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December 26, 2004

Social Security Yet Again: A Clarification

A clarification: Michael Kinsley writes:

washingtonpost.com: If It's Right, It's Wrong: Berkeley economist Brad DeLong... challenged my argument that nothing about privatization promises to increase private investment. They cited the well-known research by economist Martin Feldstein showing that Social Security reduces personal savings. Big surprise: If you know you've got a bit of a nest egg coming from the government, you may not be as avid a saver. It follows that less Social Security should increase personal savings. But privatization is not supposed to produce a net loss in anyone's retirement nest egg. In fact, if it worked as promised, it would enlarge the nest egg. By the Feldstein thesis, that would reduce private saving. So, once again: Privatization relies on a theory that is wrong if it's right, and right only if it's wrong....

I was actually thinking of a different line of argument that Marty makes. These days he is more likely to stress not the reduction in personal savings that may be generated by expectations of the continuation of the pay-as-you-go Social Security system, but the gap between stock and bond returns. Marty's argument these days is much more likely to be the claim (with which I have a lot of sympathy) that the stock market does a lousy job of mobilizing society's risk-bearing resources. Stocks appear to be priced as though the marginal investor is a rich 62-year old with some clogged arteries and a fifteen-year life expectancy who is not expecting to leave a fortune to his descendants. But if the stock market were working well, the marginal investor would be a 40-year old in his or her peak earning years looking out to retirement spending 40 years in the future--an investor much less averse to risk than the 62-year old.

Turning Social Security into a forced-equity-savings program would, Marty believes, not only produce huge profits for the system but also materially improve the efficiency of U.S. financial markets.

I would rather see this forced equity savings done not through private accounts but through allowing the Secretary of the Treasury to invest the Trust Fund in equities. I would rather see this done by the Treasury Secretary for three reasons: (1) if I'm wrong, then there's no great harm, while there is great harm if you cut people's benefits assuming expected stock returns will be high and they aren't; (2) there's still a lot of risk out there, and the government is better-positioned to bear that risk than individuals; (3) offer individuals the opportunity to do so and they will churn their investments, buying high and selling low. The only reason to use private accounts for this forced equity savings is the fear that having the Secretary of the Treasury control a lot of equities will magnify our corporate oversight and control problems, and I don't see this is a first-order problem.

Posted by DeLong at December 26, 2004 10:53 AM

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» Conservative Economics from Political Animal
CONSERVATIVE ECONOMICS....Today I find myself reading Brad DeLong's blog and I am puzzled. He summarizes Martin Feldstein's current thinking about Social Security privatization thusly:Marty's argument these days is much more likely to be the claim (wit... [Read More]

Tracked on December 26, 2004 02:16 PM

» Government Invstment In Equities: It's Not As Simple As It Looks from Discourse.net
Brad DeLong writes writes in favor of federal investment in equity markets in the context of various Social Security privatization proposals. After demolishing some really bad ideas, he says, I would rather see this forced equity savings done not throu... [Read More]

Tracked on December 26, 2004 03:03 PM

» Froomkin 1, Treasury 0 from Emergent Chaos
Michael Froomkin sees the idea of the secretary of the treasury investing the social security trust fund, and finds it wanting.... [Read More]

Tracked on December 26, 2004 06:44 PM

» My Point, But Better! from Obsidian Wings
DeLong makes part of my point (see below, including comments) regarding the benefits of Social Security reform, and makes it better that I did (or could). [Read More]

Tracked on December 27, 2004 08:57 AM

» Equity market inefficiency & Soc Sec privatization from Crossing the Globe

Now here's a comment from Kevin Drum that's worth pursuing -- he's picking up on a Brad DeLong analysis of Martin Feldman. This is worth exploring further -- Drum thinks either DeLong's got the argument wrong or conservatives have left the reservation.

[Read More]

Tracked on December 27, 2004 04:51 PM

» Catching my eye: morning A through Z from The Glittering Eye
Quite a few blogs are still on holiday hiatus. Here's what's caught my eye this morning: The Becker-Posner Blog's topic for the week is Disease, Population, and Economic Progress. Brad DeLong has a good, succinct statement on where my thinking... [Read More]

Tracked on December 28, 2004 06:51 AM

Comments

Why wouldn't current investors get in front of this thing by altering their asset allocation and leave the predictable newcomers to buy stocks with pre-shrunk risk premiums?

Posted by: snsterling at December 26, 2004 11:41 AM


Are you really saying you want John Snow investing Social Security funds?


I'm no libertarian, but the notion of the Secretary of the Treasury controlling a trillion dollars or so in equity is terrifying. The political pressures on investment decisions, and shareholder votes, would produce corruption, inefficiency, and just plain terrible decision-making. This idea is a disaster waiting to happen.

Posted by: Bernard Yomtov at December 26, 2004 01:40 PM


SNSterling asks:
"Why wouldn't current investors get in front of this thing by altering their asset allocation and leave the predictable newcomers to buy stocks with pre-shrunk risk premiums?"

precisely. One only has to look at what happened in 2002 to understand that the current "rally" exists, at least in large part, by the expectation that there will be increased demand for stocks in the not too distant future thanks to "privatization."

By the end of winter 2002, the stock market had recovered most of the value lost in the immediate aftermath of 9-11, the recession had ended, and things were looking pretty good overall. Nevertheless, in early spring of 2002, the market tanked....

Now, the only reason that I can come up with for this is that the Democratic Party decided to make the GOP's support for privatization of Social Security a major issue during the mid-term elections----and in the "risk averse" post 9-11 environment the GOP's own pollsters were saying that support for privatization could hurt the GOP a LOT. So the GOP ran screaming as loud and fast as it could from privatization---at one point even denying that the party ever supported the idea of privatization of Social Security. (of course, it was in the 2000 GOP platform...)

....and with the GOP running away from privatization, it meant that all that new money that would be coming into the stock market wasn't going to materialize. In a classic example of the supply and demand theory, the market had been driven up by the prospect of increased demand for stocks, and when it became obvious that the demand was not going to materialize, the market tanked.

There is an "economic Heisenberg principle" at work here---the minute an true observation is generally accepted about the stock market, it is no longer necessary true, and is more than like to be false. We're still working from the premise that you can't do worse in the stock market over a 30 year period than you do with Social Security.

But the fact that we accepted that premise means that it no longer is true---americans now invest more (increasing demand for stocks and raising their prices) because they don't think there is any risk. An observation that was true based on stock pricing that assumed there was a risk in investing will probably not be true when stock prices are based on the assumption that they represent no risk, because the initial purchase price of the stock will be inflated by the "no risk" expectation.

I think my "favorite" bad argument for privatization is the one that says there will only be 2.3 workers per social security recipient in 40 years. Well, you know what---there will only be 2.3 workers to buy the stocks being sold by retirees in 40 years as well---in 40 years, those 2.3 workers with their own private account will be creating far less demand for stocks than will be needed when all those retirees are selling off the assets of their own "private accounts" to maintain their retirement standard of living. Stock prices will take a long, sustained dive, and all those private account holders will find themselves out of luck....

Posted by: paul_lukasiak at December 26, 2004 02:36 PM


Brad - ...stock market does a lousy job of mobilizing society's risk-bearing resources

What, if anything, is a "risk bearing resource?"

If you mean we aren't investing enough in dubious enterprises, then, hey, we tried that in the late 90's.

Posted by: CapitalistImperialistPig at December 26, 2004 02:37 PM


Is that listed under the privatization options? I think it is, but I am not sure.

Posted by: Brian at December 26, 2004 04:49 PM


"...the one that says there will only be 2.3 workers per social security recipient in 40 years. Well, you know what---there will only be 2.3 workers to buy the stocks being sold by retirees in 40 years as well..."

Not true. Stocks (and bonds) trade worldwide. This is the key point everyone seems to be missing.

If we stay with the current SS system, we're stuck with the 2:1 ratio to finance it. But if we move to a true investment system, then we accumulate capital worldwide. I.e. we would overcome the demographics that doom the current system.

Posted by: Patrick R. Sullivan at December 27, 2004 06:58 AM


"Stocks (and bonds) trade worldwide. (...) But if we move to a true investment system, then we accumulate capital worldwide. I.e. we would overcome the demographics that doom the current system."

So we must rely on Chinese and Indian investors buying the stocks from our portfolios when we retire and want to cash out our investments. In effect, we "save Social Security" by selling American companies to China and India.

Posted by: enfant terrible at December 27, 2004 07:33 AM


Patrick E. Sullivan - "If we stay with the current SS system, we're stuck with the 2:1 ratio to finance it. But if we move to a true investment system, then we accumulate capital worldwide. I.e. we would overcome the demographics that doom the current system."

OK, let's see. Right now we are the biggest debtor nation in history. So you now propose to borrow another $10k or so per capita to invest in other countries to fix that problem? Sounds like schmuckenomics to me. If we want to accumulate investment in other countries, we need to reverse the current accounts deficit, not increase it.

Posted by: CapitalistImperialistPig at December 27, 2004 07:36 AM


The Federal Government is already purchasing stocks on behalf of a group. The National Railroad Retirement Investment Trust already does this. A few years ago, the Congress gave away the Railroad Retirement Trust Fund, the equivalent of the Social Security Trust Fund, but on a much smaller scale, to the private NTTIT. The NRRIT invests these funds in any instrument it wishes. These assets fund railroad retirement benefits.

Posted by: arthur arfa at December 27, 2004 10:58 AM


"So we must rely on Chinese and Indian investors buying the stocks from our portfolios when we retire and want to cash out our investments. In effect, we "save Social Security" by selling American companies to China and India."

Supply and Demand. When you put your house up for sale, do you hope for more or fewer potential buyers?

"OK, let's see. Right now we are the biggest debtor nation in history. So you now propose to borrow another $10k or so per capita to invest in other countries to fix that problem?"

Elementary economics: If one can borrow at low interest rates and invest the money at a higher return, then you should. But, especially when you're going to have to borrow the money regardless (or cut the promised benefits, or raise taxes).

"Compared to what?", people.

Posted by: Patrick R. Sullivan at December 27, 2004 05:07 PM


"If one can borrow at low interest rates and invest the money at a higher return, then you should."

That's either arbitrage or leverage. If it is arbitrage then, yes, you should, but good luck that you'll ever have the opportunity. If it is leverage, then you should only do it if you wish to take on more risk.

And I don't see what your house for sale example has to do with my remark about moving Wall Street to Bombay (or leaving it where it is if Indians prefer to outsource the work to low-paid Americans).

Posted by: enfant terrible at December 27, 2004 08:09 PM


I find it somewhat surprising that so little discussion exists about ways to improve returns to the Social Security Trust Fund by creating a mechanism for allowing managers of the funds to make investments directly in a variety of equity, debt or other financial assets. The main objections to such a direct approach appear to center on (1) concerns about the ability of such managers to act responsibly, and (2) some naieve belief that only individuals have the ability to make the investment decisions necessary to improve overall returns for their accounts.

Certainly, it is challanging to develop a process that ensures that invstment advisors hired by Social Security Fund managers act in the best interest of Social Security enrollees. Nonetheless, it is possible to picture better investment results from internal investment of funds based on examples from current public retirement funds that do a good job of investing assets for which they are responsible. These well managed funds appear to improve ignificantly the overall return on investment relative to returns from treasury bonds. Given these examples, it is reasonable to believe that policies guiding such investments for SS funds could improve returns significantly across the next 25 to 30 years. Such an approach actually could reduce the current actuarial deficit and reduce the need for some or all of the currenly assumed need for an external injection of funds to fuel the transition to a system of private accounts of unknown quality.

Having made the pitch for an internal strategy, it is important to note that there are activities attributed to public retirement funds that some consider controversial. Specifically, some object to the corporate governance activities often ascribed to these funds. If these activities are of concern, one should be careful to ensure that the investment activities of the well managed funds remain insulated from such pressures. Whether we like private accounts or not we should continue discussion of options for improving returns to the current Social Security system.

Posted by: David Illig at December 28, 2004 01:04 AM


"...Stocks appear to be priced as though the marginal investor is a rich 62-year old with some clogged arteries and a fifteen-year life expectancy who is not expecting to leave a fortune to his descendants..."

??????

Everything I have seen on P/E ratios indicates that they are at one of the highest levels in history, far above historical averages, and that the underlying earnings are substantially overstated.

Dividend yields are extremely low by historical standards. Many tech companies never pay dividends; though the justification for this is that their enterprise value will just increase forever thanks to reinvestment of the profits, in fact most of them live a fairly short life, and the gains of the early shareholders are negated by the losses of the suckers they sell out to -- their business operations never return a dime of income to the investors.

On what basis do you opine that stocks are underpriced?


Posted by: jm at December 28, 2004 07:20 AM


David suggests: "Whether we like private accounts or not we should continue discussion of options for improving returns to the current Social Security system."

Well, that's easy enough to do. Just have the government pay a significantly higher rate of interest on Treasury notes held by the SS Trust than those offered to the private sector.

I mean, this simple step could, by itself, guarantee the long term solvency of the Trust Fund. We don't need more money coming in to the Trust from SS taxes, all we need to do is make sure that SS surplus is earning the "right" rate of interest to ensure the solvency of the system.

I'm surprised I never thought of this before---I usually come up with stupid ideas pretty quickly

Posted by: paul_lukasiak at December 28, 2004 02:25 PM


[yet another comment spam makes it through]

Posted by: at December 31, 2004 10:51 AM