« More Rumors from Inside the Topkapi Palace | Main | Questions to Ask Social Security Planners »

December 16, 2004

Could Social Security Privatization Succeed?

Michael Kinsley writes:

Talking Points Memo: by Joshua Micah Marshall: December 12, 2004 - December 18, 2004 Archives: My contention: Social Security privatization is not just unlikely to succeed, for various reasons that are subject to discussion. It is mathematically certain to fail. Discussion is pointless.

The usual case against privatization is that (1) millions of inexperienced investors may end up worse off, and (2) stocks don't necessarily do better than bonds over the long-run, as proponents assume.But privatization won't work for a better reason: it can't possibly work, even in theory. The logic is not very complicated.

1. To "work," privatization must generate more money for retirees than current arrangements. This bonus is supposed to be extra money in retirees' pockets and/or it is supposed to make up for a reduction in promised benefits, thus helping to close the looming revenue gap.

2. Where does this bonus come from? There are only two possibilities: from greater economic growth, or from other people.

3. Greater economic growth requires either more capital to invest, or smarter investment of the same amount of capital. Privatization will not lead to either of these.

a) If nothing else in the federal budget changes, every dollar deflected from the federal treasury into private social security accounts must be replaced by a dollar that the government raises in private markets. So the total pool of capital available for private investment remains the same. b) The only change in decision-making about capital investment is that the decisions about some fraction of the capital stock will be made by people with little or no financial experience. Maybe this will not be the disaster that some critics predict. But there is no reason to think that it will actually increase the overall return on capital.

4. If the economy doesn't produce more than it otherwise would, the Social Security privatization bonus must come from other investors, in the form of a lower return.

a) This is in fact the implicit assumption behind the notion of putting Social Security money into stocks, instead of government bonds, because stocks have a better long-term return. The bonus will come from those saps who sell the stocks and buy the bonds.

b) In other words, privatization means betting the nation's most important social program on a theory that cannot be true unless many people are convinced that it's false.

c) Even if the theory is true, initially, privatization will make it false. The money newly available for private investment will bid up the price of (and thus lower the return on) stocks, while the government will need to raise the interest on bonds in order to attract replacement money.

d) In short, there is no way other investors can be tricked or induced into financing a higher return on Social Security.

5. If the privatization bonus cannot come from the existing economy, and cannot come from growth, it cannot exist. And therefore, privatization cannot work.


There are a bunch of possible responses to Kinsley.

Marty Feldstein and company might say that Kinsley's (4c) is false: the inflow of money will bid up the price and lower the return on stocks a bit, but not enough to make long-run stock market investments by private account holders a bad deal. And he would say that taking some of the high returns earned by today's stockholding rich and transferring them to Social Security beneficiaries is the point of the exercise.

Kent Smetters and company might say that Kinsley's (3a) is wrong: that once the privatized parts of Social Security are off the books, the Republican High Politicians will have no option but to propose serious spending cuts or tax increases in order to bring the Federal Government's General Fund into long-term balance. These changes in fiscal policy triggered by the fact that the government is no longer allowed to use the Social Security surplus to pretend that it has a plan for funding general spending will raise national saving, and boost economic growth.

Andrew Samwick and company might say that we dare not raise Social Security taxes without establishing private accounts because we do not dare have the Federal Government voting for CEOs and Directors. This line of thought is that Kinsley is not wrong but incomplete: private accounts then make the policy of raising Social Security contributions a good one.

Ned Gramlich and company might say that raising Social Security contributions becomes politically possible once you have private accounts--that it is the fear that people won't see any return for their contributions that blocks raising more resources for the system. This line of thought is that Kinsley is not wrong so much as incomplete: it's not a privatization bonus, it's the tax increases that privatization will make possible.

All these arguments have, I think, some force. None of them--not even all of them taken together--make a case for whatever monstrosity is about to emerge from the Bush administration.

Posted by DeLong at December 16, 2004 03:04 PM

Trackback Pings

TrackBack URL for this entry:

Listed below are links to weblogs that reference Could Social Security Privatization Succeed?:

» Good post on Social Security privatization from Backseat driving
A post by Brad DeLong covers some of the for- and against- arguments on Social Security privatization. The part I'm most sympathetic to is this one: "Kent Smetters and company might say that Kinsley's (3a) is wrong: that once the privatized parts [Read More]

Tracked on December 18, 2004 05:46 PM


Just a quick question, is there enough established precidence for figuring out what will happen to stocks as the bond market moves from a 2-4% return to say a 6-8% return? It seems that this should cause money to flow from the stock market to the bond market, driving stock prices down. So, are we not set for a correction? Isn't this something that should be added to the discussion?

[Yes. If interest rates go up *faster than the stock market currently expects*, stock prices will come down.

The problem is figuring out what is the rate of increase of interest rates that investors in the stock market currently expect...]

Posted by: Ron Sturtevant-Stuart at December 16, 2004 03:57 PM

The best answer to Kinsley is; "work" compared to what? The current system won't "work" in about 12 years. It really, really, won't work in about 30 years when SS and Medicare combine to approach 20% of GDP.

Posted by: Patrick R. Sullivan at December 16, 2004 05:01 PM

"The only change in decision-making about capital investment is that the decisions about some fraction of the capital stock will be made by people with little or no financial experience. Maybe this will not be the disaster that some critics predict. But there is no reason to think that it will actually increase the overall return on capital."

The argument that the masses are idiots exposes the author as an elitist.

If Social Security reform is what it takes to educate millions of people about markets, so be it.

Maybe a side benefit will be an increase in the number of people voting to change the system back in 30 years if "reform" is a failure.

Posted by: Winslow R. at December 16, 2004 05:12 PM

[The first piece of comment spam to get by MT-Blacklist...]

Posted by: Anonymous at December 16, 2004 06:24 PM

I would argue that the real plus of privatization is not that it addresses the upcoming problem, but that it prevents it from ever happening again.

Posted by: fling93 at December 16, 2004 07:34 PM

I was going to enter the fray directly, but Paul Krugman has already done it for me in tomorrow's NYT Op-Ed column. Even if this scheme were zero-sum as Kinsley's arguing, you will likely be forced to contribute indirectly through a mutual fund, much like in the Section 529 education plans. So the optimistic 6-8% return will have 2% subtracted right out of it. So you'll---at best---break even compared to investments in US gov't bonds.

Posted by: Pete Coffee at December 16, 2004 09:07 PM

I think that any analysis of whether or not social security privatization will fail has to begin with: what are the goals of those who wish to privatize social security?

And since their goal is to throw social security into such a dire financial crisis that we'll have to abandon it, I think they're likely to succeed. Sadly.

Posted by: Jemal at December 17, 2004 06:04 AM

What would generate more wealth: A Soc-Sec contribution to the general fund, or more money in the stock market?

As a conservative I see the general fund as a terrible investment.

I see an investment in the stock market as giving motivated organizations resources to invent and produce.

The money invested in the stock market would generate taxable revenues which would legitmatly flow to the general fund.

What if the SS investments were restricted to go to companies who follow guidlines about min-wage, affirmative action, outsourcing, envirornmental performance, health care for employees, etc?

It is a mystery to my why democrats want to keep the status quo seeing how the current raiding of SS creates a heinously regressive tax.

Posted by: wizard61 at December 17, 2004 10:24 AM

Patrick Sullivan is still convinced that the US Government is going to stop paying its bills in 12 years, and REALLY stop paying them in 30 years. Patrick, do you have lots of canned goods hidden away under your gold-laden mattress?

As for Winslow R. saying that Kinsley is an elitist, I assume you have evidence of a privatized social insurance system that demonstrates the investing accuity of the of the average participant? From what I've seen of the already-privatized systems in the UK, Chile, and Sweden, the average investor's desire and ability to aggressively (and successfully) manage his own account has been extremely limited, and the end result in all cases is that the State has to step in again to make up the difference.

Keynes had it right: "We cannot, as a community, provide for future consumption by financial expedients but only by current physical output." I assume the friends of privatizing on this site are sincere, unlike the bagmen who are behind the administration's Welfare for Fund Managers plan. But it's time to face the fact that, whatever your idealogical proclivities are, you can't solve the "problem" by turning over the trust fund to Wall Street. If you think that all that cash going into stocks is going to fuel a real investment boom, consider this: according to Doug Henwood (1997), "Corporations fund almost all their capital expenditures internally, through profits and depreciation credits. Since 1952, internal funds have covered 91% of capital expenditure; since 1990, 96%." The argument that buying stocks is an efficient means of increasing the actual capital stock (and thus increasing output) is one of the myths that drives this delusion about privatization.

Think the general fund is sink hole? It funded the development of computers when the market wouldn't touch them; it funded the creation of the internet via DARPA (if you have time, just for kicks, search the net for the mid-80's Bill Gates memo talking about what a collosal failure and waste of money the web was going to be); it funds R&D for billions of dollars worth of life-saving pharmaceuticals each year, then turns them over to the drug companies, who gouge us on them. I could obviously go on and on, but the point is that this is a general fund issue, and we either need adults in thew White House and Congress to approach it from that direction (which we don't have), or we need a vigorous anti-propaganda campaign to force the prodigal sons to at least do no harm for the remainder of their tenure.

Posted by: Julian Apostate at December 17, 2004 02:44 PM

The Conservative (note case!) above questions "why democrats want to keep the status quo seeing how the current raiding of SS creates a heinously regressive tax."

Even if I set aside the point that it is the Conservatives that are doing the raiding of SS right now, I'm still left wondering what the point of his question is when right-winger Sen. Graham of SC this weekend proposed RAISING your SS taxes in order to pay for this privatization. If Republicans supposedly want to "get government off our backs," then why are they acting like our nannies wanting to force us to make investments they prescribe? How about if you guys leave me alone so that I can invest my capital as I see fit?

Posted by: Pete Coffee at December 17, 2004 10:16 PM

The "note case" post seems overly concered with the politics. Who is raiding the fund right now is a distracting, the raidig will never stop on its own.

Instead of enlarging the debate into tired Left vs Right, lets talk about what is best for "us" meaning the retiree, the economy, domestic jobs and economy.

The current situation is simple: a regressive tax has been going to the general fund for decades, and will continue to do so unless something changes.

What are our options?

Posted by: Anonymous at December 20, 2004 10:47 AM

Post a comment

Remember Me?