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Privatization or Socialism

Brad Delong says he has five reasons to support Social Security privatization. I say all of his reasons are compatible with my preferred solution -- federal investment in a broad index of stocks -- except for a sub-section of argument 3: "prefunding requires raising Social Security contributions and building up huge assets in the Social Security Trust Fund--enough assets to give the Managing Trustee of the Trust Fund effective voting control over corporate America. The Managing Trustee is the Secretary of the Treasury. Do we want the Secretary of the Treasury casting the deciding votes in every election for corporate boards of directors? No."

Fair enough. But since to do any kind of Social Security reform would require a major piece of legislation, why not just write this piece of legislation to tie the Managing Trustee's hand and direct him to invest the money in the broadest possible index of stocks? "Don't be silly," you say, "that might be the rule you start out with, but soon enough the political pressure will build up to prevent the government from investing in such and such a company ('why is the government supporting Big Tobacco? Big Liquor? Big Gun? etc. etc.') and control of corporate America will be increasingly politicized." Fair enough, that's a possible problem. But at the same time it's also likely that pressure will build to tie precisely equivalent mandates to investment decisions made with people's "individual" Mandatory Social Security Savings Accounts. It's true that the possibility of politicization is somewhat less under an individual accounts model than under a collective model, but I don't think it's a lot less.

Against this you need to consider the fact that many people will use the money in their personal accounts in an unwise or unlucky manner. This will lead either to old people starving, or else (more likely) to the construction of a secondary safety net. This, in turn, will create a moral hazard and uncourage unduly risky investing. More money into the secondary safety net. Etc. Besides which there's every reason to believe that the unwise/unlucky investments will be disproportionately concentrated in the hands of the most vulnerable seniors. And all manner of dishonest schemes will proliferate to try and take advantage of financially unsavvy senior citizens (look at what a high proportion of frauds are directed at senior citizens under current arrangements). If the purpose of investing payroll tax funds in the stock market is to take advantage of the risk premium (and Brad Delong says that it is) then the risk should be managed by the entity best equipped to bear risk. That entity is the government of the United States of America. Socialism -- the collective ownership of the means of production -- is the solution to the Social Security funding shortfall (either that or average productivity growth that's slightly higher than currently projected, or a rather small increase in payroll taxes).

September 30, 2004 | Permalink

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Comments

I never follow this issue. So I read what Brad said. And I read what you said. And I prefer what you said. But what do I know?

Posted by: Meteor Blades | Sep 30, 2004 12:44:29 AM

No, what Matt said is good and fine. And you can believe it...

"Good" forms of privatization would have your private account "managed" along the lines of the Treasury's Thrift Savings Program. IIRC your choices are an index fund, a basket of bonds, a basket of Treasury securities.

The difference between private accounts constrained in such ways and having the Secretary of the Treasury invest the fund directly in private securities is rather... scholastic.

And, of course, our fear is that "privatization" would start out with people's accounts tightly constrained, but would not stay that way for very long.

Posted by: Brad DeLong | Sep 30, 2004 12:54:56 AM

I would love it if this came up in the debates, and the media concluded that Bush was endorsing socialism.

Posted by: Bob Violence | Sep 30, 2004 1:38:04 AM

If you're going to have government accounts, why do you have to have two or three funds, when you can have a coupla hundred? A coupla hundred *government-owned* funds. Each fund would have a different manager who did the voting. Compensation would be based entirely on fund performance. (I am thinking of Vanguard as the model here.)

Split the incoming funds, half go to the treasury (to supply current old people and to preserve a 'survival pension' for anybody who goes negative in investments), and half goes to user to invest in whatever *government-funds* he/she/it deems acceptable. You replicate the effects of privatization (or suddenly cutting payroll-taxes) while keeping the investments monitored and regulated by the feds. Treasury is hands off, except to make sure fund managers are clean.

(Their own investments go blind, can't trade except for their fund, etc. Anytime the rolling five-year average is negative growth (lose money) AND it is say, at least 5% points lower the than the rolling 5-year growth rate, the fund manager gets canned. Exceed the growth rate, get a bonus.)

Feel free to eleaborate.

I don't think it work for the same reasons that SS 'won't work' in the long run. Because people (like Congress, for instance) are greedy and stupid. Someone would wind up collectivizing the money. On the other hand, it couldn't hurt (viz. congressional management of social security), provided you could actually fund it.


ash
['I do expect it would be inflationary as hell, and the markets would adjust to effectively reduce returns to treasury bill levels, but hey...']

Posted by: ash | Sep 30, 2004 1:43:53 AM

Uh, I'm confused. I don't understand the details so let's not get bogged down in those types of things. I take it Mr. Delong is acknowledging that the ultimate goal of Bush et al. is to elimate Social Security altogther. Correct? Assuming constrained privitization is the wave of the future, how do centrist-liberals position themselves to come out on top? Is there such a thing as a privatized safety net?

Posted by: fnook | Sep 30, 2004 1:47:29 AM

First off, reasons 2), 4) and 5) also seem to argue in favor of private accounts over merely switching the SS Trust Fund from Treasury bonds to a stock index fund. One can disagree that those are important goals, or argue that some could be realized through careful (and unlikely) reform of a centrally administered system; but not, I don't think, that they are more likely to be better addressed by PSAs.

Second, all this concern that the poor unwashed would somehow manage to pick "bad" stocks is misplaced. It is just as impossible for an uneducated ignorant to pick "bad" stocks because, oh I don't know, they like the name or something, as it is for some yuppie to pick a "good" stock by reading thestreet.com or something. It simply does not happen.

I'm no believer in the strong version of efficient markets theory, but the evidence for a weak version is unimpeachable. It is probably possible to beat the market in statistically significant fashion the way hedge funds claim to do it--by attacking some low-volume derivative market with a brilliant proprietary model and a gaggle of supercomputers to execute your trades for you. But an ordinary investor has zero chance of deviating in statistically significant manner from the overall market direction, for good or for ill. Read Henry Blodgett's recent Slate series if you don't understand this.

The only remaining dangers are that people would choose a portfolio that a) does not properly reflect their ideal risk tolerance; b) does not adequately take advantage of diversification. These dangers could be substantially addressed with some sort of mandatory advice given as part of the program. It could even be computerized fairly easily.

Look; I prefer the "Yglesias plan" too, but mainly because of the problem of paying for a transition out of a pay-as-you-go system.

Posted by: Dave H | Sep 30, 2004 4:59:21 AM

"why do you have to have two or three funds, when you can have a coupla hundred? A coupla hundred *government-owned* funds."

I think Sweden has great recent experience with this, and useful empirical date. Over 50% chose the default fund. Very few, if any funds, performed to the level of the index, or to the level of the default. Etc. I wish I had a link.

Posted by: bob mcmanus | Sep 30, 2004 5:11:22 AM

Matt, worst idea ever. If it's okay for the government to invest in the stock market, it's okay for the people to do it.

Posted by: Adam Herman | Sep 30, 2004 7:43:04 AM

To address your concern about individuals making bad decisions:

If the only allowable investments are publicly traded stocks on the major exchanges, mutual funds that invest in those stocks, grade A or better corporate or government bonds, etc., the risks long term are extremely low. You could also mandate diversification, ie at least four securities would be required unless they go with certain ultra-safe investments, like money market funds of treasuries. Only the tiniest fraction of retirees will end up with less than they would get under the current system. For those that do, the government would spend a pittance raising them up to a minimum standard.

Posted by: Adam Herman | Sep 30, 2004 7:46:36 AM

Um, so the point here is that, since people occasionally drop their baskets of eggs, all our eggs should go in one basket, on the assumption that you could assign that basket to somebody who was really good at not dropping baskets?

1. I don't think there's reason to believe that there actually IS somebody who's that good at avoiding mistakes investing in stocks. Or even a committee of people that good.

2. I don't think there's good reason to believe, if they did exist, that they'd get the job.

3. It's a rather iffy proposition that we're better off with a small but still finite probability of everyone's retirement plans going bust at the same time, than with some percentage of people screwing up their plans, and leaving everyone else still ok.

The fundamental problem here, is that a government which could be trusted to administer everyone's retirement plans, wouldn't have screwed up Social Security in the first place. The point of Social Security privatization isn't just to get the money into the stock market, but to get it OUT of the government's hands.

Posted by: Brett Bellmore | Sep 30, 2004 8:13:03 AM

Or looking at this administrations fiscal policy, maybe they plan on moving SS into equities, and then engineering a decade of hyper-inflation. They'll get those boomers for ya, Matt.

Posted by: bob mcmanus | Sep 30, 2004 8:16:21 AM

Why doesn't anyone mention the transition cost? I think that Bush's hiding of the transition cost is what made Paul Krugman a radical in the last presidential election. The Bushies merely implied that there were no costs. Since there really is not social security trust, building it, while simultaneously paying out current retirees (who are grabbing current social security payments) will cost big.

Paul O'Neill in his book says that he and Greenspan estimated that a modest privatization, I believe it was for people 35 and below, would cost 1.5 trillion. When he brought that to Bush, he met a hard-to-read reaction which was either "we're not really interested in this stuff" or "what do you mean it will cost money?"

At any rate, such a scheme either will be paid for by the recipients in increased social securty taxes, or will be paid for by everyone and be an new entitlement for the recipients, or will simply be added to national debt, (that is, paid by the recipients children).

I'm certainly no economist, but transition costs of any plan have to be addressed. I think they are a much bigger issue than whether the investments are safe or dangerous.

Posted by: John Kubie | Sep 30, 2004 8:24:38 AM

Transition costs are an issue, but they're not a problem caused by privatization, they're a problem caused by the fact that the current system isn't financially sound. The same costs would eventually be encountered trying to keep the current system from imploding.

Posted by: Brett Bellmore | Sep 30, 2004 8:41:34 AM

Many problems with privatizing.

1) Equity premium is not all it is cracked up to be. Over the longest run. equities outperform bonds for a given level of risk. But over less long-term -- say 20 years or 10 years, an equity bear market can screw your pension. If you had a privatized SS account in equities and retired in 1976, you'd be screwed. See all the private pension plan shortfalls today.

A partial solution to the problem of the inconsistent equity premium is to have the private SS accounts invest in bonds. But then why privatize -- they're already invested in bonds.

2) Forced savings, even in pvt accounts, reduce or eliminate volountary retirement savings. The World Bank will shortly be coming out with a book (an update to the landmark _Averting the old age crisis_) describing how forced savings reduced volountary retirment svaings in Latin America.

3) Even in, on average, folks do better with pvt accounts, there will still be many who crap out. Unlike crapping out at a casino, losing all your retirement savings is very worrying. These aggreived Americans will demand the government _Do_ _Something_ -- most likely a bail out. Political risk cannot be avoided.

Lots of other arguments both ways on this issue. But a blog is no place to have a policy discussion. Remember B$SHH SUXS!!?

Posted by: Ikram | Sep 30, 2004 9:14:53 AM

If you want to know how an advanced democracy handles the Social security Investment Policy you should study the Singapore government model.

Posted by: George | Sep 30, 2004 9:32:20 AM

Whatever real reform Social Security might need cannot be safely implemented as long as Bush is in power. You wanna reform Social Security? First, elect a competent president, then let's talk.

Bush has no genuine interest in reforming social security. He wants to kill it because he thinks it's socialism.

First, Bush wants to Enronize Social Security, then when the system is shown to be obviously corrupt, he or his heir will take further steps to dismantle it.

To engage virtually any of Bush's arguments as "legitimate points of view" is to give them a status and importance they don't deserve. It's like arguing with the Birchers or Jehovah's Witnesses. You waste your time, you get nowhere, and they gain a foot in the door.

Posted by: tristero | Sep 30, 2004 9:45:42 AM

"You wanna reform Social Security? First, elect a competent president, then let's talk."

But will there still be time to reform it, if we wait until 2008 at the earliest to start the discussion?

Posted by: Brett Bellmore | Sep 30, 2004 9:57:36 AM

"This will lead either to old people starving, or else (more likely) to the construction of a secondary safety net."

But it would be a real safety net, intended for poor people who don't have a retirement income.

It wouldn't involve a huge waste of money to rich and middle-class retirees.

Posted by: Sebastian Holsclaw | Sep 30, 2004 10:24:54 AM

I like the idea that the typo "uncourage unduly risky investing" created. It's not simply the opposite of "encourage". It's more like making someone an offer they can't refuse.

Posted by: Jeffrey Davis | Sep 30, 2004 10:34:15 AM

In re "Don't be silly," you say, "that might be the rule you start out with, but soon enough the political pressure will build up to prevent the government from investing in such and such a company ('why is the government supporting Big Tobacco? Big Liquor? Big Gun? etc. etc.') and control of corporate America will be increasingly politicized."

Why necessarily? Most central banks across the wetern world are independent and heavily insulated from political pressure. If politicization of independent bodies were so easy ECB interest rates would be really low, given the employment crisis in Europe.

When we look at occassional AFL-CIO proposals to politicize the pension funds, the "fiduciary trust" provisions become supported by the members against the leaderships calls to use pensions as political tools.

Also one reason for not letting individuals, as opposed to government, invest is that the government can reap economies of scale in information and may suffer from fewer information asymmetries, as well as have access to better expertise. Private funds, operating on commission, etc., may have greater incentives to distort, unless we have a major overhaul of how the finance sector works. Admittedly, I have to think about that one more.

Posted by: Robin | Sep 30, 2004 12:20:07 PM

Bret Bellmore - you are dramatically overstating SS's fiscal problems. It is solvent for the foreseeable future, much beyond 2008. Most crisis mongers conflate SS and Medicare.

Your assertion that "transition costs" are inevitable, even without anything to transition too, is incoherent. There may be costs related to demographic changes, but those are not transition costs.

Please explain how the government has mismanaged social security. Spending the trust fund? You don't strike me as a lockbox fan. Raising payroll taxes under Reagan and then using them to finance military expenditures? Indexing problems?

Posted by: Dave | Sep 30, 2004 12:20:50 PM

One problem with just throwing the money in an index fund is that most advisors suggest having a much loswer percentage of investments in stocks as you approach retirement age to avoid a sudden down turn in the market. You would not want to be someone who retires on September 20, 2001 with all your money in index funds.

Posted by: Dave | Sep 30, 2004 12:27:18 PM

Paying down the debt is the only solution.

Posted by: fasteddie | Sep 30, 2004 1:04:11 PM

This whole issue of SS privatization strikes me as more than a bit silly. A vehicle for private pension plans already exists--IRA's. The contribution limit on IRA plans can be increased. There is no need to provide a separate account to represent a substitute for SS.

To encourage contributing to the IRAs, it might be desirable to provide a credit of some portion of the IRA contribution against SS taxes, but that is a relatively simple matter to accomplish if so desired. It strikes me that congress has no intention of providing for such a credit for a number of reasons, including the fact that they want to spend SS tax money that is taken in. That includes the Republicans, given their obvious profligate spending habits--which were evident long before Bush II took over.

And the idea that the gov't should have voting control of shares of private companies should scare any conservative.

Posted by: raj | Sep 30, 2004 1:17:54 PM

"Please explain how the government has mismanaged social security."

How about the fact that the "trust fund" is nothing but an accounting gimmick? When an organization holds it's own bonds, they don't constitute any store of value, the moment they're to be redeemed, it must be from current revenue. And yet we're constantly treated to the pretense that the trust fund is a real fund, which will actually help the Social Security system make payments.

Posted by: Brett Bellmore | Sep 30, 2004 1:18:15 PM

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