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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.

February 12, 2005 | Permalink


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> not to have thought through most of the
> big technical

On the technical side I would disagree. Any plan for private accounts, even a moderate one, would result in enormous profits for various large private entities - mostly Wall Street brokerages. I think this is thought out and understood.


Posted by: Cranky Observer | Feb 12, 2005 2:25:21 PM

I guess you have to assume this is the Straussian "noble lie" strategy applied to the domestic front. Alternatively, that they don't have the best interests of the American people at heart. Which is more likely?

Posted by: larry birnbaum | Feb 12, 2005 2:35:06 PM

"Excessive" stock returns doesn't really require the elimination of the EMT. Getting rid of the EMT is one way to solve the problem, but not the only way. Many on the right would say that there maybe large constraints on investment that keeps participants from teh market so the returns on stocks reflect the risk tolerance of investors but not the public at large. Opening up SS to private accounts would eliminate that barrier.

Of course a big problem with that is that if that is truly the reason, excessive returns would go away once the accounts are opened and money flows to the market. And so your 7% returns aren't going to happen. Instead you'll get 5% or so. Now there maybe economy wide allocation benefits to doing so, but individuals are not made any better off when the cost of the added risk is calculated.

Posted by: Rob | Feb 12, 2005 2:44:43 PM

I have definitely heard that "making explicit" line -- in those words, from Jacob Sullem on Town Hall.

A couple of interesting things. One, according to CBPP, the gap will cost $4.9 trillion in the program's first 20 years, and more after, which obviously is more than the 75-year shortfall projected for OASDI (not that privatization is related in any way to the shortfall). And that's just 4% -- Privateers' "future liabilities" include the whole program.

Second, I don't see why Privateers stop there. Making the Bush tax cuts permanent would cost, say, $2 trillion in today's dollars. Why don't we just borrow $2 trillion from China and put it in the stock market? Dice, do your stuff!

Posted by: Ezra | Feb 12, 2005 2:48:27 PM

There's an incongruity between the trillions to be borrowed for the transition costs and the reductions in unfunded liabilities that the privatizers say will make the borrowing palatable to the bond market. The borrowing will result in bonds that the government is obligated to redeem, while the unfunded liabilities are only projections -- not promises or obligations -- which can be made to vanish by an act of Congress. (Look at your statement from SS -- it pretty clearly warns you not to expect the system to pay more than 72% or so after a certain point.) And Bush himself says the system will be "flat bust" and unable to pay the full benefits. So, the financial markets will see an increase in ironclad obligations, and no reductions in actual liabilities -- which to them will probably quack like a debt.

Posted by: Barry | Feb 12, 2005 4:56:00 PM

Barry: That may be true, but it's not a winning argument for Democrats. They have to argue both that SS as it exists is secure, but borrowing for private accounts leads to a debt increase. I don't see how the Democrats can argue that Bush's plan is a financial disaster because it makes SS benefits more secure.

Posted by: Xavier | Feb 12, 2005 5:05:21 PM

"a fully-funded pay-as-you-go pension plan"

Is that like, jumbo shrimp?

Btw, Brad DeLong has taken the first step in surrendering the "No Economist's Left Behind Cup" to Tom Maguire.

Posted by: Patrick R. Sullivan | Feb 12, 2005 6:28:07 PM

Doesn't the argument that social security will be able to pay 70% of its benefits after 2042 assume that the unfunded liabilities are honored by the government? If the liabilities are not honored, the benefits will be begin to fall as soon as the program begins to run a deficit in 2018, and as Matt explains, the decreased revenue from privatization will only exacerbate the problem.

Posted by: Jake H-- | Feb 12, 2005 6:57:21 PM

Patrick--when does the stock market crash happen? You selling off your stocks now?

Posted by: Rob | Feb 12, 2005 7:00:10 PM

"result in enormous profits for various large private entities - mostly Wall Street brokerages. I think this is thought out and understood."

The tech bubble leads me to believe they don't even have this well thought out. They are completely capable of screwing up their own interests, wasn't Greenspan himself involved in a hedge-fund that needed bailing out?

Under this plan or without it, I have no clue of what will happen in the equity and bond markets in the next fifty, five, or even this year. I don't think they do either.

Posted by: bob mcmanus | Feb 12, 2005 7:06:11 PM

This a great post, but I think its important to note that they are very focused and definite on what they want to achieve in the next 3-5 years. Bush wants to achieve something "bold" and "decisive", something which will feed his ego and smite his enemies. People lower down on the scale want to pass some legislation which allows them to make a plausible case that they deserve a good consulting or lobbying job. e.g. Phil Gramm pushed through lots of rules favorable to the accounting/investment banking industry, so now he gets a very lucrative job at UBS Warburg. As with investment banking, so to with defense/homeland security spending, privatizing government functions, and environmental/labor regulations. Ordinary Republicans not caught up in the wurlitzer want more money via tax cuts, private accounts, or indirectly via priming the local economy via corporate welfare/pork barrel spending. They also want to see their domestic enemies smoten, which means cutting food stamps, section 8, etc.

Lastly, they don't like running deficits, so they try to reduce the deficit to the extent they can given the above constraints. Failing that, they want to salve their conscience with some cockamamie reason why its okay to run deficits at this crucial moment of history. i.e. it's okay because of 9/11, or it's okay to go 2 trillion in debt because SS is really 42 trillion in debt in future years if we don't do "something" now.

The rationales for the out years change, but the substantive policy goals for the next 3-5 years stays the same.

Posted by: roublen vesseau | Feb 12, 2005 7:10:55 PM

Whoa. This is a very very good rant. Very angry, very correct. I love it.

Posted by: Mitch | Feb 12, 2005 8:39:22 PM

As for right-wing intellectuals/policy analysts, they are thinking and analyzing within the constraints of two unbreakable commandments 1) Thou shall not imply that the Democrats are better than the Republicans in any way on any issue. 2) Thou shall not contradict the Czar

David Brooks and the media establishment in general occasionally flirt with breaking commandment 2, but they never, ever, ever break commandment 1.

Mitch Daniels, for example, is doing a not completely terrible job as governor of Indiana. But it was impossible to do a good job as OMB head without breaking commandment 2, so he folded like a cheap accordian and didn't even try.

It's good clean fun, though pointless, to speculate which of the right-wing movementarians are cowards, which are crooks, and which are fools.

Posted by: roublen vesseau | Feb 12, 2005 9:13:11 PM

Hey. The only math I want to use is addition, subtraction, multiplication, division, and the fact that things have to add up.

It's... persons who wish to remain off the record... who want to drag out the intertemporal utility maximization apparatus, and it certainly does not clarify things...

Posted by: Brad DeLong | Feb 12, 2005 10:40:50 PM

Why was partial privatization of Social Security a good idea when Bill Clinton suggested it and a bad one now?

I'm not interested in adopting Bush's position on such a major issue by default just because I support his war aims, but why should I pay attention to the Democrats when they can't even be intellectually honest enough to explain their opposition clearly?

Posted by: Toby Petzold | Feb 12, 2005 11:12:41 PM

Toby: you need to do a little more reading. The Democrats aren't the one's hiding the ball here.

Posted by: fnook | Feb 12, 2005 11:22:11 PM

Big surprise. People who can't think, who have no track record of actually thinkin coherent thoughts, are being asked to think, and fail to think. We are supposed to be surprised at this? Thinking is hard work. It gives you headaches, and anxiety attacks. Easier not to think. Let others do the thinking. Take the money and run.

Posted by: Knut Wicksell | Feb 12, 2005 11:26:52 PM

I'm with Brad.

No fuzzy math. Stick with the basics and let's lay it on the table.

Where are the discussions about the Social Security Plus program? It has no major transition costs. None.

Who would be so crazy as to incur many trillion of dollars in transition costs when that waste of tax money isn't necessary?

What's wrong with this picture?

Posted by: Movie Guy | Feb 13, 2005 3:01:02 AM

Was wondering, if we divert the low-grade fiscal backing of the monstrous trust, what effect will that have on the dollar?
The bonds Social Security weights are a constant in our fiscal equation?
It is most pegged to oil? Oil is getting less in supply, the value always goes up. If we had the deficit clear then the dollar would make Euros pale in comparison.

It would be nice to afford trips to Europe with disposable income. Or buying up stock with a valued dollar.

This deficit makes no sense, the dollar buys less with a deficit and this Social Insolvency plan only magnifies that. Former employer (old money, someone Bush's frat has to pledge name loyalty to) once agreed that Clinton's budget made sense. He would pay marginally more, gladly so, if the deficit vanished because his dollar would buy more.

More money, with worth near half its value, is like trying to use Monopoly money on the market. The deficit whops a third of the the cash value away, and when you have millions (or more) the currency value plays more into the picture than does a tax rate which you've already deducted or cleared comfortably.Do not pass go with Bushco.

Face it, we're falling behind. Europe is full of technology and renewable energy, better pay scales and health care.

Hell France starts their overtime at 34 hours. We could esily do the same damned thing here to expand the tax base and expand consumer purchase power.

Back to the stong age instead.

Posted by: Mr.Murder | Feb 13, 2005 4:19:57 AM


Sorry to say, but that post could be your best ever. As for the 'intertemporal utility maximization apparatus,' Matt's (correct) reasoning shows that specified correctly, privatization is an unambiguous net loss in discounted future utility. The only thing that can save it is fantastic stock market returns, which as Matt rightly points out in the second part of the post, are inconsistent with the case for privatization.

Posted by: Marshall | Feb 13, 2005 4:47:08 AM

Personally, I think it would be very easy to sell a tax increase to young workers in exchange for the right to invest it in a private account.

But I guess at that point we're just doing the Democratic plan of add-on accounts anyway, aren't we?

I do think there is plenty of room for compromise here.

The only thing that is really non-negotiable to me is tax increases to support the CURRENT system. Any other solution(benefit cuts, raise retirement age, means testing) is a-OK with me. I just don't like the idea of further burdening workers with ever increasing payroll taxes. Nor do I favor moving Social Security from a stand-alone program funded by the trust fund to a system that is funded out of general revenue. That's the quickest way to make the program politically vulnerable is to use regular income taxes to fund it. Then you have a significant portion of the population getting a raw deal and Social Security's invincibility is over.

Posted by: Adam Herman | Feb 13, 2005 5:07:57 AM

"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."

The analysis that followed this sentence was excellent, absent knocking off everyone 55 and older, the dollars for transition have to come from somewhere, someone has to be double taxed to eliminate what some disparaging call "intergenerational income transfer" (as if supporting your grandmother was a moral flaw) and others like me call "pay as you go".

But it is not bold enough. The easiest way to "assume there was no unfunded Social Security liability" is to adopt a data set officially endorsed by the Trustees of Social Security. Right in the exact same Report that produces the 2018 and 2042 dates are two alternative data sets, one (High Cost) more pessimistic than the Intermediate Cost alternative that produces 2042 and another (Low Cost) that is more optimistic. But before we go on let us nail one thing down: these are official numbers, they are the work product of the Chief Actuary of the Social Security Administration, they are not coming from some left-wing think tank, they derive from a Report signed by three Bush cabinet secretaries. Everyone who has EVER used the declarative voice when talking about Intermediate Cost dates "Social Security WILL start running a deficit in 2018 and WILL run dry in 2042" is implicitly accepting Intermediate Cost economic projections. Okay fine. Let us turn that around. If you trust that Intermediate Cost WILL return the numbers you cite, you have to admit that Low Cost WILL return its numbers. It is exactly the same work product, it is all the same Report, you can't reject its implications without abandoning 2018 and 2042 altogether.

What is Low Cost? What does it mean? You can follow the link or just examine the following figure from the same Report that returns 2042 2004 Trustees Report: Trust Fund Ratios The Chief Actuary of Social Security, in a report signed by three Bush cabinet secretaries asserts that if we hit the numbers of Low Cost the result is outcome ( I ): the Trust Fund sails through the traditional 75 year window with a five year reserve.

That is the target, if we hit Low Cost numbers Social Security is fully funded per the exact same people who supply the Intermediate Cost numbers underlying 2018 and 2042.

How hard would hitting Low Cost be? If you examine the Social Security Reports over time you can see that Low Cost traditionally required an economy to grow faster in the future than it had in the past, it was truly an optimistic, pie in the sky forecast right up until about 1997. But wherever you want to put the credit, the same economic engine that took 1992's "deficits as far as the eye can see" to 2000's surplus had its effect on the Trust Fund. In retrospect how could it not? The result has been to drive Low Cost down, each year the numbers became easier to reach.

Now they are ridiculously easy. Under Low Cost productivity growth of 2.8% in 2004 (did that and then some) 2.1% in 2005, 2.2% in 2006 and 2007, and a slide to 1.9% in 2011 and beyond is all it takes. The conclusion is obvious, who doubts that the American economy will hit these numbers? And if it does three Bush cabinet secretaries officially admit the Trust Fund is fully funded going forward. 2004 Report: Economic Assumptions

This was a "Phony Crisis" in 1997 when Dean Baker and Mark Weisbrot wrote their book. It has passed beyond strawman status today. Social Security is not broke, at all.

Posted by: Bruce Webb | Feb 13, 2005 5:32:47 AM

Excellent post. Incidentally, you provide a nice retort to the snarky characterization of the two parties found in "The Note" and a recent TAPPED entry by your colleague Garance. For while the Republicans are the more organized, politically keen, and communications savvy party, they appear to have no apparatus for designing real world policies. Is there a single area of governance that they haven't been screwed up, taken on conservative terms: education, drugs, stem cells, tariffs, Iraq troop strength, the CPA, Korea? In every case, the policies were designed either by political consultants or by ideologues. Have they appointed any bureaucrats who have the core expertese necessary to do their jobs? A few, but most are hacks like Paige, Snow, Gonzalez, Goss, and Rice.

Of course, it's telling that Helperin et al. judge the parties solely on their ability to communicate a clear message quickly. The complexity of the issues has come in conflict with the division of labor, which guarantees that journalists lack deep knowledge of any subject.

The question is: is this sustainable? Can a 21st century party dominate through high ideals and public relations skill alone? I'm skeptical. We're not living in 1880. Eventually people demand some accountability.

Posted by: AWC | Feb 13, 2005 7:54:23 AM

Excellent rant identifying the weakness of privatization arguments. These calculations are important for the defense of Social Security. I fear however that with this focus on these calculations that we are focusing very clearly on the tree while the SS destructionists are cultivating their forest. This is just falling into a rovian trap, they say they are saving Social Security while we get tangled up in calculations.

This is just one more piece of their agenda to shift the federal tax burden away from land and capital and onto labor. This very clearly is a tax increase on workers. They have eliminated the taxes on both on estates and dividends. They are trying to use the technique of food companies to disguise their actions. A bag of coffee is no longer a pound of coffee but 12 ounces. The price is the same but the portion is smaller.

I believe that this frame will make it clear what they are up to. Say this loud and and clear:


Posted by: JB | Feb 13, 2005 8:30:51 AM

Shorter Bush/Cato/right-wing argument for privatization: The problem with Social Security is that it exists. Our plan fixes that.

Posted by: R. Porrofatto | Feb 13, 2005 8:52:48 AM

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