Asset Returns and Economic Growth

UPDATE: Greg Mankiw has sent along his comments...

There's lots I would dispute. Let me just note one point. Mankiw's last paragraph seems just wrong:

I don’t think the key issue in the debate over Social Security is whether, over the next century, the risk-free return will be 1 or 3 percent, or whether the equity premium will be 3 or 5 percent. So even if I agreed with the arguments raised in this paper and lowered my estimates of rates of return, it would not change my mind about the need to reform Social Security or the kinds of reforms that are desirable. I would guess that, in their hearts, the authors of this paper agree with me about this. To see if I am right, I would like them to answer the following question: Suppose that next week, the stock market falls by 50 percent, so dividend and earnings yields double. Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform? I suspect they would not. If I am right, this suggests that while the paper raises some interesting questions about the future of asset returns, as far as the debate over Social Security goes, it is largely a non sequitur.

As I see it, there are four important reasons to be against Bush's Social Security plan:

1. The terms on which it offers private accounts to the non-rich make them not a very good deal.
2. The plan does nothing to raise national savings in the short and medium run.
3. Applying price indexation to the bend points produces a Social Security program that is an ever-decreasing share of GDP.
4. The Bush administration is incompetent--corporate tax bill? farm bill? budget balance? Iraqi reconstruction? handling of our alliances?--and so there's every reason to think bad things would happen in implementation.

If reasons (2), (3), and (4) were not each of them dealbreakers, and if the stock market today were half what it is today, then yes, I would be in favor of a well-designed and well-implemented private-accounts plan (even with the 3% real clawback). With such a high prospective rate of return on equities, the benefits of grasping for some of the equity premium, of prefunding, and of getting a share of Social Security taxes out of the "federal revenues" column would, I think, significantly outweigh the costs of the risk that private-accounts plans impose on non-rich beneficiaries. But with current prospective equity and asset returns, private accounts make no sense with a 3% real clawback.

---

Max Sawicky reports from the Brookings Institution:

MaxSpeak, You Listen!: GUNFIGHT AT THE BROOKINGS CORRAL: "Dean Baker and Paul Krugman presented their paper, co-authored with Brad DeLong, on 'Asset Returns and Economic Growth,' at the Brookings Institution today. They lay out the problem of what makes a logically consistent scenario of economic growth, in terms of assumptions on interconnected variables, including labor force growth, productivity, immigration, stock prices, returns on equity, etc. N. Gregory Mankiw, late of the President's Council of Economic Advisers, acted as discussant.

The authors zero in on 4.5 percent as the most plausible estimate of future returns to stock ownership. This tracks closely with the 4.6 of Robert Shiller, discussed here previously. When you include this in a diversified portfolio that has bonds and government securities, the average rate of return is much lower than the numbers routinely thrown around by privatization snake oil salesmen.

The paper discusses how plausible economic growth elsewhere does not change the basic scenario, a previously neglected subject.

Mankiw gave me a Groucho Marx moment -- as in, 'who are you going to believe, me or your own two eyes? -- by suggesting that the connection between stock returns and Social Security privatization was spurious. So why, you may ask, are the President and Vice Pres . . . Oh never mind.

Mankiw also accused the authors of Galbraithian lack of faith in 'corporate capitalism,' due to what he construed as their assumptions about corporate dividend policy. This was good timing, since there happens to be an event at Brookings next week about Galbraith and his life's work.

Nobody in the room (about 50 heavy-weight economists) sided with Mankiw's comments. Robert Gordon and Benjamin Friedman made fun of him. Gordon for Mankiw's New Republic article, where Mankiw cited the investment opportunities of the Harvard faculty as a model for working people. Friedman noted that he was implicitly attacking George W. Bush for mixing up the issue of Social Security privatization with that of solvency.

Gordon is much more optimistic about economic growth than the Social Security trustees. This suggests better stock market performance, but it also means the Trust Fund balances persist for much longer than 2041. He said 'the big deal here is immigration.' He went on to point out that a modest assumption about immigration meant a huge difference for labor force size in the long run.

There was a fair degree of consensus, as there is in the literature, that privatization and solvency are two separate matters that don't have much to do with each other. Privatization -- not necessarily in the form proposed by the Bush Administration -- allows the individual to revel in his own risk-taking, enjoying the thrill of success and the agony of failure. It entails the replacement of social insurance with individual saving. You could be for this irrespective of whether the market rate of return is much higher than that under Social Security, or under riskless U.S. government bonds.

Solvency or 'pre-funding' is the grim task of matching the present value of future spending to future receipts, mostly by reducing benefits. An irony of this is that 'solvency' proposals typically take a burden that is otherwise spread over all future generations and concentrate it on . . . why, on you, dear reader. As long as you're under 55. The people who have been told they benefit the most from 'privatization' are precisely the ones who get screwed the worst.

I met Mankiw afterwards. He wasn't too familiar with this site, which was predictable and is probably just as well. I told him I quoted him periodically. He was pleased.

Most of the conference was on some crazy little thing called the current account deficit, which maybe could cause interesting problems in the future.

---

So Greg didn't say that a 3% real clawback on private accounts is too high? That the clawback rate should be matched to the actual Treasury borrowing rate? Sigh...

Bob Gordon is--as is almost invariably true--smart. Raising immigration by 0.3% of the workforce every year wipes out nearly half of the 75-year Social Security deficit--and that's the decline in immigration that the SSA expects to happen between 2000 and 2030.

Comments

[dilbert dogbert]

Why does anyone think that a future repub government won't go after the benifits of the over 55 crowd if they need to fund a tax cut?

[Miracle Max]

For the record, Mankiw did say that 3% was too high, and the TIPS rate made more sense. (This would cost the Gov more, of course, other things equal.)

As for the over-55s, I for one think there is an excellent chance of them being affected because of the generally sad state of the overall budget, if not because of Bush's privatization.

[wkwillis]

The clawback rate should match the Fed funds rate, because that is the cost to the government (read, the other social security recipients).
The problem with that is that we don't just import crude, cars, computers, and clothing, we also import cash for buying tbills. If we don't import 600 billion dollars a year from the rest of the world the social security trust fund is going to be earning ten percent interest on it's bonds.

[anne]

Indeed Social Security benefits to those over 55 are threatened. There is an increasing cost in Social Security benefits to cover Medicare benefits. The cost of living increase is gobbled up by Medicare costs. Social Security is indeed under threat, and we must be concerned.

[anne]

The Senate has passed a tax cut on Scoial Security benefits for wealthy retirees. If this tax cut is passed by the House, there will be a significant loss of Medicare revenue for the tax is used by Medicare. This loss in revenue in turn will add to the costs of all who receive Social Security benefits. Social Security is surely and sadly under threat.

[anne]

Another reason why stock market returns may well be limited for some while:

http://www.nytimes.com/2005/03/25/business/25norris.html

Too Much Capital: Why It Is Getting Harder to Find a Good Investment

THERE is too much capital in the world. And that means that those who own the capital - investors - are in for some unhappy times.

That thesis may sound inherently unlikely, but it explains a lot. Those with capital find they must pay high prices for investments that are likely to produce only a little income. The relative importance of things other than capital, like commodities and cheap labor, has grown.

Evidence of the capital glut can be seen in interest rates. Market rates are low, and even when central banks set out to raise short-term rates, longer-term rates are slow to move. Little additional yield is available to those who buy very risky bonds. For the same reason, stock prices are high. Profit disappointments may not cause the stock market to plunge, since the capital will have to go somewhere. But the return on the underlying investments is likely to be below what investors have expected.

With capital in a weakening position, returns that once would have gone to owners of capital have gradually been redirected....

[dogfacegeorge]

anne,
You left us hanging -- the returns that once would have gone to owners were redirected to whom? According to the article, the returns were redirected to management: "That is one way to explain the surge in management compensation in the last two decades."

[anne]

http://www.nytimes.com/2005/03/25/business/25norris.html

That is one way to explain the surge in management compensation in the last two decades. In the early 1980's, when interest rates were high and stock prices low, the average chief executive received no stock options in any given year. Now nearly all get sizable grants, and one study found that chief executive pay rose faster than that of any group save for professional athletes and movie stars. Those who provided the capital had less power to demand the profits from the enterprises they financed.

Another sign of excess capital can be seen in what Argentina did to its creditors - and in how they reacted. When Argentina defaulted on its debt in December 2001, many thought it would eventually negotiate a deal with creditors that was similar to previous arrangements made by countries in default. Instead, this year it imposed far harsher terms and refused to talk about them. The vast majority of the bondholders meekly went along and bonds of other emerging markets have not suffered.

Emboldened, Argentina's government is sounding an uncompromising note regarding foreign-owned utilities and oil companies. It is betting that it can get away with treating the owners of capital badly and it may be right.

Why is there too much capital? One answer is that central banks reacted to the bursting of the technology bubble by cutting interest rates by too much for too long. The resulting liquidity might in other times have sent inflation soaring, but now China's emergence has placed offsetting deflationary pressures on consumer goods prices. The excess liquidity is sloshing around world capital markets.

At the same time, China's emergence is spurring investment that the world may not need. The world automobile industry is plagued by overcapacity, but every car company believes it must have plants in China.

We have seen too much capital before, but not on a worldwide basis....

[anne]

Thank you, George :)

[Dave Schuler]

"Raising immigration by 0.3% of the workforce every year wipes out nearly half of the 75-year Social Security deficit."

Is that true or does it depend on the nature of the immigrants and the immigration? For example, is it true if 100% of the immigrants don't contribute into the Social Security system at all? If 100% contribute at full-time minimum wage levels (and collect Social Security benefits at that level)? If 100% contribute at full-time FICA max levels (and collect Social Security benefits at that level)? I'm not trying to be snarky. I'm really curious.

[old ari]

So you suggest exporting money, and importing people.

[beowulf]

Dave Schuler,

You make a good point. Unlike Canada and Australia, which favor immigrants with advanced degrees, our immigration policy seems designed to bring in more day laborers with 4th grade educations.

[Allen K.]

Why does poor Chico Marx always have his most memorable quote stolen from him and attributed to Groucho? And I'm supposed to trust this guy re Social Security?!

[nick]

Unlike Canada and Australia, which favor immigrants with advanced degrees, our immigration policy seems designed to bring in more day laborers with 4th grade educations.

Probably because the American economy is better suited right now to employing day-labourer immigrants than ones with advanced degrees. Now, if low-skill, low-wage immigration is beneficial to the economy as a whole, so be it; though the long-term prospects seem (to me, at least) problematic.

[Miracle Max]

The antecedent of 'he' is Mankiw, not Friedman, from which standpoint your comment, like so many others, makes no sense.

[wkwillis]

Even unskilled immigrants make America richer because we get them free. It's only educating their children and paying them social security that make America poorer. That's why George Bush Junior wanted to let them come in freely if they left their wives and children behind and left themselves after five or ten years.
Also, unskilled immigrants transfer money from upper income to lower income people. After they've been here a few years they learn enough to start competing with people who vote Republican by starting small businesses and making it to the lower levels of management.

[liberal]

nick wrote, "Probably because the American economy is better suited right now to employing day-labourer immigrants than ones with advanced degrees."

Not at all clear. Allowing immigration has the effect of decreasing the market wage. Immigration of day-laborers forces down the market wage for the working poor. Immigration of e.g. MDs would force down the market wage of MDs.

I suspect the immigration of day-laborers has more to do with the lack of political clout of day-laborers in the US (as compared to, say, MDs), and little to do with the what's suited to the American economy.

[Uncle Jeffy]

Miracle Max - nice shot!

[PaulB]

Patrick, determined to make a fool of himself, writes: "Did he attack Krugman et al, for doing so, too?"

Why no, Patrick, most likely because they didn't.

[Barry]

But it's nice to have you back, anyway, RoseFeeder. It's spring, and my roses need strong food to grow tall and beautiful. I'll get my wheelbarrow.

[Auros]

Not to go off on a tangent, but... Anne, or anyone else: Do you think that perhaps the reason for the stagnancy of real wages is that despite a lagging return to capital, productivity gains have been captured almost entirely by the executive class?

I've been wondering, almost from the moment I started working (I had an internship in a technical job when I was 15) whether the only way those of us who do the actual work of the "Information Economy" were ever going to get our due from management, was to unionize on a large, AFL-CIO kind of scale. But how to get such a thing started, when so many of us are Randian extreme Libertarians?

[Auros]

@ WKWillis: One phenomenon worth noting is that, because many of the recent sun-belt immigrants are very, very Christian, and join wing-nut churches, they may pull money from Republican voters when they become small-business owners, but if they get naturalized, they end up voting Republican too, in much larger numbers than previous waves of immigrants who've benefitted from Democratic policies that keep them afloat through rough periods, educate their children, etc. Most irritating.

[anne]

"Do you think that perhaps the reason for the stagnancy of real wages is that despite a lagging return to capital, productivity gains have been captured almost entirely by the executive class?"

Interestingly phrased question. Top executives have directly benefited from from their position whether there have been significant productivity gains or not or whther there have been earnings gains or not. Of course, earning and productivity gains have made justifying top executive pay packages all the easier. There is also the indirect gain that goes to shareholders of a company from earnings increases. Obviously wealthy executives are far more a part of the shareholder-ownership class than others.

The problem has been that workers below executive level have had too little bargaining power to command wage and benefit increases in line with productivity and earnings increases.

[anon.]

"Raising immigration by 0.3% of the workforce every year wipes out nearly half of the 75-year Social Security deficit."

-----------------------

...sooo, what about the other half?

Also, did Gordon take into account the slowing of wage growth that would necessarily occur as more labor enters the labor market, largely from Mexico? Particularly given most of the jobs taken would be lower-paying jobs, which are already under threat of stagnant or even negative nominal wage growth?

[Bruce Webb]

"Is that true or does it depend on the nature of the immigrants and the immigration? For example, is it true if 100% of the immigrants don't contribute into the Social Security system at all? If 100% contribute at full-time minimum wage levels (and collect Social Security benefits at that level)? If 100% contribute at full-time FICA max levels (and collect Social Security benefits at that level)? I'm not trying to be snarky. I'm really curious."

Well a couple different issues are being mixed in here. First you need 40 quarters of Social Security earnings to even qualify for benefits and people working 39 quarters or less over their lifetime don't get any refund. You would think a substantial numbers of immigrant workers are paying in without getting anything out. Second a lot of illegal immigrants are working under someone else's Social Security number. As I understand it there are programs in place to keep that from being credited to the real owner of the number, but in any event probably a net gain to the Trust Fund. And third workers, illegal or not, paying Social Security or not, contribute to overall productivity, someone is extracting value from that labor, and while the exact relation is in some dispute there is no doubt that increased productivity works to the advantage of the Trust Fund.

Much of the rhetoric now flowing is on the declining worker/retiree ratio. More workers less problem.

[anne]

http://www.nytimes.com/2005/04/02/international/asia/02gyun.html?pagewanted=all&position=

Born to Be a Foreigner in Her Motherland
By NORIMITSU ONISHI

TOKYO

CHUNG HYANG GYUN'S news conference was a sight seldom seen in Japan, the raw anger written across her face, the fury in her voice and words, the palpable feeling that these last words would somehow redeem the futility of her actions.

'I want to tell people all over the world that they shouldn't come to Japan to work,' Ms. Chung said in the perfect Japanese befitting someone who has lived nowhere else but Japan. 'Being a worker in Japan is no different from being a robot.'

After a decade-long battle, the Supreme Court ruled recently that Ms. Chung, the daughter of a Japanese woman and a South Korean man, who was born in Japan and has lived all her life here, could not take the test to become a supervisor at her public health center because she is a foreigner.

'I have no tears to shed,' said Ms. Chung, a 55-year-old nurse. 'I can only laugh.'

Ms. Chung is what the Japanese call a Zainichi, a term that literally means 'to stay in Japan,' but that is usually shorthand for Koreans who came here during Japan's colonial rule, and their descendants. Considered outsiders both in Japan and on the Korean peninsula, they have, over the years, adopted different ways of living in Japan.

In a Japan that has softened its attitudes toward the Zainichi, many have become citizens and taken Japanese names, melding into the larger population. Others have taken citizenship, but kept their Korean names. Others still, like Ms. Chung, have taken neither citizenship nor name. Disagreements exist, even within the same family, including Ms. Chung's....

[Keith M Ellis]

"Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform? I suspect they would not. If I am right, this suggests that while the paper raises some interesting questions about the future of asset returns, as far as the debate over Social Security goes, it is largely a non sequitur."

As you point out, that assertion does not give one confidence in Mankiw's analytical abilities. Not incidentally, the reverse speculation/accusation is probably true: were privatization a really bad deal relative to the current system, I suspect Mankiw would support it anyway. So is his defense of the financial advantage of privatization largely a non sequitor? Hmm.

This also demonstrates the seductive-yet-destructive nature of these sorts of counterfactual arguments that are built around guessing an opponent's secret motivations. Take note: our side does it, too.

[piotr]

Mankiw: "if I am right, I would like them to answer the following question: Suppose that next week, the stock market falls by 50 percent, so dividend and earnings yields double. Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform?"

I wonder what it would take for Mr. Mankiw to reject Bush's quasi-proposal (as the details are still unofficial). If I understand correctly, nothing. He seems to imply that he is a political shill and that he fully expects that his political adversaries are shills too.

[jm]

The only right way to deal with Social Security is to finance it on a pay-as-you-go basis by taxing income at a reasonable rate and adjusting retirement ages according to the worker/retiree ratio so as to keep the tax rate reasonable.

Any other approach violates the most fundamental dictum of engineering: Keep It Simple.

The current brouha is a direct consequence of that dictum having been violated by the 1983 Greenspan "fix" that set up the Trust Fund. It should have been intuitively obvious to the casual observer back then that the baby boomers' prepayments into the Trust Fund would need to be matched symmetrically by future buybacks of the Trust Fund bonds with general tax revenues, requiring future general tax rates to be higher by the same amount that Social Security taxes would have been higher in the absence of the Trust Fund. So all the Trust Fund did was to obfuscate the basic issue that the goods and services to be consumed by future retirees in some year "Y" can only be some fraction of what is being produced by the workers in year Y.

Any other investment plan has the same defect. For the retirees to live off the investments, whether they're Trust Fund Treasury bonds, privately-bought Treasury bonds, corporate bonds, common stocks, or McMansions, the workers will have to buy them from the retirees, and there will be a limit to how much of their income the workers will be able to pay.

Making SS an explicitly pay-as-you-go program has the overwhelming advantage of keeping this fundamental reality clearly in view.

Trying to finance it with "investments" -- which is essentially what we did in 1983 -- leads to exactly the problem we have now. Trying to finance it with common stock investments would invite the even more pernicious situation we saw back in the dot.com bubble era, when innumerable fools thought they could all retire at 45 just by bidding stock price sky-high.

"Keep It Simple" works in engineering because the simpler you keep things the less likely it is that someone will fail to understand what needs to be done, or fail to notice something going wrong.

When economists step into the realm of public policy-making, they enter the realm of applied science, i.e., engineering. They would do well to study the great engineering successes and failures of the past.

[Keith M Ellis]

I wrote:

"I suspect Mankiw would support it anyway."

Well, he says so right in that paragraph. I didn't read his paper, what is it he says are the real reasons to support it? Does he come right out and admit that the impetus behind this is really an antagonism to The New Deal and a desire to eliminate SS as a fundamental attack against its ethos?

[A. Zarkov]

“If reasons (2), (3), and (4) were not each of them dealbreakers, ...”

Mankiw is therefore right when he says BDK would still not support the Bush plan for SS if the stock market fell by 50%. Their reasons for opposition go beyond future asset returns. So should we not focus on (2), (3), and (4) as the problem with the Bush plan? Isn’t the BDK essay on asset returns a bit of a red herring? Lots of people (including me) think we would be lucky to get returns on a broad market average as high as 5%. This is why I would not take the lump-sum cash out on my defined benefit pension. If the market did fall by 50% next week I would. Especially if you believe market returns are mean reverting. Of course if that were the case, the random walk model would be false, and many professors of finance would need to beat a retreat.

[Ah, but (1) is a problem that I think we can fix. And--since the thing might actually get implemented--we should fix all the problems with it that we can...]

[Keith M Ellis]

"Isn’t the BDK essay on asset returns a bit of a red herring?"

No, because the superiority of privatization in this regard is a core talking point of its supporters. Also, it is an assertion, in the form it has been asserted, quite amenable to a rigorous analysis. Which BDK provide.

Finally, there's good reason to believe that the popular support that exists, or could potentially exist, requires this assertion. While Mankiw may oppose social insurance inherently and others support social insurance inherently, I strongly suspect that popular opinion is mostly concerned with what is best for them financially. This happens to be a matter of ideology that is deeply, immediately practical and the GOP, or this admin, overestimated the degree to which the general public would accept the triumph of ideology over practicality. (Even if disguised.)

[trevelyan]

>> Ms. Chung, the daughter of a Japanese woman and a South Korean man <<

This is somewhat off-topic but in response to Anne's post on Japanese labour laws it is worth noting that American citizenship has traditionally been passed paternally. Children born abroad to American mothers were not been granted citizenship through most of the 20th century. There were changes made in the 1980s, but they were not retroactive don't affect anyone over 20.

[anne]

Thank you, Trevelyan :) Interesting.

[RonK, Seattle]

If the market drops 50% tomorrow, is it shedding 100% overvaluation (in terms of ultimate real returns on real capital)? Or is it undergoing an episode of irrational abhorrence?

Both cases bolster prospective returns (whether or not we know which is which) but neither bolsters our faith in the prospective wisdom of speculative markets.

Also, suppose the market drops as described. What should we then assume about market behavior in the window of opportunity between passage of The Act, and investment of The Funds?

[Rob]

Mankiw: "if I am right, I would like them to answer the following question: Suppose that next week, the stock market falls by 50 percent, so dividend and earnings yields double. Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform? "

given the President's assumed growth rate for the economy and his assumed rate of return on equities leaves the terminal position for the stock market inconsistent with the terminal position for the economy.

Yes if we had a crash today that could rationalize his terminal positions given his rates BUT.... if we had a stock market crash today would you really then predict a 6.5% return on equity? I wouldn't. I would still predict a 4.5% return on equity just starting from a lower initial position.

[Bruce Webb]

"While Mankiw may oppose social insurance inherently and others support social insurance inherently, I strongly suspect that popular opinion is mostly concerned with what is best for them financially."

Bingo. Mankiw is close to letting the cat escape right from the bag. The 'tuquoque' implied in his insistence that BDK would oppose privatization even if it would work (i.e. with the stock market sitting at the bottom) reveals his belief that privatization is an inherent good no matter how the numbers run. The seventy year Randian dream of killing Social Security is melting down in front of the Cato Institute and the Club for Growth's eyes and they are beginning to lash out in ever increasing frenzy.

The irony is delicious. I can make a solid case why diverting 4% of payroll to private accounts would make perfect sense for anyone earning between $50k and $90k, which is to say the point when the progressivity built into Social Security begins to bite. The problem for privatizers is that the economic numbers that would return this good result for higher earning workers would produce a fully funded program for lower earning workers, and one that would give them better results than any diversion to private accounts would.

Clearly it is killing Mankiw et al to defend 1.6% ultimate productivity. They are dying to inject higher numbers and so justify private accounts for better earners. But in doing so they would lose "crisis" and the Rovian dream of using the "ownership society" to cement Republicans in power forever.

Man it blows when your karma runs over your dogma.

[Xpatriated Texan]

The best reason not to endorse President Bush's plan is that 75% of all people - whether they invest in private accounts or not - will lose money. When you consider that over 50% of all Social Security recipients depend almost entirely on Social Security, that would be hurting a lot of people.

Why trust the economic voodoo of a man who said his tax cuts would extend the budget surplus and then presided over the largest negative jump in net government revenues in history? How wrong does someone have to be before they totally lose credibility?

XT

[A. Zarkov]

“if we had a stock market crash today would you really then predict a 6.5% return on equity? I wouldn't. I would still predict a 4.5% return ...?

Yes I would. For one thing that would change the dividend yield substantially. If the yield on the S&P 500 were (say) 5% instead of the current miserable 1.5% then I know I could do better than 6.5%. Unless the cause of the crash reflected a structural change in the economy where earnings were so low firms couldn’t even pay a dividend. But returns do seem to be mean reverting (although this is disputed) so a crash would represent a buying opportunity. One who believes the market today is overpriced (that’s me) also believes future returns will be low. If you don’t believe price matters then go buy real estate.

[RonK, Seattle]

The 500% Thought-Experiment: If expected real returns were 500%, would pay-as-you-go be silly?

Further supposing a confidence interval of 400%-600% for this estimate, it would be easy enough to miscalculate my PRA balance at retirement by a factor of one billion or so.

Pay-as-you-go is, among other things, an option ... and options have value (for individuals, and for social aggregates) ... and option value increases with uncertainty.

Noting that, and noting also that almost all of my nestegg accrues in the last 2 years pre-retirement, it would seem unwise to voluntarily (and gratuitously) lock in budget constraints 35 years out.

There may be a sweet spot somewhere between 5% and 500% where advance-funding is wise ... but the optionality of paygo deserves a bit more attention in the analysis.

[anne]

Values of stocks have little significance in discussing proposals to privatize Social Security. What is significant is that each proposal aims to limit and reduce Social Security benefits so ending the program. Change the indexing of benefits from wages to prices, and benefits will fall ever further behind average wages and support for the program will end.

If we wish to continue Social Security, but wish to bolster long run returns, we can have the system invest part of the surplus in a total stock market index of non-voting shares. Also, we can keep the current benefit structure as is, and as in Sweden we can add private acccounts by modestly increasing payroll taxes and using the increase for private accounts. However, the privatizers wish to end the program not bolster it.

[masaccio]

I agree with JM. It just makes me feel an undirected hostility that my social taxes were raised so that recipients of "My Big Fat CEO Paycheck" http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?
can have lower taxes.

[masaccio]

Whoops, should be

http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?

[anne]

The level of the stock market is where it is this day, and not 50% lower. Were the level to fall 5% to 50%, of course stocks would be 5% to 50% more attractive unless long term prospects for the economy changed with the decline in stock prices. Would I buy more General Electric shares at a 50% discount? Of course, but the price can not to wished to my liking so easily :)

[anne]

http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?pagewanted=all&position=

My Big Fat C.E.O. Paycheck
By CLAUDIA H. DEUTSCH

...

In fact, the boss enjoyed a hefty raise last year. The chief executives at 179 large companies that had filed proxies by last Tuesday - and had not changed leaders since last year - were paid about $9.84 million, on average, up 12 percent from 2003, according to Pearl Meyer & Partners, the compensation consultants....

[wkwillis]

If the stock market fell fifty percent tomorrow, would I favor letting today's Republicans control my social security pension?
Given that the last twenty five years were the biggest bond, stock, and real estate booms in the history of the world, and that despite that most big corporations have pensions funds that are seriously underwater, the answer is no. If they can't run a pension fund in the last twenty five years economic environment and have it break even...

[anne]

Though I would change most to some, a close look at pension fund investment over the last 25 years is surely in order. There are puzzles about a seeming lack of returns that come up too often.

[jm]

Following on from my April 2, 2005 09:31 PM post above, I must point out that if the hundreds of billions of dollars now going into the SS Trust Fund every year are diverted into the stock market, we can be quite certain that stock prices are going to rise. It's a safe bet the rise will be amplified by smart money private traders who will be guaranteed a source of dumb money to sell out to before the peak.

We can also be certain stocks will continue to rise until the day when the retiree/worker ratio rises to where the outflow from retirees selling to live exceeds the inflow from workers still contributing, and that they will then start falling. And it's a safe bet that the smart money will have been long gone, forseeing this inevitable event.

Those who retire while the rise is in progress will likely get a larger share of the pie than they would have in an honest, Keep-It-Simple pay-as-you-go system.

But in the long run, if the entire population is invested in marketable securities. it will not be a case of market prices deciding retirement incomes. Rather, it will be a case of market prices being __decided__by__ the retirement incomes that the retiree/worker ratio can reasonably support.

If workers of the future won't have the surplus income to pay general-account taxes to buy back the SS Trust Fund Treasury bonds, neither will they have the surplus income to buy the securities in private accounts. And if they do have the surplus income to buy any of those things, well, they'll have enough to support the retirees with pay-as-you-go FICA contributions.

Some might opine that if the above is correct it just proves that either approach is equally good. But that's not so. Both the current Trust Fund approach and the proposed Private Accounts approach violate the Keep It Simple rule. Pay-As-You-Go doesn't.

Why is Keep It simple so important? Because the more complex you make any system, the more people are going to be unable to understand how it really works, and make bad decisions. And the easier it will be for malevolent or incompetent people to sow confusion and induce people ot make bad decisions. The current consequences of the Trust Fund are prima facie evidence. The confused debates going on about future stock market returns are also symptomatic.

[theCoach]

I took Macro 101 in college. I have never used qualification to dishonestly schill for a corrupt administration. I think that makes me more credible than Mankiw on this subject, so I am suprised Brad would lend any weight whatsoever to Mankiw. I am suprised with how unscathed even Brad DeLong thinks his reputation is.
The proper respose when someone from the Discovery Institute puts forth an argument against evolution is not to get into an honset debate on the merits setting implicitly lending credence to their point of view. The proper response is to recognize the argument itself as a sham. I see no reason to treat Mankiw any differently.

[Ottnott]

Brad wrote:
"...if the stock market today were half what it is today, then yes, I would be in favor of a well-designed and well-implemented private-accounts plan (even with the 3% real clawback). With such a high prospective rate of return on equities, the benefits of..."

If a private-accounts plan w. clawback is only a good idea when stock prices have been beaten down, then it clearly is not a good idea.

Money put in right after the hypothetical 50% drop in stock prices would do well, but what about money put in after some years of "high prospective rate of return" come to fruition?

You could have entire generations get lousy returns while their parents or offspring did quite well.

Low equity prices might be a good argument for the SocSec trust fund to invest money in equities, but private accounts still transfer too much risk to individuals.

[A. Zarkov]

“... honest, Keep-It-Simple pay-as-you-go system.” The “simple” system we inherited is essentially a Ponzi scheme. That’s the opinion of Nathan Keyfitz professor of mathematical demography at Harvard and consultant to the SS system. He predicted circa 1978 that SS would run short of money soon and it did. In about 1982 SS could not meet its obligations and had to borrow from other government agencies (see the SS web page). Why did those early cohorts deserve a free ride? But we are stuck with this monster and the best thing to do is leave it alone and trim benefits as necessary for it to meet its obligations. If we just keep raising FICA taxes people will cheat. Once enough people cheat, there is not much to be done; you can’t put half the country in jail.

[RonK, Seattle]

Zarkov -- A mathematical demographer can be forgiven for not knowing a Ponzi scheme from a hole in the ground.

[tante aime]

Anytime you see the word, "SS privatization", remember, hiding right behind that is the word, "market gaming."
All the clawers-on to Black-Schoales derivative pricing models failed to understand how easily they were gamed, and you can still see that circus today. Derivativers, market-timers, momentum players, hurry, hurry, hurry!!! Put your money down. Now which card has the mark on it? Ha,ha,ha,ha. Wrong! You're the mark!

[Anarch]

The “simple” system we inherited is essentially a Ponzi scheme. That’s the opinion of Nathan Keyfitz professor of mathematical demography at Harvard and consultant to the SS system.

By most standard definitions, he's incorrect. Do you have a cite handy wherein I can find out exactly what his definitions, and thus what his conclusions, are?

[jm]

A. Zarkov: SS is not a Ponzi scheme. A Ponzi scheme is an outright fraud in which people are induced to invest by promises of quick and easy riches. That people who retired in the early years of the system got back more than they paid in does not make it a Ponzi scheme.

When someone starts up a new insurance company, the first customers to file claims get back much more than they paid in. Does this make every new insurance company a Ponzi scheme?

All that is necessary to keep SS solvent is to keep adjusting the tax rates so they remain reasonable.

My point above was that the returns on any securities in trust funds or private accounts that we try to build up to finance future retirements are going to be determined by how much the workers of the future can afford to pay for those securities when the retirees start to sell them. So the same thing holds for any "private-account-funded" scheme as for a pay-as-you-go system. The difference is that with pay-as-you-go it is absolutely clear that that is so, whereas with investment schemes it is very easy for people to get the confused impression, as they see the market valuations of their accounts rise up in the years before purchases exceed sales, that they are going to be really well off when they retire, only to find when they finally get to retirement that sellers outnumber purchasers and they weren't rich after all. If we're going to label something a Ponzi scheme, the private accounts concept is much closer to one than pay-as-you-go SS.

[Luc]

I'm going to repeat myself here, just for ego purposes.

"In the real world SS would be a simple income redistribution program. Money from the working to the retired and needy. Simple, clean and efficient."

It is a bit unrespectful, but my choice quote from Mankiw would be "approximately irrelevant". Nice wording.

As for the unfunded liabilities, which are supposed to be such a problem. They're not. Just as the current surplus is not a problem. Have the politicians read a bit of old fashioned Keynes, and they could easily make a balanced judgement about when to accept surplusses and shortfalls, and when to adjust tax levels and benefits. As noted above the bond trick was a mistake, because it absolved those politicians from making that judgement.

But the objections of Brad Delong also point in the wrong direction. So, in my view,
(1) is irrelevant, since SS should be a strict pay as you go system.
(2) SS shouldn't be a program to raise savings. Use 401k's or whatever, but don't (ab)use SS for that. KISS and all of that.
(3) is absolutely true.
and argument (4) should not be neccesary.

[bakho]

Take that, Private account investors:

CREF Variable
Annuities Performance Data1
as of 04/01/2005
YTD Return 5 Year
Stock -2.28% -0.73%
Global Equities -1.38% -4.64%
Growth -6.02% -11.31%
Equity Index -2.92% -0.95%
Social Choice -2.21% +3.13%
Bond Market -0.35% +7.46%
Inflation-Linked Bond 0.00% +10.02
Money Market 0.50% + 2.59

For most of these, stuffing money in a matress would have been a better option.

If you start out in the hole for 5 years, isn't that bad for the compounding effect?

[anne]

We need a better idea of how difficult a time this has been for personal pension plan investing. Real estate has provided a large wealth gain, but there has been a general investment loss for stock market investors these last 5 years. What has happened to pension plans?

[johnchx]

It looks like most folks overlooked the really big news in Mankiw's notes. On page 4, he reveals, "There are two elements of the President's proposal on Social Security reform. First, the President wants to eliminate the system's unfunded liabilities by bringing promised benefits into line with dedicated payroll tax revenues."

He does? This is the first I've heard about this. And it's the first element? Did we miss a press release?

Also, I can't let this pass without comment: "Suppose next week the stock market falls by 50 percent, so dividend and earnings yields would double."

They would? What part of "stock prices are endogenous" do we suppose Greg doesn't understand?

I suppose that, as a matter of arithmetic, yields might double...if unadjusted for risk. Privatizers are always a little fuzzy about the meaning of the risk premium. They have a habit of treating risk premia as free money, at least when they're thinking about the risk to other people's investments.

[dogfacegeorge]

johnchx,

That's a good point. What exactly does Mankiw mean when he says Bush wants to "eliminate" the SS's unfunded liabilities? Aren't these "unfunded liabilities" the SS "promised benefits"? So isn't he saying that that Bush wants to eliminate the SS "promised benefits"?

And when he says that Bush wants to eliminate the promised benefits by bringing them "in line" with "dedicated" payroll tax revenues, isn't he saying that Bush wants to eliminate payroll tax revenues that are "dedicated" to SS?

[anne]

"Suppose next week the stock market falls by 50 percent, so dividend and earnings yields would double."

The more I think of the supposition, the odder it becomes. Suppose next week the stock market were to gain 50%, so dividend and earnings yields would halve. Well, it would be nice to be invested this week and next week there would be new conditiuons to consider. But what does this have to do with privatizing Social Security? Over the coming 40 years, stock are so likely to return more than bonds that I would favor having part of the Social Security surplus invested by the system in an index fund of non-voting shares. Cutting Social Security benefits and having workers risk individual investing to form a social insurance base, is however to end Social Security.

[johnchx]

dogfacegeorge: "And when he says that Bush wants to eliminate the promised benefits by bringing them 'in line' with 'dedicated' payroll tax revenues, isn't he saying that Bush wants to eliminate payroll tax revenues that are 'dedicated' to SS??"

Actually, taken literally, this would mean cutting benefits to the point that they don't exceed payroll tax receipts...EXCLUDING interest payments from the general fund to the SSTF.

When I first read Mankiw's comments, I took it for granted that this was simply an oversight on his part. But the more I think about the totality of the Bush Administration's public statements on Social Security, the more I begin to suspect that this may be exactly what they have in mind.

Consider:

(1) The administration's penchant for big, world shaping "game-changing" gestures. They're not "reality-based," they create their own realities. (Remember, in context, that old quote wasn't meant as an admission of being delusional, it was about a willingness to take radical action to re-shape reality instead of nibbling around the edges.)

(2) The rhetoric of "the trust fund doesn't exist," "it's just money we owe ourselves," etc., aimed at creating the impression that the SSTF is a mere accounting fiction.

(3) The focus on the 2018 date...the date on which SSTF expenditures begin to exceed payroll tax receipts, NOT the date at which SSTF expenditures exceed total revenues. (I.e. 2018 is when the SSTF begins spending some of the interest it is owed, rather than lending it all back to the Treasury.)

(4) The complete lack of a plan to bring the federal deficit under control, due in large part to the desire to permanently reduce the level of taxation faced by the wealthiest.

It begins to look like this administration may actually be laying the groundwork for a serious effort to repudiate the Treasury's debt to the SSTF.

I know it sounds crazy. But I keep hearing Krugman's words in the back of my head...democracies often have a hard time grasping just how extreme, just how radical the radical extremists can be.

Shock and awe indeed.

[anne]

Repeatedly and ever more insistently we are told that Social Security benefits must match payroll tax receipts. The trust fund has no meaning, for it is a debt we owe to ourselves, and how can we owe ourselves a debt and pay for it? What we must do then is create private accounts, which will appear attractive enough to allow for benefit cuts. Social Security will end, but we will be the better for it for we can all become investors so the program really will not end.

[Inderpreet Singh]

Business and Stock Market News with Daily Updates and Special Coverage.

[Alon Zhang]

Anyone could do me a favor? I am Alon Zhang, from China, now doing something with my graduate paper. I want some papers for information. But I cann't find it. they are listed as following:
1) Victor Zarnowitz:"Theory, History, Indicators and Forcasting",
2) Jill Jacobs,"Profits and Labor, the Pendulum at Rest", Economic Research, Goldman SAchs, June 1996.
If you find them, please send them to me: alonzhang@hotmail.com Thank you very much!