nest eggs. The monthly payout from SS seems rather small, relative to what most retirees will want to spend.

Posted by: kharris at September 30, 2004 08:05 AM

I join with others in saying that point (5), at least, is unpersuasive. There is simply no reason government could not appropriate these accounts, or a substantial portion of them, through taxation. Surely the chance of that is as good as the chance that it will drastically cut benefits under the current system.

And to some degree that applies to (4) as well.

Posted by: Bernard Yomtov at September 30, 2004 08:13 AM

Wouldn't Point One Create a Bubble Market, much decried in the 1990's?

Point Two ignores the huge transition costs required to create these "private accounts" and it also ignores the non-ROI functions of SS...Survivors insurance, disability insurance and COLA adjustments.

Point Three ignores the influence of Wall Street and "private" corporations on our electoral process and the ultimate amoral nature of the corporation which only wants PROFIT and COMPENSATION FOR IT'S CEOS AND EXECUTIVE STAFFS.

Point Four again ignores the transition costs

Point Five ignores that you wouldn't own anything worth having. I'm reminded of Groucho Marx "I wouldn't belong to any club that would have me" I wouldn't want anything in the way of private accounts that the government is willing to give me.

Posted by: Oleary at September 30, 2004 08:30 AM

Vicki Meagher's questions get to the real problem, and the fault of the Bush govt's support of privatization. To make it work, a tough system of regulation and protection is required to guarantee that people don't get wiped out by bad investment decisions and exploitative investment advisors. Getting wiped out of their retirement and health savings will leave them a burden on the public, again. I don't think it is reasonable to assume or expect that 95% of the public can adequately understand markets and investing and adequately protect themselves. Investing is still an insider's game, and probably will always be so.

The problem is that the Bush Republicans are adamantly against regulation that protects people but makes things difficult for big business. As Brad says, they want to feed the Mutual Fund industry's pockets. And they use the old conservative saw, 'people want to be responsible for/in control of their own lives', that is, 'we insist people bear all the risk'.

For liberals/progressives to simply oppose privatising SS in principle is close-minded. The issue is how to make it work for the people. That is the last thing Bush has in mind (if he has anything at all in his mind).

Posted by: paulo at September 30, 2004 08:38 AM

"I don't think the Bush administration itself knows why it is in favor of Social Security privatization. It only knows that it is."

The Administration wishes to lessen the influence of government on the economy. Of course, having a proper budget would do just this, but logic is not as important as ideology. Social Security is a New Deal social benefit program that conservatives have long wished to limit. Privatizing Social Security has the flavor of lessening government influence and that is all that is needed for conservative support.

The reason the Administration was able to convince conservatives in Congress to expand Medicare, is that the expansion will be to the gain of private insurance and drug companies. Again, there is a sense that government influence will be limited even in the expansion. Notice that the government will not be bargaining over drug prices for the coverage.

Posted by: anne at September 30, 2004 08:45 AM

Yea, I mean if nothing else being a Republican means being against private property. I wish Brad would go straighten out Ramesh Ponnuru. RP is always whining about how SS is like grandparents mugging grandchildren. I wish Brad would let him know his whining about pre-funding is inconsistent with his right wing beliefs.

I won't let the inane and ludicrous partisan hackery of claiming, not just that the that the right does not support SS privatization for any of the good reasons and instead for all the wrong and venal reasons, but going even further and claiming that all the good reasons for supporting SS privatization are inconsistent with the beliefs of the right, stop me from saying

nice post.

Posted by: BigMacAttack at September 30, 2004 08:48 AM

Pretty impressive, Professor; you've made d squared turn to religion. I guess there really are no atheists in foxholes.

Posted by: Patrick R. Sullivan at September 30, 2004 08:52 AM

I see no reference by Brad or in any of the posts (sorry if I missed one) to the recent report in the Economist (sponsored by the World Bank) discussing the problems with privatization in Latin America. Odd, as I believe it is to be published by Stanford University Press.

Posted by: Sam Taylor at September 30, 2004 09:55 AM

You are right in saying that Duncan Black's argument are not consistent with the right's view of the world. While I'm not sure if I would even agree with all of his arguments for privatization as it is commonly defined, this is intriguing. Only question: where is his argument to be found?

Posted by: pgl at September 30, 2004 09:59 AM

OK - skip my dumb question as I did not realize that Duncan Black is none other than Atrios.

Posted by: pgl at September 30, 2004 10:02 AM

Jonathan Goldberg,

You mean we could lend them, businesses in other nations, current production?(For their future production.) That we could do and it might benefit all parties.

Private investment, as opposed to government investment in paying farmer's not to grow corn and midnight basketball courts, results in a higher rate of return, in the form of higher real GDP growth, which makes it easier for future generations to shoulder the burden however the payout is made.

Posted by: BigMacAttack at September 30, 2004 10:07 AM

"On top of all that, SSA can survive only as long as each successive generation is bigger than the previous."

Actually, SSA can survive only as long as each successful generation is more productive than the previous.

In addition, the public must have some claim to a portion of that increased productivity (e.g., due to public investments - transportation, etc.)

Posted by: peBird at September 30, 2004 10:10 AM

DSquared

Interesting complaints!

Posted by: anne at September 30, 2004 10:52 AM

peBird,

Kinda of but not really. Because if the next generations is twice as productive thanks to the investments of the previous generation but the previous generation is 4 times as large as the next generation the previous generation is uhhh in trouble.

Posted by: BigMacAttack at September 30, 2004 11:11 AM

Maybe d-squared will fight with me.

I only have time for point 2.

'2. Aside from the fact that this is social engineering far more radical than the French working hours legislation, savings are fungible. It could easily go the other way; that households do not currently count SS as part of their savings and would reduce other savings if they began to do so.'

They would reduce their other savings in excess of the new savings? I am not counting on SS. So I save 10% of my income in pile A. SS is privatized so I can now count on 5% of my income being saved in pile B. I donít need 15% of my income saved, I need 10%. So I reduce my savings rate for pile A by 8% to 2% so I am only saving 7%?

Might go the other way. Not bloody likely.

Now someone might argue that since I expect a higher rate or return on pile B I might do that.
Two answers.

One, someone so risk averse they wonít count SS as part of their retirement fund would seem to be a very unlikely candidate to count so much on that higher rate of return.

Two, so what? We donít care if less is invested if the higher rate of return means the final return is the same.

Posted by: BigMacAttack at September 30, 2004 11:43 AM

brad,

Something I don't get -- we have a national debt greater than the social security current accounts surplus, right? and the excess social security money is just kept in the treasury, right?

So it just helps cover the deficit. In effect, we've bought t-bonds with it.

If you released it to people to invest, someone would have to buy the t-bonds. You wouldn't have any change in the amount of money invested in private stocks. You'd simply have 1) a change in who was picking which stocks to invest in; and 2) a change in the price of and the composition of the investor pool for t-bonds. Nothing would really change.

Posted by: wilson at September 30, 2004 01:02 PM

brad,

Something I don't get -- we have a national debt greater than the social security current accounts surplus, right? and the excess social security money is just kept in the treasury, right?

So it just helps cover the deficit. In effect, we've bought t-bonds with it.

If you released it to people to invest, someone would have to buy the t-bonds. You wouldn't have any change in the amount of money invested in private stocks. You'd simply have 1) a change in who was picking which stocks to invest in; and 2) a change in the price of and the composition of the investor pool for t-bonds. Nothing would really change.

Posted by: wilson at September 30, 2004 01:03 PM

brad,

Something I don't get -- we have a national debt greater than the social security current accounts surplus, right? and the excess social security money is just kept in the treasury, right?

So it just helps cover the deficit. In effect, we've bought t-bonds with it.

If you released it to people to invest, someone would have to buy the t-bonds. You wouldn't have any change in the amount of money invested in private stocks. You'd simply have 1) a change in who was picking which stocks to invest in; and 2) a change in the price of and the composition of the investor pool for t-bonds. Nothing would really change.

Posted by: wilson at September 30, 2004 01:04 PM

brad,

Something I don't get -- we have a national debt greater than the social security current accounts surplus, right? and the excess social security money is just kept in the treasury, right?

So it just helps cover the deficit. In effect, we've bought t-bonds with it.

If you released it to people to invest, someone would have to buy the t-bonds. You wouldn't have any change in the amount of money invested in private stocks. You'd simply have 1) a change in who was picking which stocks to invest in; and 2) a change in the price of and the composition of the investor pool for t-bonds. Nothing would really change.

Posted by: wilson at September 30, 2004 01:06 PM

I apologize for the multiple post -- it took several minutes to post, and in the meantime, I pressed post again to see if it would then go through. Sorry

Posted by: wilson at September 30, 2004 01:08 PM

Dear Brad

As you know I think that the federal govt should buy corporate shares. I think your point 3 is just silly. The treasury is subject to the law. Congress can require the treasury to vote its shares proportionally to how other shares are voted. There is no logical reason why the Federal Govt is forced to participate in control of firms if it owns shares. Nor, in the USA is there any noticible temptation.

Now if the US had a national corporate code, it could say that Treasury owned shares had no vote and the number of votes is equal to the number of shares in other hands. Still I don't see the problem.

As to private social security accounts being safe from the grasping hand of congress, I think congress ruthlessly cutting the pensions of the baby boomers is the least of our problems bar none. We can take care of ourselves (sorry Brad we were born in the last year of the baby boom so, like it or not, we are technically boomers). The current retired can make congress jump through hoops. The risk is retired boomer tyranny not that we will be left on the ice flows.

Note Atrios mentioned publicly owned shares. What's wrong with it ? It's socialism but what is wrong with socialism ? Totally aside the equity premium puzzle, just the thought that Ed Prescott and Martin Feldstein could be remembered as the intellectual fathers of American socialism is worth 13 trillion in my book anyday.

Posted by: Robert Waldmann at September 30, 2004 01:31 PM

I donít often disagree with Professor DeLong. But here goes:

1. Complaints about the historically high equity risk premium suggest under-investment in equities but this has nothing to do with privatization. The government can invest in equity indexes more easily than individuals. Iím skeptical about investing a high share of social security assets in equities since this will correlate social security asset returns with shortfalls in private retirement accounts and in government tax receipts.

2. Echoing other posters: forced savings will only make a difference with individuals currently not saving privately. Everyone else will merely substitute mandated savings for their private savings. Low and middle income individuals pushed into inappropriately risky high-fee investments might well become discouraged savers due to the volatility of mandated equity-based personal accounts.

3. As others pointed out, government can easily refrain from voting their shares or say buy corporate bonds .

4. Investing social security funds in corporate bonds would force the Congress to attract private bond investors for substitute funds. The resulting pressure on treasury rates would offer some counterweight to congressional over-indulgence.

5. Isnít it appropriate that citizens have a common interest in defending social insurance programs? Social security divided into private accounts undermines the common interest voters have in defending social security and opens the door to congressional mischief. It isnít hard to imagine Tom Delay et al crafting special tax benefits for particular classes of private accounts.

Finally, discussions of private accounts should always be prefaced by acknowledging our inability to afford the transition costs given a budget with a deep structural deficit.

Posted by: ftm at September 30, 2004 09:03 PM

The most important fact about social security is that it is a mechanism for transfering goods and services from working people to people no longer working due to age or disability.

The basic mechanisms for allocation are not monetary. They are moral.

We use monetary terms and measurements to describe how much people are expected to contribute and how much they are expected to receive, because most people are used to exchanging goods and services for money and to discussing the allocation of goods and services in monetary terms.

Social Security sets up a benefit that varies over a narrow range depending on one's contributions to it during one's working life. There are three ideas behind this. One is that everyone who has contributed to the economy for a good portion of their working life should receive some basic benefit when they have reached a certain age. The second is that people who have contributed more should get more. The third is that there is no moral obligation to make anyone rich.

If you want to get rich, go to the private sector.

The relative narrowness of expected contribution has a different moral basis.

Social security actually works pretty well in its hybrid moral/monetary accounting. We require people to put in goods and services and we dole out goods and services. Both the working and the retirees achieve some consensus as to what comprises an appropriate benefit based on moral grounds, and then fudge the dollars to make it work.

Contributions and benefits vary with the moral consensus with regard to what goods and services people get and what people are expected to contribute. As noted earlier, at any given time, goods and services are transfered from working people to people no longer working. If a retiree buys a can of beans, those beans were farmed and put in the can by a worker. If a retiree gets a haircut, that haircut is provided by working person. Everything else is just bookkeeping to determine how many cans of beans or haircuts we agree that retirees are entitled to.

Money is not magic. Stock prices are not magic.

If you put a dollar or a chunk of gold in a safe, or buy a block of stock in a company, the value of that money, or gold, or stock is determined relative to the changing demand and supply of other goods and services. If everyone is selling stock to buy cans of beans, then the price of beans goes up with respect to the value of shares of stock. If everyone is selling gold to get haircuts, then the value of gold depends on the supply of barbers and beautificians.

Social security lets us deal with a moral obligation in monetary terms. The more complex and variable the external factor we tie it to, the harder it is to fudge the monetary terms to meet the moral obligation.

Of course, one can argue that the quantity of goods and services one receives upon leaving the work force should be allowed to go to zero, or perhaps lower. One can even make a symmetric argument that the fear of starvation in retirement will encourage people to starve while still working in order to provide for later. I've actually heard this argument made, usually by people making well over the median income.

In a democracy, we have a political mechanism for determining a minimum benefit. Social security allows us to argue about it directly. If we haul the stock market into the argument, we may wind up making moral arguments that all companies need government subsidies since they may be owned by retirees who otherwise would be forced to eat dog food.

This is not far fetched. They used to call Bell Telephone the canonical "widows and orphans" stock, and regulators actually set phone service prices so they could pay an appropriate dividend.

I shudder when I consider the market distortions tying retirement income to the stock market this would cause.

Posted by: Kaleberg at September 30, 2004 10:46 PM

The reason to privatize SS is to use "The Wisdom of Crowds." Its time has come. The 21 Century will be seen in this light. We are witnessing the birth of a new form of collective governance. I propose its name. WOC :-)

Posted by: Huggy at October 1, 2004 06:07 AM

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Posted by: Phone Chat at October 1, 2004 07:02 AM

Anne writes, "Since 1983, American workers have been providing a surplus to Social Security to prepare for the demographic shift that will occur as the baby boom generation retires..."

That means nothing, Anne. Every cent of that surplus has been spent. That money is gone.

"Baby boomers have been most responsible in preparing Social security for the future."

Again, that's too bad. It doesn't matter whether the Baby Boomers were responsible...because the federal government was did not behave responsibly. They spent every penny of that surplus. It's all gone.

"To threaten the benefits of baby boomers on the eve of retirement is thoroughly immoral."

What the federal government did *was* immoral. But it's ALREADY been done. The immorality has ALREADY occurred. The surplus is not there. It's been spent.

"The problem with privatizing Social Security is above all the cost that will further threaten promised benefits."

There is no cost to privatizing Social Security that is not already present. Every dollar not put into the system by the younger generations is a dollar that the federal government doesn't owe in the future.

"Well, the promises have been made and payroll taxes collected to provide for the baby boom generation. Keep the promises."

The promises simply can NOT be kept for every generation, Anne. The federal government already spent the excess money that was put in above what went out to Social Security. ***SOMEONE*** is going to get hosed. It's just a matter of how the hosing is distributed. If all the promises are kept for the Baby Boom generation, it's going to mean that much more that future generations will get hosed.

P.S. Truth-in-Commenting Note: A way that one *might* rationalize cheating future generations on Social Security is the possibility that they will be so wealthy that it won't make any difference that they get cheated:

http://markbahner.typepad.com/random_thoughts/2003/12/economic_growth_1.html

Posted by: Mark Bahner at October 1, 2004 02:33 PM

On what planet does letting people choose where to invest their social security money meet social security's #1 goal - providing a guarenteed baseline level of retirement income?

Posted by: Jason McCullough at October 19, 2004 07:52 PM