Land and Sea
Private Accounts, Social Security and Risk
(written by Lancelot Finn, October 21)
Land and sea, state and market
The sea's moods are always changing. It is smooth one day, choppy the next. It changes color, from light blue (a bright summer day) to dark blue-gray (in a storm) to white (when the waves crash) to pink (at dawn or sunset) to black (at night). From moment to moment, hour to hour, and day to day, the sea is fickle and changeable.
By contrast, the land seems firm and steady. You can rely on it to look the same today as it did yesterday. The towering mountains, the broad-shouldered hills, the commanding cliffs, the high, rocky steppes and the rich, deep fields, all these seem constant. "Solid ground" is a metaphor for constancy.
But now change your perspective. Take the God's-eye view. You are high above the earth, a thousand years are the blink of an eye. What do you see now?
As geological time unfolds, you watch the continents slide this way and that, run together and split apart. Mountain ranges rise and then erode away, deserts turn to forests and plains to glaciers. Islands pop up and sink back into the sea.
Yet the sea remains, the one permanent fixture, a great wet blue expanse that wraps up most of the Earth, rising and falling with time, changing shape to make room for the constant, but always the same level, the same color. If you take the long view, it is the land which is always changing, and the sea which is constant.
Land and sea are a metaphor for government and the market economy. The private sector, like the sea, is always in motion, rising and falling with the tides (business cycles). Private employees, like waves, move up and down, press forward and sometimes gets smashed against the rocks. Firms, like storms, appear, grow large, make a big impact, and then, often as not, die away just as quickly. The government is like the land. Bureaucrats, like rocks, are held firmly in place by lifetime job security. Government agencies, like mountains and cliffs, are rigid and hard to destroy, as many would-be small-government conservatives have discovered.
Yet if you take the long view, it's the other way around. The secular trend of rising living standards and advancing technology has continued pretty steadily, generation after generation, for two centuries. It is trends in the political arena that are transient.
In the past century, America has gone through the Progressive Era, the "business of America is business" 1920s, the New Deal of the 1930s, the moderate conservatism of Eisenhower in the 1950s, a new phase of welfare-statism with the New Frontier of Kennedy and the Great Society of Lyndon Johnson, and then, after 1980, in a sharp reversal, the Reagan presidency and the re-birth of conservatism, culminating in welfare reform in 1996.
Socialists once called for the government to care for people from "the womb to the tomb." Yet the main welfare program to emerge from the New Deal, AFDC (Aid to Families with Dependent Children) didn't last even as long as it takes a typical person to get from the womb to the tomb.
We should bear this in mind with respect to Bush’s and Kerry’s plans for Social Security this year. With plans for Social Security "privatization," or "reform," or "modernization," playing a large role in this election, the public is worried that private accounts will prove risky, prone to ups and downs, in short, inconstant. The promise of higher returns from private markets is appealing, but they're more concerned about being left penniless in old age.
They have it exactly backwards.
The wrong debate
The debate about Social Security reform has tended to focus on "transition costs." This is a red herring. Arnold Kling and others have explained this better than I can, but I’ll review the case briefly.
In one of the Washington Post's more egregious misrepresentations in recent memory, a headline stated "$3 Trillion Price Tag Left Out as Bush Details His Agenda" This was picked up by blogger Andrew Sullivan as indicating that Bush's proposed second-term domestic agenda would cost $3 trillion. But if you read the article, it said something quite different. Of this $3 trillion, $1 trillion was the "cost" of the extension of the tax cut. Hmm. I probably don't have to explain to anyone that there's a difference between the government spending your money and the government not taking your money.
The other misrepresentation was more understandable. The Post, like everyone else who talks about "transition costs," claimed that if part of younger workers' payroll taxes goes into private accounts, then there will be fewer payroll taxes left over to pay current retirees, which will drain the Social Security "trust fund" (smoke-and-mirrors, that "trust fund," but never mind) and require the government to pay current retirees out of other revenues, either taxing or borrowing. This is true. But at the same time, as younger workers shift to private accounts instead of the traditional Social Security program, the government is being unburdened of future Social Security obligations to these workers. So even if the government borrows all the money it needs to pay current retirees, this will represent no increase in the government's total liabilities.
The Washington Post, then, had it completely wrong. There was actually no "price tag" at all, properly speaking, for the programs they were reporting on. (Other Bush programs do have “price tags,” of course, but overall, the new spending Bush has proposed is small.)
There are red herrings on the other side, too. Advocates of Social Security reform tend to argue that it would benefit the economy by raising savings rates. They also sometimes claim that workers could earn much higher returns on the stock market than in the current Social Security system.
For an explanation of why the more optimistic claims about private returns are based on a faulty extrapolation into the future of a one-off increase in the price-to-earnings ratio, see (again) Arnold Kling. As for savings, Social Security reform would, in effect, turn a worker's payroll tax into forced savings. This would raise the workers’ savings rates, whether workers liked it or not. But these payroll taxes would have been going to current retirees, so the government will have to make up the difference. It might decide to do this through borrowing. In that case, increased (forced) saving by the private sector will be fully offset by increased dissaving by the government.
If there is any increase in net saving as a result of Social Security reform, then, it will be because the government reacts to the increase in its visible (though not its real) liabilities by reducing spending, rather than by borrowing more. This just might happen, but there's no good reason it should.
Imagine a guy (Congress) who likes to sleep in (deficit spend), so he sets his alarm clock half-an-hour slow (maintains the present PAYGO Social Security system with its unfunded liabilities). When he wakes up at eight o'clock (approaches fiscal responsibility), he looks at his alarm clock and sees "7:30," (“surplus”) and thinks to himself It's still an hour and a half before work, and goes back to sleep (starts spending again) for another half-hour (presidential administration or two).
Then he starts feeling guilty about being late for work so much (for running such big deficits), so one day he changes his mind and sets his alarm clock half-an-hour fast instead (changes the PAYGO system to a funded system with private accounts). He tells himself that when he wakes up at eight o'clock now, he won't sleep in. I'll see "8:30," and panic, throw on my clothes, dash out the door with no breakfast, and arrive early! he tells himself. (If we reform Social Security, Congress will spend less, some hope.)
Well, psychologically, the trick just might work. But if the guy is rational, it shouldn't make any difference, since he always knew how fast or slow his clock was, and thus he knew the real time. Establishing Social Security private accounts would turn a lot of unfunded—invisible—liabilities into funded—visible—liabilities, and thus would make the debt and deficit look a lot worse than they look now, but it wouldn't affect the true debt or deficit, so it would give Congress little reason to stop spending. (A change in the formula for the growth of benefits, likely to accompany the creation of private accounts, would, but that's another topic.)
So what would be the effect of establishing private accounts on government spending, and therefore on the national savings rate? No one knows for sure. If all members of the government and all participants in the macroeconomy were rational, creating private accounts per se, should have basically no impact. Of course, in practice, there's a lot of irrationality out there.
But this is an argument between red herrings. The real question concerns risk. Which can do a better job of providing (lower-case) social security, the public sector, or the private sector?
Public-sector and private-sector risk
A lot of people are savvy enough about investment to understand that having a private account doesn't mean being a helpless victim to the mysterious, tidal-wave motions of the stock market. There is a wide array of assets and financial instruments, with varying returns, risk and liquidity. Stocks are lucrative and risky. Some stocks are riskier than others. A diversified portfolio is less risky. Bonds are generally less risky than stocks, since the issuer must redeem them unless they go bankrupt. T-bills are traditionally considered zero-risk, but have a low rate of return. Junk bonds pay more, but with higher risk attached. Bank accounts are zero-risk and highly liquid but pay little or no return. Owners of a Social Security private accounts would choose higher-risk investments early on, shift towards lower-risk investments later, and annuitize the whole portfolio upon retirement. If you don't mind risk you can get a higher return, but you can make the risk pretty low if you want. Still, wouldn't you be even safer with a government guarantee?
And this is where people go wrong. Even though one's retirement security is the ultimate long-run investment, people fail to take the long-run view with respect to the government’s ability to commit.
Those who think Social Security can provide social security should learn a lesson from welfare reform. Time was, when millions of single mothers in America (and others, but they were the biggest group) thought they could live indefinitely off the government's largesse, with no need to get a job. Then welfare became unpopular, and suddenly in 1996 AFDC was phased out and replaced with Temporary Assistance for Needy Families, which came with a five-year time limit attached. They were in a jam. If you think that can't happen to Social Security, bear in mind that very few people would have anticipated in the 1960s that the welfare state would get rolled back—all the trends then suggested it would keep growing. Social Security benefits may be untouchable now. But there's no reason to expect the political equation to hold. People over 65 will always be a minority, so an anti-Social Security majority is always a possibility. Indeed, many elderly have other resources and do not rely heavily on Social Security. If Social Security becomes stigmatized, as welfare became in the 1980s, the better-off elderly may be willing to part with it. In the political arena, there is a lot of randomness: this sex scandal or that unappealing smirk can tip elections and trigger political avalanches. And the winds and currents of popular sentiment are always washing away political consensuses and washing up new ones. The political tables could turn on Social Security in two or three election cycles, easy.
As the Social Security program approaches bankruptcy, Social Security will become the latest incarnation of Orwell's insight that government ministries usually achieve the opposite of what their names suggest, so that their labels routinely turn into euphemisms within a generation or two. The market made the workers better off than the "workers' state" ever did. A Polish labor union triggered the collapse of communism. The market provides for people's welfare better than the "welfare" system. To be on welfare meant you were not faring well. Social Security, in turn, is about to become a major source of social insecurity, for millions of people contemplating retirement.
People in the Soviet Union, Argentina and dozens of other countries worldwide have watched their governments have to break financially unsustainable promises. When the ground was washed out from under their feet, they had a long way to fall. Current trends suggest that will happen to us. If we want to stay afloat, we need to build the ship of Social Security private accounts and set out on the sea of the market.