Now we come to the issue which stirs up the most controversy, but also offers the most opportunity for creative solutions: if the Social Security system is to invest funds, where should it invest them, and who should control the actual choice of securities? All-out privatizers want to deploy all the funds in the private sector of the economy, and to let workers who pay into the system pick for themselves the assets which they will hold. Last-ditch enthusiasts of public enterprise want to direct all the funds into activities of the government, and in any case let government manage the portfolio. With remarkable uniformity, Republicans line up behind privatization, while Democrats are adamant for keeping it in the government. A few of the latter would settle for government management of funds dumped into the private sector.
Why the fury? Most of what stirs the adrenalin can be summed up under four headings: redistribution of income, safety of retirement savings, return on investment, and control by whom. An additional consideration which has thus far failed to excite anyone, but ought to, is the value of government investment.
1. Redistribution of Income.
Social Security has been the most popular enterprise of those who want government to redistribute income. They see unequal incomes as largely a product of luck: above all, the accident of birth. Without redistribution, they foresee an ever-widening gulf between the rich and the poor, the growth of a permanent underclass, a hardening of class attitudes, eventually a rejection of the economic system, taking democracy with it. Since Social Security offers a principal means of redistribution, they are extremely suspicious of any changes other than a scheduled increase in taxes to support it. Some of them are quite cavalier about the maximum percentage of income which it is tolerable to tax. Others react with denial of the arithmetic.
On the opposite side, passionately hating redistribution, are of course any who feel that they have earned their incomes fair and square, and shouldn’t have it taken away from them to support those who didn’t earn it. They see all too many cases of "misfortune" that are clearly the result of people’s own choices in life. They feel that they, the "fortunate", are being penalized for good behavior, and argue that in the end, this undermines productivity and does no good for the poor. It merely brings everybody down to the level that an ailing economy will support.
Redistributionists are unhappy, to be sure, that Social Security sometimes redistributes income in the wrong direction: from poor to rich. It takes payroll taxes from minimum-wage workers and shells out money to elders who are comparatively well-off. They see this as a fault to be corrected by taxing back the benefits of higher-income retirees, raising the retirement age, and any other means-tested takebacks they can think of. They have to be careful, though, about even this sort of change, because the universality of Social Security is a key part of its popularity. Obviously people who foresee being gouged will drop out of the cheering squad.
This brings us to the nub of the matter: politically, redistributionists are in a bind. They want Social Security to redistribute income, but they have to keep the losers in a minority. For a long time, the Ponzi scheme accomplished this gracefully: the losers were new classes of workers whose payments into the system redeemed the promises to earlier participants. Since the newcomers were promised the same sweet deal as their predecessors, they didn’t expect to be losers. Now the system has matured: almost all employment is already covered. At the same time, there’s the population thing: not only are there no more "outsiders" to bring into the tax base, but new births have failed to replenish workers in the original categories. The only way Social Security can any longer redistribute income is to bear down harder and harder upon the better-off elders ¾ and whether by means-tested cutting of benefits or by progressive taxation, it’s all highly visible. Social Security will lose its mandate if it carries this sort of thing very far.
Yet, as we’ve suggested before, there’s a degree of income redistribution that most people will support, even those who expect ¾ nay, hope ¾ to be payers rather than receivers. Namely, just that amount of redistribution which is entailed by an actuarially fair form of "career insurance". The tricky part, of course, is to define the risks which go into actuarial fairness, the tests for eligibility, and an appropriate minimum level of insurance to be carried. All that must be settled by a mix of good research and tense negotiations. Redistributionists, though, would be well advised to settle for just this and no more, since it wins solid consensus behind a justifiable amount of redistribution.
We were talking, though, about "the proper mix of public and private investment". What does this discussion of income redistribution have to do with that? Just this: private enterprise, on the whole, rewards investors in proportion to their investments, not their "need". Yes, business enterprises, like the government, are vulnerable to extortion by militant interest groups. In the end, though, their hands are tied: revenues have to exceed costs, or the enterprise stops. They can’t force payers (their customers) to keep on paying just because those who are paid (their employees, stockholders, creditors, and suppliers) "need" the money. They can’t water down promises to their payees by debasing the unit of account (as can the government). Private business is not a well-suited agency for distribution of income on grounds other than productive contribution.
Except that: private enterprise can conduct an insurance business at least as well as the government. It is requisite only that the terms of the contract be clear ¾ what premiums are the insurees to pay, for what benefits, to be received under what circumstances, ¾ and that business be free to accept or reject the contract at the time it is proposed. To this extent, private business is perfectly prepared to redistribute income on the basis of defined "need". It’s just that the bets must be placed before the wheel is spun, and everyone must pony up to be in the game.
So if redistributionists will settle for actuarially fair "career insurance", and for a modest minimum level of participation, they can tolerate investment of the funds in the private sector. It is only if they’re looking for additional redistribution by the workings of government that the private sector and its "bottom line" should pose any threat.
2. Safety of retirement savings.
Not all who cling to a government-operated system are looking for income redistribution. Well-off people, too, want their retirement nest-eggs to be secure. In this era so far from the 1930’s, it is necessary to stress again and again the circumstances in which Social Security got its start: private business went broke, millions of people lost their savings, and nobody trusted private business. It’s faint reassurance to argue that over the long run, most people who hung onto their stocks made out pretty well. Many people lost shorter-term assets such as bank deposits, and anyhow, people need their retirement funds when they need them, not a decade or two later.
The trouble is, we’ve now lived long enough to see that government is also unsafe. We’ve seen the difficulty with which it readjusts when events make nonsense of its original calculations. We’ve seen how the pressure to pay benefits immediately, and to raise them as fast as current receipts would allow, turned the system into a Ponzi scheme. We’ve seen how politicians twist and turn and look for politically vulnerable victims to stick with the bill (for example, well-to-do seniors), or for surreptitious ways to slip it over (such as obscure revisions of the Consumer Price Index). And though a decade of curbed inflation has put it out of everybody’s mind, we should never forget that the government has its hand upon the crank which turns out money, and the temptation to use it becomes irresistible when the alternative is to admit bankruptcy.
The fact of the matter is that there’s no way to convey current earnings across the decades with perfect security. [27] Private enterprise is swept away by speculation, miscalculation, and the crazes of the moment ¾ but so is government. Insurance salespeople try to focus attention upon benefits and distract attention from costs ¾ but so do politicians. Bankers sometimes embezzle what they’re supposed to keep in trust ¾ but so does the U.S. Treasury. [28] Thousands of businesses declare bankruptcy every year, and creditors have to settle for so-much-on-the-dollar ¾ there’s only one U.S. government, and it never admits bankruptcy, but it takes back so-much-on-the-dollar through taxation, inflation, or the unilateral adjustment of what people had supposed to be the contract.
Nonetheless, we have to provide for the winter of life. So we do the best we can. A prudent strategy is keep our eggs in more than one basket. As regards Social Security, this means that a mixed system would be safest. It can’t be mixed if we allow the governmental share to keep growing without bound ¾ as it will, if we do nothing to revise the present system.
Opponents of privatization have argued, not unreasonably, that when private firms manage workers’ retirement accounts, they’ll invest much of it in government securities anyhow, and charge fees for doing so. This is true, for private fund managers, like ordinary observers, regard Treasury bonds as the safest of investments. They’re alert, though, to the danger that inflation may eat away the "safe" return, so they seek a higher return upon some portion of the portfolio, and this is earned by betting part upon the somewhat riskier activities of private enterprise. Assuming they bet correctly, that’s a service worth paying for. Also, to the extent that their redeployment of funds into the private sector influences the interest which the government must pay, it’s a useful discipline upon the government’s own decisions.
In the end, of course, the real effect of government or private borrowing depends upon what either sector does with the money. Opponents of the private sector envision, if Social Security is invested there, an endless orgy of leveraged buyouts, speculative runup of stock prices, "investment" in bets upon stock indexes, manipulation of the market to reward corporate executives who hold stock options, and a great deal more. It is difficult to see what any of this does to help the economy. Opponents of government envision, in the opposite case, just as endless an "investment" in vote-buying, brainwashing, busybodying, grandstanding, turf warfare, competitive victimhood, makework, and appeasement of whoever is most turbulent. How does any of that help the economy?
So wherever we invest our money, we’ll have to keep an eye upon what its custodians are doing. What else is new? Meanwhile, diversification is still the best strategy ¾ and the Social Security system, as now designed, is not well conceived to protect our savings.
3. Return upon investment.
For many years, the proponents of privatization have argued that the private economy is simply a better investment than Social Security. Workers, they protest, are being forced to invest at a very low rate of return. They could become downright rich, in a lifetime of such saving, if only they were allowed to put the money into stocks and bonds, and they’d still be just as well covered for early death or disability.
Peter Ferrara, in 1980, argued this case in detail. [29] That is no small undertaking, and probably won’t be done often, for Social Security is a complicated system. There are a wide variety of benefits, to be received under a variety of contingencies, and tied to people’s earnings histories in ad hoc ways. Ferrara’s approach was to put together a package of private insurance contracts which would mimic all the coverages of Social Security. Then, assuming the same actuarial statistics used by Social Security, he figured how well various workers would make out, if the money now paid into Social Security were invested instead in these contracts and in trust funds. The bottom line is how much would be left over for retirement, after insuring all the other contingencies such as early death or disability.
The result, of course, depends upon the assumed rate of return upon private investments such as stocks and bonds. (This governs the premiums which insurance carriers must charge and the annuities or lump sums which trust funds can deliver upon retirement.) Ferrara calculated results for every possible rate of return from 3 percent to 8 percent, in steps of half a percent. Take your pick, but Ferrara himself considered even the top figure, 8 percent, a conservative one. [30]
Some typical results are that even at the lowest rate of return, 3 percent, the private deal could offer a single worker in Social Security’s "low income" category, at retirement, a life annuity of $10,356; Social Security would provide that same worker a life annuity of $5,270. (The figures are in 1980 dollars.) If the same worker had a living spouse, the couple would get $8,631 from the private arrangement, versus $7,905 from Social Security. [31] And that is the very worst deal, for the very worst-off class of worker.
From there, the figures march upward, all the way to an astounding $221,521 life annuity for a single worker with "maximum income" invested at 8 percent, versus the $12,525 which that worker would receive on Social Security. [32]
We should not wonder at the results. Three percent real growth, sustained over a worker’s whole career, is a powerful rate of interest. Eight percent would be phenomenal. The question is, can private investment really deliver this much? Supporters of privatization cite actual averages observed over a period of sixty or seventy years. They can also point to the results experienced, so far, in countries such as Chile which have privatized their systems. The figures seemingly bear them out, and are more on the eight percent side of their hopes than the three.
It is possible, though, to feel some reasonable qualms. High initial returns are plausible enough. A huge flow of income is suddenly redirected from public expenditure to private investment. A horde of entrepreneurs go dashing off in every direction after opportunities which previously had to be ignored. This is rather like emerging from a traffic jam and speeding down preternaturally empty lanes. There needn’t be another traffic jam, but after a while, won’t normal congestion (whatever that may be) reestablish itself?
This is not a question of "limits to growth", it’s about the pace of growth. Remember that the return on capital is a time rate. Take a project that requires a single outlay of $1,000,000 today, and will return the principal plus $100,000 in a lump sum a year from today. That’s a 10 percent return. Suppose, though, that something delays completion of the project until a year later. Now it’s only a 4.9 percent return, assuming nothing else has changed besides the completion date. Similarly, a stretchout to 5 years reduces the return to 1.9 percent.
Let us go back, for a moment, to basics: what is it about an investment that allows it to produce a return? Expenditure is diverted from present consumption to something else, and that which is purchased is used in activities which reproduce the original value and add something more. Equivalently, income which could be realized immediately is foregone until later, and that which would have been sold to obtain the income appreciates in value. For example:
In every case, the key is waiting. If any of these expenditures could produce its effect instantly, it would simply figure as current consumption. [33] It qualifies as an investment because its output is spread over time, and is purchased at the expense of things that could be enjoyed right now.
There is also, of course, the element of risk, and this affects the rate of return at which we will accept a given investment proposal. However, we wouldn’t call it an investment if no waiting were involved. (Buying a lottery ticket for a drawing next Saturday may arguably be called a very short-term investment, but never would we say that of an "instant winner" scratch ticket.) Gambling affects the quality of an investment, but waiting is what makes it an investment.
Keeping all that in mind, why should we expect the average return on private investments to remain at a high level when a huge chunk of forced savings is redirected from government to the marketplace? Surely we must reach for riskier, less productive, more time-consuming opportunities as we pump more and more savings into the market. The high average returns recorded over the last fifty years must, surely, reflect that very starvation of private funding which we now propose to end.
Looking ahead, we can anticipate that the result of today’s investments will create new and enlarged opportunities for future investment. At any given point in time, however, the immediate opportunities must be subject to diminishing returns. How could it be otherwise, when the scheduling of some, out of current resources, must block the scheduling (and hence lower the return) of others? Indeed, if there were an unlimited supply of investment opportunities available at once, subject only to the supply of savings at some historically observed average return, we would be hard pressed to explain how investment projects were chosen at that rate. Why were all those others, alleged to be available at the same high return, turned down?
Moreover, the fruits of enlarged investment will include higher income, out of which people will wish to save still more. Both the supply of savings available for a given return and the supply of investment opportunities which can generate that return may be expected to increase over time ¾ but not necessarily by the same amount. The resulting rates of return which clear the market are likely to trace some path which we can’t foresee at all. It’s a footrace.
Nor would it quite settle the matter, even if the anticipated high rates of return should turn out to be sustainable. Looking for a moment at the supply of savings, we see that it’s determined by people’s average time preference. That is, individuals may prefer to consume part of what they’ve earned immediately, and defer some of it to the future, but as they save more and more, they are led into a range where it takes a reward to motivate any further waiting. As long as there are investments capable of producing a positive return, people will be led to save beyond their natural inclination, until, at the margin, that return just overcomes their preference for the present moment. (Yes, they must also be rewarded for risk, but if savers are well-informed and rational, they’ll acquire a portfolio of assets whose expected ¾ i.e., average ¾ return just compensates their time preference. Forced by life to gamble, they choose the role of the house.)
Now, it can be argued that the time preferences of one generation are not those of later generations, and that society (as represented by government) should try to balance these conflicting interests. That is, the "time preference" of a future generation, if it could be polled, would be that our generation should save all of its income, except as needed to insure procreation. From their standpoint, looking back on investments which have come to fruition, forced savings (up until their own time) are a not bad idea. They, however, are inherently unable to be consulted. Shouldn’t the government, which thinks as if it were immortal, redress the balance? Social Security, as now designed, doesn’t really insure any saving, but if we redesign it, shouldn’t it implement a social time preference, overriding the selfish time preferences of any one generation? Shouldn’t this social time preference, in fact, be zero?
The argument is moot, since there is little or no evidence that governments think that way any more than the constituents whom they tax. Some of the governments of the former Soviet Bloc, responding year after to year to emergencies and pressures of the moment, committed environmental depredations worse than anything ever charged to private enterprises. Are we supposed to look on this as an illustration of social time preference? Maybe there ought to be an arbitrator between future generations and those of the moment, but there isn’t, and government is not a candidate. As a practical matter, each generation holds all of its successors hostage, and will serve them best if its own time preferences are honored, as theirs will be in turn.
Finally, there is another point about the return on private investment: how does it compare with the (unaccounted) return upon investment-like activities of the government? What’s the opportunity cost? But this is important enough to warrant a separate heading of its own. See below.
4. Control by Whom.
Let’s face it, high-flown thoughts about the public weal are not all that motivates people. Somebody gets to administer the system, and to many, this is the real nub of the question. There are jobs, there are pickings, there are power trips. There is traditional distrust of the private sector by those working for the government, and vice-versa. Like religious sects, the public and private sectors tend to build up comprehensive worldviews which assure each side that its members are closer to God. Neither will readily trust the other with anything more than is unavoidable.
Viewed in this unfortunate light, all the talking points about income redistribution, the safety of savings, and return upon investment are just special pleading by the political equivalent of trial lawyers. Moreover, all of us who work for a living must do so in one sector or the other, and acquire the one or the other set of enthusiasms.
Yet all of us must one day rely upon savings, public or private, for our support. Income redistribution, the safety of savings, and return upon investment are real issues, and we had best detach ourselves from our usual predilections while we consider them.
Realistically, what the control issue means is that any system which can be adopted is bound to be a hybrid. Our overall retirement system already reflects this, for it includes IRAs as well as Social Security. Any reform which can win acceptance in a democratic society will at most move a portion of Social Security savings toward the private sector; the voting power of public employees alone will assure that another large portion remains in the public sector.
That I contend, can be a good thing, because some activities of government have an investment-like character, and because government will be better if Social Security reform promotes those activities to their proper place in congressional budget debates.
|
|
|
|
|
 |
 |