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March 31, 2005

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.


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.

Posted by Brad DeLong on March 31, 2005 at 08:14 PM in Economics, Economics: Finance, Economics: Growth, Social Security | Permalink

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Comments

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?

Posted by: dilbert dogbert | March 31, 2005 08:54 PM

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.

Posted by: Miracle Max | March 31, 2005 09:14 PM

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.

Posted by: wkwillis | March 31, 2005 10:32 PM

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.

Posted by: anne | April 1, 2005 02:50 AM

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.

Posted by: anne | April 1, 2005 03:14 AM

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....

Posted by: anne | April 1, 2005 03:25 AM

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."

Posted by: dogfacegeorge | April 1, 2005 04:09 AM

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....

Posted by: anne | April 1, 2005 04:27 AM

Thank you, George :)

Posted by: anne | April 1, 2005 04:28 AM

"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.

Posted by: Dave Schuler | April 1, 2005 06:07 AM

So you suggest exporting money, and importing people.

Posted by: old ari | April 1, 2005 06:25 AM

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.

Posted by: beowulf | April 1, 2005 07:02 AM

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?!

Posted by: Allen K. | April 1, 2005 07:18 AM

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.

Posted by: nick | April 1, 2005 08:00 AM

"Friedman noted that he was implicitly attacking George W. Bush for mixing up the issue of Social Security privatization with that of solvency."

Did he attack Krugman et al, for doing so, too?

Posted by: Patrick R. Sullivan | April 1, 2005 09:11 AM

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

Posted by: Miracle Max | April 1, 2005 09:15 AM

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.

Posted by: wkwillis | April 1, 2005 10:34 AM

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.

Posted by: liberal | April 1, 2005 10:47 AM

Miracle Max - nice shot!

Posted by: Uncle Jeffy | April 1, 2005 11:09 AM

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.

Posted by: PaulB | April 1, 2005 11:15 AM

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.

Posted by: Barry | April 1, 2005 12:22 PM

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?

Posted by: Auros | April 1, 2005 01:07 PM

@ 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.

Posted by: Auros | April 1, 2005 01:11 PM

"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.

Posted by: anne | April 1, 2005 02:23 PM

"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?

Posted by: anon. | April 1, 2005 09:15 PM

"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.

Posted by: Bruce Webb | April 2, 2005 06:00 AM

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....

Posted by: anne | April 2, 2005 06:44 AM

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