Tuesday, February 26, 2008

The Logic of Privatization Ain't That Inexorable, Bud

by Tom Bozzo

Konstantin Magin of UC-Berkeley has a little Economist's Voice article given the provocative title, "Why Liberals Should Enthusiastically Support Social Security Personal Accounts." You can Read the Whole Thing via a guest registration step, but Magin's argument is, in summary:
  1. Lots of people don't own stocks, and
  2. Therefore they're foregoing stock market returns, which are
  3. Really, really good, especially over the long haul,
  4. Really, really! so
  5. Private Social Security accounts would let everyone in on the bounty at negligible risk [*], while simultaneously solving the problem that politicians raiding the Lockbox imperils the payment of future benefits. It's a win-win!
Under Magin's assumptions, I can easily construct a system that should both perform better and appeal more to liberals: allow the Social Security trust fund to buy stocks with the same amount of money as might be put in private accounts, holding the assets in the Social Security Trust Fund. That would have the following benefits:
  1. It would add at least a couple tenths of a percentage point to the average return through reduced administrative expenses, which is especially beneficial for individuals who by virtue of low wages (and hence low early-career account balances) could pay out their entire returns in expenses for some time unless the expenses were subsidized.
  2. The trust fund (unlike individuals) wouldn't especially care about the performance over any particular 30-year period, so it could improve the fairness of the system in a way liberals would like by absorbing fluctuations in realized returns; beneficiaries wouldn't get differential payouts by virtue of choosing to be born at times that put them on the job market in more- or less-favorable stretches.
  3. Even sane conservatives should like it (notwithstanding the public ownership of private property) because those super-duper returns should allow promised benefits to be paid out without future payroll tax increases, or hey maybe even future tax reductions!
In the end, liberal opposition to Social Security privatization wasn't predicated on the idea that it's a bad thing to have stocks in one's portfolio. I, for one, have a lot of retirement money in stocks! Rather, the actual privatization proposals that were floated were Trojan horses with repeal of the New Deal as the primary goal.

[*] Assuming the assumed distribution of returns is correct, and that the program is set up in such a way that prevents the returns being dissipated by middlefolks or by bad investment choices by individuals, which are big assumptions.

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You cannot earn traditional rates of returns on equities using the economic assumptions of the Social Security Trustees Intermediate Cost alternative (the one always cited). The economy might crash down to the levels the Trustees project (2.2% Real GDP starting in 2013 trending down to ultimate 2.0% in 2025) but if it does it will take any equities based plan with it.
On the other hand economic growth at historic levels fully funds Social Security as is.

This inconvenient truth is what lies at the heart of Dean Baker's No Economist Left Behind challenge from Nov 2004. We have a model that shows a combination of economic and demographic changes that fully funds Social Security with no changes in payroll tax, benefits or retirement age. It is just as official as Intermediate Cost and appears in the same work product, in short Low Cost is out there.

Few privatizers even acknowledge the existence of Low Cost and those that do tend to nitpick at some of the demographic numbers, but the facts are what they are, over the last eleven years actual results have more often than not been better than Low Cost. That will not be true for 2007, Q4 economic numbers were dreadful, on the other hand actual receipts to the Trust Funds came out ahead of projections and more than half way towards Low Cost. Year End Balances (from Treas via my site)

Privatizers, if they want to be honest, need to present their own growth assumptions and then rescore Social Security under them. It is not fair to use one set of books (Intermediate Cost) to project crisis and then use another set to propose a fix. But that is exactly what is going on here. Give me an economy that gives a 6.5% return on a private portfolio and I will give you a fully funded Social Security system as is. Low Cost is the invisible elephant in the room. But if you listen closely you can hear it rumbling.
Excellent points, Bruce. My intent was to accept Magin's return assumptions only arguendo, and the meta-point (not a new one to this blog) is just that *any* private-accounts plan is dominated, mostly for transcations-costs reasons, by a plan that skips the private accounts and lets the trust fund be invested in whatever assets the privatizer is pushing.
"Rather, the actual privatization proposals that were floated were Trojan horses with repeal of the New Deal as the primary goal."
This may not be completely fair.
I don't know, but I assumed that a significant goal was also directing investment fees to Wall Street.
The issue of fees is in my view overstated, it historically has not been Wall Street pushing for private accounts, by and large they understand that you don't profit from accounts as small as most of these would be. Moreover you can bet there will be enormous political pressure to keep those fees low, if nothing else to maintain some kind of actual return.

No the opposition to Social Security has always been ideological and driven by politics and not the economics. While I may be missing the intended point of Tom's last sentence, it is not my experience that privatizers are at all focused on improving Trust Fund performance through diversification, the focus never seems to be on the asset class as such but always on the PRA angle.

I would welcome a discussion revolving around diversification of Trust Fund assets, in fact I have argued that not doing so has the potential to set up an intergenerational clash around mid-century. Because oddly enough a Trust Fund entirely invested in Treasuries can in some circumstances be too large to be politically viable, a vulnerability it would not have if say invested in state and local bonds. But that discussion won't go forward until we get past the 'crisis' model and admit that given normal economic growth Social Security is very close to being fully funded as is.

It is no longer astonishing to me that people don't realize that Social Security's actual future performance is contingent and not fixed. You would think people might get an inkling of this from the fact that the dates of depletion keep moving and mostly out, but in my experience one and the same reporter will segue in their reporting from "Social Security will go deplete in 2034" to Social Security will go deplete in 2037" (the actual change between the 1999 and 2000 Reports) without asking what to me seemed like obvious questions: one, why did it move so much in a year, and two, can that go on? Those questions never seemed to get asked.
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