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From Privatization To Socialism

So I'm reading Delong on Feldstein on social security and I'm thinking once again that the logic of the economist's case for social security privatization actually provides better support for the contention that the state ought to simply take on (partial) ownership of the means of production. What's good about a privatization plan that avoids transition costs is that the relatively high returns you can get in the stock market allow us to magically conjure up enough expected value to cover the transaction costs. But there are two downsides -- one is that if the expected value of private accounts equals the expected value of social security benefits under current law then some accounts will overperform the market and other accounts will underperform it. This is contrary to the underlying logic of social security as a social insurance scheme which is supposed to diffuse risk among the population. Or, to put it more bluntly, we instituted social security because we didn't like to see old people starving, but under private accounts at least some people will make foolish or unlucky investments and wind up starving, which is precisely what we were trying to avoid. The other thing, as Brad says, is that at certain points in time the market as a whole will be underperforming vis-à-vis the long term trend. Unfortunately, these times will be the exact same time that large numbers of seniors need to rely on social security benefits to avoid the aforementioned starvation problem.

In short, as is always the case with the stock market, we're conjuring up additional expected value by taking on more risk.

Fortunately, since social security is a government program (and even a system of government-mandated savings accounts would still be a government program) we have at our disposal the ultimate risk manager -- the government of the United States of America. If, instead of diverting money out of the social security trust fund (i.e., if instead of loaning the money to the "on-budget" portion of the government) and into millions of little private accounts, we simply diverted into one giant government account owning the broadest possible index of American stocks, then we could gin up the exact same overall amount of additional expected value (markets being rational and all, a massive government purchase of an index fund should generate the precise same outcome as millions of people trying to play the market) but maintain the same benefit structure so that stupid and/or unlucky seniors don't wind up starving. At the same time, the government has the capacity to borrow money at a much cheaper rate than would any private senior citizen in order to ride out whatever cyclical rough patches might emerge, secure in the knowledge that over the long term the market will be up.

August 18, 2004 | Permalink


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Tracked on Oct 6, 2005 11:18:04 PM


Markets are not rational. They are not always the best solution to delivering goods and services. Not even close.

Investing in a huge index of American stocks just because they're American and stocks strikes me wrong, somehow. Investment strategies should be more focused.

That's part of it, but I think most of it is that I just don't trust corporate America one freaking milimeter.

The idea we could do better by trusting the market seems incredibly foolish. I'd feel a lot better if all of this ridiculous talk just went away. Can't we get our people meaningful employment before we start to worry about their retirement?

Posted by: paradox | Aug 18, 2004 2:51:34 PM

the argument is that having the govt invest distorts (and according to the privatizers, it is absolutely impossible to shield the system from this influence [protests demanding that the US not 'invest' in tobacco companies, and all that]).
The other argument is that by shifting so much into the stock market we would reduce the relative returns (but I do not see how this would not apply to any privatization scheme).
Additionally, it seems to me that markets are not perfect but that they do take advantage of new information fairly well, and the historically high returns of the stock market might be conventional wisdom and be baked into the current prices (I believe there is a gap between expected risk and the historical return, but could be very wrong).
Also, it seems to me in all of these situations where the goal is universal something [education, health care, minimal retirment] that the governement, being the biggest risk pool [and once we get a world government...], should take on that risk. We can still leverage some market incentives, but the universal nature of the goals breaks the traditional privatization model.
Of course, as we get better I also see these universal minimums increasing as their cost decreases relative to production [universal transportation anyone?].

Posted by: theCoach | Aug 18, 2004 3:05:58 PM

You know that's a clever argument and I'm surprised, now that you mention it, that it hasn't been made more often.

It seems to me that the main problem to solve would be preventing excessive distortion of the market as a result of a massive infusion of government funds. Assuming that you're enough of a free-marketer to think of distortion as a bad thing.

There might be an analogy with the behavior of international currency markets. Currency traders in banks tell me that changes in currency values are easier to predict than changes in stock prices, mainly because some of the biggest players are governments, and they are not playing the same game as profit-maximizing speculators. Something similar could conceivably happen in the stock markets if governments suddenly became big investors, with investment strategies driven by policy rather than pure profit.

Anyway, I sure don't see any snappy answer to your argument that Social Security privatization misses the main point, which is to keep people from starving.


Posted by: MKP | Aug 18, 2004 3:08:03 PM

There's a danger here beyond merely the volatility of the stock market. As Tom Frank noted in a Harper's piece a while back, privatization advocates are trying to ensure that Wall Street becomes the new third rail of American politics. In other words, the well-being of our senior citizens would be dependent on the health of the stock market (which is not always synonymous with the health of the economy as a whole, much less society). So any attempt to do things that might adversely affect corporate profits, such as raising the minumum wage or passing new environmental laws, could be painted as an attack on our elderly, much more directly than is the case now.

Posted by: chilly | Aug 18, 2004 3:08:27 PM

Of course, the major problem with this is the reliance on the stock market. Most stocks are horribly overvalued right now as it is.

An influx of a massive amount of money would only make that problem worse, not better.

And of course, that bubble too shall pop. More specifically, when the baby boomers start pulling their money out of the stock market, values are going to go down signifigantly, which is going to leave a whole lot of people in the red.

Posted by: Karmakin | Aug 18, 2004 3:08:52 PM

Lunch is free! Lunch is free!

Posted by: praktike | Aug 18, 2004 3:10:43 PM

Argghh. One of the insights of Modigiliani & Miller is that it makes no difference to the value of a company whether you finance it with debt or equity* - the more debt you use, the higher the risk, and lo-and-behold, when you adjust the discount rate to reflect the added risk, you're back where you started.

So, as we're going to pay for retirement using the whole productivity of the US economy, it makes no difference whether we're doing so using a defined-benefit like social security (which is like a bond) or using yields on equity from the market.

(*Except for the tax shield of interest on debt)

Posted by: Tom | Aug 18, 2004 3:16:06 PM

What is your problem, Matt? Bush has proven that everything is a free lunch! Tax cuts, increased spending, private accounts, and no negative consequences what-so-ever!

Just like his entire life -- do whatever he wants, and no negative consequences what-so-ever!

Posted by: MattB | Aug 18, 2004 3:20:32 PM

Seems that you would reduce stock market liquidity if this huge new player (the government, or else millions of individuals) bought into some sort of broad index fund and used a buy-and-hold strategy.

Posted by: next big thing | Aug 18, 2004 3:34:19 PM

Conservatives will never go for it. Their purposes include:

1) Shift risks/costs down the economic laddet
2) "Incentivize" the younger generations toward wiser life decisions (16 hours days w/o overtime) by the example of the old lady starving in the street
3) Make "compassionate conservatism" and private charity necessary by minimizing the public safety net.

Matt has a great idea. One argument I have heard against it (it is a good Idea, but not new) is that it gives government bureaucrats too much power and influence in the market. The broad-based index fund undercuts that objection. A good test if you want to see what the "privatizers'" true purposes are.

Posted by: bob mcmanus | Aug 18, 2004 3:42:49 PM

Mr. Yglesias,

Republican though I am, I believe you are mostly correct. It seems to me that there would be much danger if the government were to direct such enormous resources with respect to equity investment.

So I am opposed to any privatisation scheme that leaves it up to the government to direct investments. Which would leave us without the social insurance aspects of social security. Which raises the question of why we should enforce such savings anyway.

I would prefer instead a means tested social insurance program paid for directly out of current revenues, or debt.

The social security trust fund is a fiction. If one considers the government a black box, which has to balance the money supply through manipulating taxes, spending, and borrowing, the social security fund just looks like irrelevant internal accounting. If social security payments exceed contributions, no matter how well funded it is on paper, the government will still have to adjust taxes, borrowing, and all other government spending to keep the monetary system in balance.

Posted by: luisalegria | Aug 18, 2004 3:50:24 PM

Theoretically, shareholders of any size are supposed to make at least some decisions for given companies. A state entity that held a couple trillion dollars in assets in competing companies would have a devil of a time holding those shares responsibly.

Also, any state asset holding scheme of that size would have unbelievable opportunities for corruption.

Posted by: Kimmitt | Aug 18, 2004 3:50:43 PM

The social security trust fund is a fiction.

The social security trust fund is not a fiction. It's a trust fund. It receives revenues, pays out benefits and invests what's left in T-bonds. It's way too ordinary and boring to be a fiction.

Posted by: abb1 | Aug 18, 2004 4:11:45 PM

what kimmit said....

and then, what's the difference between this and nationalization of companies in socialism?

Posted by: captainblak | Aug 18, 2004 4:16:53 PM

Great post, Matt.

One of the things that always puzzled me about Lindsay's free-lunch scenario was that, in order for market gains to make up the revenue difference caused by reduced contributions to the SS trust fund, the government would in effect have to take money out of outperforming private accounts.

That seems contrary to the whole 'ownership' idea behind private accounts, and guaranteed to make those with private accounts see red. "Whaddya mean I gotta give some of it back?"

I can't imagine how anyone ever thought the idea would fly.

Posted by: David Yaseen | Aug 18, 2004 4:18:40 PM

what's the difference between this and nationalization of companies in socialism?

Matthew very carefully code-worded this post, although I fear it was tongue-in-cheek.

Posted by: tcb or tcb3 | Aug 18, 2004 4:33:34 PM

No one can or should any longer make assumptions that state: "relatively high returns you can get in the stock market." History may not repeat.
"TIPS (Treasury Inflation Protected Securities)should be the asset/security of choice in any Social Security scheme.

Posted by: Peter Mack | Aug 18, 2004 4:38:01 PM

I also have a problem with the risk/return calculations. I have usually seen this expressed as "If you bought the Dow Jones in 1925 and sold in 1965" or as "The average value of stocks over the last fifty years...." This says very little about how actual investors behave.

But companies go bankrupt and disappear constantly. Or, positively, are bought. I have always been afraid that just looking at the Dow, and disregarding the change in components, distorts the calculations. Obviously, it is a little crazy to believe no one else has had my doubts.

So my question:Has anyone random-walked a 1925 newspaper exchange listing, buying a thousand stocks, and then looked at where you would be in fifty years, or 75? Is it available on the web?

Posted by: bob mcmanus | Aug 18, 2004 4:57:36 PM

"If you bought the Dow Jones in 1925 and sold in 1965" or as "The average value of stocks over the last fifty years...." This says very little about how actual investors behave.

Quite. It's like saying that people are taller now than they were in 1776: a generalisation which doesn't properly acknowledge that those people from 1776 are somewhat dead.

Posted by: ahem | Aug 18, 2004 5:03:16 PM

I've been convinced that privativation is not the answer. Indexing the retirement age to life expectancy is. If life expectancy is 70, the retirement age you begin receiving benefits is 70.

Posted by: Chad | Aug 18, 2004 5:08:53 PM

Mr. Abb,

From your point of view as an individual, it is a trust fund. From a macroeconomic point of view, it doesn't look like one. It is part of the great government money cycle. What goes in must balance what goes out, more or less, accounting for economic growth and inflation.

Posted by: luisalegria | Aug 18, 2004 5:22:23 PM

The Social Security trust fund is merely a promise made by present and past politicians that future taxpayers will honor a particular type of debt obligation. The value of any debt obligation is merely a combination of a debtor's ability to repay, plus the degree to which the debtor is motivated to do so. The reason current taxpayers, and future taxpayers, are overwhelmingly likely to honor debt obligations held by the governments like China and Japan, and individuals like George Soros and your Aunt Millie, has nothing to do with the moral or ethical goodness of today's or tomorrow's taxpayers, and everything to do with the fact that nearly every taxpayer in this country would be punished severely if such obligations were not honored.

It isn't even close to being clear that failure to honor the debt obligations held in the Social Security trust fund would have a similar deleterious effect. In fact, a reasonable scenario could be envisioned in which failure to honor the Social Security Trust Fund debt obligations would greatly enhance the value of U.S. debt instruments held by individuals and foreign countries. Thus, at some point, after enough of the baby-boomers have left this Vale of Tears, at least partial default on the debt instruments held in the Social Security trust fund becomes a real possibility, perhaps even a likelihood.

Posted by: Will Allen | Aug 18, 2004 5:44:18 PM

Bob and Ahem,

I think you both are looking at this rather simplisticly. This is not some experiment where you buy an assortment of stocks in Year 1, freeze them for forty years, and then see how they turn out in Year 40.

Most privatization plans require ownership of a broad index of funds to minimize risk. You would also be allowed change their composition has market information becomes available. No one will be allowed to put 100% of their assets into Enron or Eastern Airlines.

Posted by: Warbonnet | Aug 18, 2004 8:28:57 PM

That's a clever argument. I made the same suggestion here http://rjwaldmann.blogspot.com/2004/03/post-just-below-got-link-from-brad-and.html.

Posted by: Robert Waldmann | Aug 18, 2004 8:50:51 PM

Will Allen just hit a home run with his 5:44pm comment.
Nice job.

I should add that the cumulative size of surpluses that the S.S. trust fund has been running (cash surpluses that turned into T-bill assets, as abb1 suggests) does not necessarily bear any systematic relationship to the future liability that the S.S. system will owe to baby boomers. I doubt many baby boomers have been paying attention to annual OMB reports to calculate the size of their "lockbox" holdings so that when they're old they can collectively add up their S.S. checks and claim, "Hey, we got gypped!"

(Apologies for using that invidious ethnic slur)

Posted by: next big thing | Aug 18, 2004 9:42:27 PM

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