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March 20, 2005

Paul Krugman on the "$600 Billion a Year" Number

Paul Krugman tries his hand at showing what's wrong with the Bush-Lieberman "waiting a year to fix Social Security costs $600 billion" number:

Bruce Willis, Asteroids, and Unfunded Liabilities

Sometimes you really have to wonder. It should be obvious that the Social Security Administration’s estimate of the growth of unfunded liabilities says nothing – nothing at all – about the cost of delaying a “fix”, whatever that might mean. But it seems that even many economists – to say nothing of Joe Lieberman – don’t get it.

So here’s an example, to illustrate the point.

Suppose that an asteroid is bearing down on our planet. If nothing is done, it will strike in 2019, inflicting $20 trillion in losses. At a nominal interest rate of 5 percent, that’s a present value of $10 trillion.

If we do nothing about the asteroid, by next year the present value of the future losses from the asteroid strike will be $10.5 trillion. So the “unfunded liability” from the asteroid strike rises by $500 billion a year.

Suppose that there is a way to fix the problem: we can send Bruce Willis into space to blow up the asteroid. So here’s the question: if we wait a year to send Bruce Willis into space, does that cost $500 billion?

Of course not: it could cost either more or less. If waiting a year means that we’ve lost our last chance to stop the asteroid, it costs $10 trillion – the full present value of the avoidable losses the asteroid would inflict. On the other hand, if Bruce Willis can still blow up the asteroid next year (or any year before 2019), there is no cost at all to waiting. In fact, if waiting increases the Willis expedition’s chances of success, there’s a benefit to delay.

In other words, the $500 billion increase in the present value of the future costs from the asteroid says nothing about the costs of delaying action. All it says is that the future is getting closer.

The same is true for Social Security. The future is getting closer, so the unfunded liabilities of Social Security are rising in present value (though not as a percentage of GDP). This says nothing at all about the cost of delaying a “fix.” Those costs, if there are any, depend on the nature of the fix.

And it’s hard to see any costs of delaying the Bush version of a fix. After all, the problem is that in the absence of changes in the system, at some future date Social Security may have to pay reduced benefits. The only thing the Bush plan does to help the system’s finances is – guess what – reduce future benefits. Why does waiting a year to announce benefit cuts that won’t happen for several decades have any cost?

One last point. Lieberman defends himself by saying that unfunded liabilities do too grow $600 billion a year. But that’s not what he said earlier: he said that each year we delay costs $600 billion, which isn’t at all the same thing.

Posted by DeLong at March 20, 2005 07:44 PM