Social Security and Global Warming

Arnold Kling posts on the comparison at EconoLog, discussing a post from Megan McArdle's blog. (As usual, Kling is thought provoking and worth reading.) At any rate, this reminded me of some past thinking comparing the Social Security issue to how people think about global climate change. I discussed this as part of a luncheon speech to the 2007 annual conference of the Retirement Research Consortium sponsored by the SSA. The whole text is available here and includes some discussion of the politics of reform that might be worth reading, but in any case I've excerpted the global warming parts below.

The short story is that Social Security (and broadly entitlement) reform and global warming are similar in three ways: first, the costs are potentially large, but also uncertain; second, the costs differ significantly across time, requiring us to make judgments about how to treat different generations; and third, the costs of policies today are inevitably passed on to future generations.

What I would like to do here is put forward two additional areas in which the existing toolbox available to economists may help policymakers better understand Social Security financing, its impact on the public, and the choices we face in coming years.

Interestingly, both of these areas derive from a methodological parallel between Social Security policy and the debate over whether, how and when to confront the challenge of global climate change.

Policy questions over Social Security and other entitlements are in important ways similar to questions of how to tackle global warming. But for those with their political antennae up, there is a certain irony in how climate change and entitlement reform are treated in the political process.

Stereotypically, at least, those on the right claim there is an imminent crisis in entitlements that should have been solved yesterday, while arguing for caution regarding global warming, and waiting until a consensus is reached. Those on the left do the opposite, mentioning the long time horizon and considerable uncertainty regarding Social Security projections but citing the precautionary principle in arguing for immediate action on climate change. Now, it may be that both sides are right – or wrong, for that matter – for reasons going beyond the similarities between the issues. But it is worth pointing out those similarities since the two fields may inform each other.

Both climate change and entitlements are a relatively benign issue for current generations but potentially severe for future ones, with considerable uncertainty regarding the potential effects. These lead to both philosophical and technical questions, which the people in this room are among the best equipped to inform policymakers and the public.

For anyone who follows debate over the economics of climate change, last year there was considerable discussion over the role of the discount rate in the U.K.'s Stern Commission report, which concluded there were large costs to global warming and large gains from averting it. A typical person hearing about this would assume the conclusions derived principally from scientific projections regarding how temperatures would change or how sea levels would rise. Someone in this room, on the other hand, would probably just mutter "low discount rate."

And, in fact, these results were generated in large part from utilizing a low discount rate of around 1.4 percent for intergenerational welfare comparisons, and much debate ensued over whether that was the proper discount rate. What's important here is that few typical policymakers, much less ordinary people outside this room, realize the dominant role the discount rate can play in these very long-term calculations.

For Social Security's internal finances we utilize the trust fund interest rate, which seems appropriate given the important legal role the trust fund plays. And in cases where we're actually transferring assets or debts over time, it also makes sense to think in terms of market rates.

But for calculations balancing intergenerational well-being – which, after all, is what Social Security reform ultimately comes down to – it's not clear to me that the government bond rate is necessarily more appropriate than the rate of wage growth, per capita GDP growth or some such measure. This seems to me to be an area that's both ripe for academic investigation and potentially very useful for presentation to policymakers. People in Washington, and throughout the country, have a gut feeling that entitlement reform comes down to balancing the well-being of your grandparents and your grandchildren, but lack a rigorous framework within which to think these questions through. I'm not saying that we should send every American an index card with the Ramsey formula on it and ask them to fill in their pure rate of time preference and return to Washington for tabulation.

Nor would such a formal framework guarantee success. After all, economists do have a rigorous framework and still they disagree. But they have a much clearer idea about what it is they disagree about, and better knowledge on how these disagreements determine their conclusions. This can only help as we think more about these problems.

There's a second way in which Social Security projections resemble those for climate change, which is the considerable uncertainty inherent in both. A literature survey undertaken by the Congressional Budget Office showed a wide range of estimates for the potential effects of global warming, with the possibility that the net effects on GDP would actually be positive. Of course, there's also the possibility of a – literal – meltdown scenario.

Likewise, as I mentioned previously, since 2003 the Social Security actuaries have included a stochastic analysis of system financing in the annual Trustees report. While some seize on this uncertainty as a reason not to act, in fact uncertainty isn't an argument for delaying action so much as an argument for acting even sooner. There is an insurance value in protecting against an unwanted outcome, even if the chance that this outcome will occur is small.

Remember, the Trustees don't project that either there will a Social Security deficit of roughly 2 percent of payroll or there won't be a deficit at all. Rather, the Trustees projection is the median outcome, with about as much chance the deficit will be double the current project as that there won't be a shortfall at all. So in our policy minds, outcomes in the worst 1 percent of the distribution should play more heavily than those in the best 1 percent.

Finally, like climate change, Social Security policy is effectively permanent. It is difficult to undo changes to the global environment, which is why advocates argue that action should be taken immediately. Likewise, the below market returns to future generations are a function of subsidies to past and present ones. While technically we can change the benefit formula however we wish, we cannot change the underlying financing constraints of a pay-as-you-go program which effectively "invests" in the growth of aggregate wages via labor force growth and productivity increases. The decisions we make about the treatment of participants in the present and near future constrain the treatment of cohorts in the more distant future, just as choices we make about the environment today may dictate outcomes for generations who will follow us.