Thinking Things Through

Mark Schmitt observes that he is "often amazed at the sloppiness of the privatization advocates" who seem "not to have thought through most of the big technical and political questions they're dealing with." This is, I think, quite true. It's most obviously true in the case of the transition costs, which will be considerable. Most recently, privaters have taken to arguing that we shouldn't worry about these costs because they merely amount to "making explicit" the implicit long-term financing gap facing Social Security. The problems with this argument are legion.

For one thing, it strikes me as extremely noteworthy that privatization advocates only adopted this view very recently. If you look at the older writings on Cato's privatization website you can see that as of just a few years ago the privatizers did think this was a problem. Their proposed solutions were not all that serious. You had talk about using the projected Clinton budget surplus to cover them (Paul O'Neil tells us that he favored this) even though the privatizers were, at the time, supporting political candidates who promised to squander the surplus on tax cuts. The other big thing you heard was that we could "eliminate corporate welfare" to cover the costs. The small problem here is that even taking an expansive view of corporate welfare, it didn't generate enough money. The big problem is that this falls into the "hope is not a plan" category, like proposals to pay for new spending or tax cuts by eliminating "waste, fraud, and abuse." Saying you'll pay for something by eliminating corporate welfare is easy. Eliminating corporate welfare is hard. The Bush administration, clearly, has no plans to do this (not that I blame them, it would be very hard and, as I say, wouldn't actually cover the costs) so this is neither here nor there as a policy intervention.

So, as noted above, the story has changed. Now we're supposed to believe that the transition costs aren't real -- they just amount to shifting the unfunded Social Security liability into the present. This, however, is clearly false.

Assume there was no unfunded Social Security liability (easiest to make this assumption by assuming the demographic shifts come out differently) and Social Security is a fully-funded pay-as-you-go pension plan. Now assume you decide to privatize it for workers under the age of 55. Again, for simplicity's sake let's say you're fully privatizing. Some percentage X of the under-55 workforce decides to enter the private accounts system. That means payroll tax revenues are immediately reduced by X percent. Expenditures, however, are exactly the same. Ten years later when the first worker who was 54 on Zero Hour retires, expenditures start to fall because people who took private accounts don't get benefits. The vast majority of retirees, however, are still drawing full benefits because they were 55 or older on Zero Hour. It's not until everyone who was 55 or older on Zero Hour is dead that the system is back in balance. Note that this will take a long time. Bush wants to calculate the transitions costs over the ten years following the passage of legislation. But not only is this misleading because of the phase-in, it's misleading because ten years has no significance. The transition costs will extend about fifty years forward from Zero Hour until the last of the legacy retirees is dead.

The fact that, under our simplified model, Social Security had no unfunded liabilities is totally irrelevant. Bush proposes to eliminate the unfunded liabilities by reducing the liabilities (liberals favor a plan more weighted toward increasing the funds), which is nice. But the transitions costs are -- as our thought experiment shows -- new costs that arise on top of the unfunded liabilities. They are not the price you pay to eliminate the liabilities. As far as I can tell none of today's privatization advocates are grappling with this. They're not even mentioning the costs that arise in the second, third, and fourth decades of privatization. But this is a huge problem. FDR wanted to design a program such that "no damn politician" would ever be able to eliminate his Social Security. You can think him a bastard for having done this, but the sleight of hand involved (known technically in the business as the legacy debt) was implemented in the 1930s and 40s and can't be wished away without the deployment of a Magic Privatization Time Machine. Roosevelt was very clever, and created a system that later generations can only dismantle at enormous cost that his foes aren't willing to grapple with.

The other signal of deep unseriousness on the part of privatizers is Dean Baker's No Economist Let Behind Challenge. Brad Delong takes a rigorous analytical look at this involving some math I can't quite follow. The shocking thing is that, as far as anyone can tell, until Brad, Max Sawicky, Paul Krugman and others put the Baker Challenge on the table, none of the privatizers had even thought about this problem. But while the technical details of the model are by no means obvious, it should have been totally obvious from the beginning that there was a prima facie problem in asserting that future economic growth will be much slower than past growth but that future stock returns will be exactly the same. For this not to have come up during the 20 year-long privatization campaign is the clearest possible indication that the drive is being motivated by a priori considerations rather than by any actual thought about the problem.

As I wrote last week, you can make the numbers add up by means of some heroic assumptions about the future. But these assumptions lack any motivation -- i.e., there are no actual reasons to believe they will happen -- beyond making the math of privatization add up. It's a degenerative research program where you're making up odd empirical predictions in order to save the theoretical assumptions.

The degenerative research program problem arises once again when you think about the eagerness of privatizers to throw the Efficient Markets Hypothesis overboard and assert that the equity premium is not a mere risk premium, but an actual outgrowth of systematic market failure. This may be right -- the EMH may be wrong. But the consequences of the EMH being wrong are large and severe. Traditionally, it's wrongness has been urged by leftwing economists because it's wrongness leads to all sorts of leftwing conclusions. John Quiggin, known to the blogosphere, believes that the EMH is wrong and spells out what follows from this. I have no idea whether or not Quiggin is right about all this, but virtually nothing Quiggin has to say is anything a reputable conservative would agree with.

An increasingly large number of rightwingers, however, are now eager to reject the EMH but not eager to draw any conclusions from this whatsoever beyond those that happen to bolster the case for Social Security privatization. Someone who was seriously contemplating the case against the EMH as part of a progressive research program would be coming to all sorts of socialistic conclusions. The privatizers, once again, are showing all the hallmarks of a degenerative research program -- adding an ad hoc hypothesis to save their theory that does not (for them) generate any new information about the world except that their old theory is right after all.

So I've now gone on for a very long time about this, but I think it's important. Not just for Social Security but because it tells us a lot about the operations of the contemporary right. It's no shame that the vast majority of conservatives haven't thought through the detailed economic questions here. Doing that sort of thing simply isn't the job of "most people." It's outsourced to a small community of specialists. But what's telling is how hollow the small community of specialists is at its core. The rank-and-file are deferring to talk radio hosts and the like who are, in turn, deferring to more highbrow pundits (this is, I think, the sort of role I play in my small way on the left). The pundits think they're deferring to a bunch of trusted experts somewhere who've run the numbers. But it turns out that no one has run the numbers. It's a systemic breakdown throughout the movement with regard to the single largest program the federal government runs.