Sunday, May 3, 2009

Smith & Osario: Fix Social Security, Ease the Credit Crisis

On RealClearMarkets, the Competitive Enterprise Institute's Fred Smith and Ivan Osario write:

Remember the looming Social Security crisis? If you don't, you're not alone. The credit crisis and economic downturn have monopolized public attention to such an extent that the Social Security crisis that was at the center of the policy debate during President George W. Bush's second term now seems forgotten.

This is unfortunate, for not only has Social Security not been fixed, but reform, if done right by tapping into the power of the market, can help provide new capital, which American businesses now desperately need.

To see how this could be done, it's worth looking at the experience of Chile. Government officials in many other countries have looked at Chile's reform during the 1980s as a model. The United States should take a look, too.

My thoughts: While there's a lot to be learned from the Chilean experience, it's wise not to extend the comparisons too far, either positive or negative. The Chilean economy was helped by the establishment of private pension accounts because first, the government ran budget surpluses in order to fund the transition – this in face helped build capital – and second, the accounts helped modernize the Chilean financial sector.

But in the U.S., any transition to Social Security accounts would almost certainly be debt-financed – that's how the Bush plan was structured, and most (but not all) other plans involve some pretty significant borrowing. If you're borrowing from the private sector to establish private accounts, on net there's no new investment going on. Second, the U.S. financial sector is pretty well developed – perhaps too developed, some might argue! – so we wouldn't necessarily benefit to the same degree that Chile did.

Again, there is something to be learned from Chile, but there's no magic that can be imported to fix either our Social Security program or our broader economic problems.


Jim Glass said...

Everything is relative.

US privatization plans involve debt borrowing (presumably) -- but the status quo involves debt borrowing too (presumably) to cover the SS Trust fund and all future expenditures in excess of payroll tax. (Certainly Congress has made no move to increase revenue to cover the amounts needed).

And when financing occurs is important.

If privatization had occurred when the first serious proposals were made, say after the 1994 advisory commission, in the 1990s, the borrowing would have occurred during years of the easiest credit conditions in recent history -- and by the 2030s when, the fiscal crunch will be really coming down, Social Security would have been removed as a general revenue expense of the govt.

Now, SS is going to arrive as a major general revenue expense of the govt in the 2030s, when the fiscal crunch will be really coming down.

"Debt forrowing" or not, the former would have been a lot better than the latter for both the capital markets and the fiscal situtaion, on net over the full stretch of time.

But today, alas, I fear it is too late. The future is arriving, what was the long run is becoming the short run as we discuss this.

Andrew G. Biggs said...

Account plans involve borrowing just to establish the accounts; whether they'd have more or less borrowing than any other plan to fix solvency isn't clear. That is to say, if you wanted to establish accounts and leave the rest of the system alone you could do so, leaving any borrowing involved with the current system still there.

If borrowing took place during a time of low interest rates -- say, today! -- then it would be easier on the budget. But economically I'm not sure whether it makes a lot of difference.

Jim Glass said...


To be clear, I'm not suggesting any kind of free lunch "capital creation" economic benefit from private accounts. Just the opposite. And it's difficult to compare hypothetical reforms of the past or today with a hypothetical futures for SS.

However, my basic idea is that while the cost of promised SS benefits is what it is, and isn't magically reduced to the economy via private accounts (to provide more capital or spur growth or whatever), still, because fiscal and thus market conditions are likely to be so greatly different between the 1990s and 2030s, the timing of *when* the cost of SS benefits is incurred might have significant fiscal and possibly economic effects.

A numerical example might be clearer than words. Say that after the 1994 advisory commission unanimously urged private accounts for all (heh, heh) Congress modified SS so that (for simplicity's sake) the SS Trust Fund started investing not in T-bonds but Eurobonds, corporates, the S&P 500, real estate, gold & whatever else, with individual share interests in the TF going to individuals through private accounts.

(Or not. What matters to the example is the method of funding of benefits, not the private accounts, and the amount funded could be more than the TF balance -- but the clearest and simplest case seems to be to just "really save" the surplus in non T-bond assets so Congress doesn't spend it.)

I'll assume that at Time 1, 1995 plus the following 20 years or so, fiscal and economic conditions are "normal" and relatively easy; and at Time 2, 2025 and later, deficits are at record-high levels and being kept from rising towards 20% of GDP only by big tax hikes and govt program spending cuts -- so there's fighting among many groups for every dollar of general revenue, and calls to cut retiree benefits by delaying the retirement age and means-testing, etc., ... and market interest rates probably have been increased by all the debt.

Anyhow, starting in 1995 people say under age 40 get private accounts with non T-bond assets in them. Assuming Congress doesn't cut spending to fund the accounts (the best option of all, but I don't want to become delusional) for each $1,000 in a private account Congress can either increase taxes by $1,000 or increase debt to the public by $1,000 to fund it....

[] Increasing taxes by $1,000 would create an unambiguous benefit, I believe, because the pre-funding would reduce $1,000 of revenue needed in 2025 and later. That would relieve fiscal and probably market conditions then by more than the tax would tighten them in 1995 and subsequent years, for net fiscal and economic gain. And promised SS retirement benefits would be fully secured "and paid for" by ownership. Win, win, win.

[] Increasing debt to the public by $1,000, if such debt was amortized down by tax increases over say 20 or 30 years, would provide the same benefits by the same logic, but on a lesser scale because the tax cost of pre-funding the benefits would be shifted backwards somewhat. Win, win, but not as much.

[] Increasing the debt to the public by $1,000 and not paying it down, just letting it roll over forever, is the worst case. Then "that world" debt owed to the public in 2025 exactly equals "our world" debt owed to the public plus Trust Fund obligations (which will have to be financed like debt owed to the public to meet Trust Fund commitments). So it may look as if there is no gain.

But I'd say there are two gains even in this scenario.

(1) Because the govt is not spending the SS surplus, which actually is being saved in the Trust Fund, the officially reported annual govt deficit would not be artificially reduced by the surplus as via our world's unified budget. It would be much larger and more accurately report the operating deficit of the govt. And the much larger visible deficits might produce political pressure to reduce them ... in which case total debt might be reduced from "our world" numbers after all. A win of some size. (Or at least we could feel better about the more honest accounting.)

(2) SS benefits again are more secure than in our world. Politically, it would be clear the deficits and national debt resulted from other programs, not SS -- and more significantly, SS then would not be tapping general revenue by redeeming T-Bonds, and thus would not be competing for general revenue against everyone from the Agricultural Dept through the Defense Dept to the Zoological Societies. So those groups would have nothing to gain by lobbying to reduce SS benefits to "the rich, and people living so much longer." (In our world, those groups definitely will have plenty of motivation for such lobbying.)

SS would still have its most valuable political asset -- a dedicated funding source.

None of this includes any magical increase in capital available to businesses starting in 1995 just from the private accounts.

But in some of these scenarios there would have been real fiscal benefits and maybe economic benefits too -- yeah, some free lunches! At least a few free bar snacks.

I've never accepted the objection, "There's no free lunch". In economics there seem to be free lunches, or at least discounted ones, all the time. Voluntary exchanges that make both sides better off, figuring out ways to improve efficiency and productivity etc. We should be out there looking for them. (Politicians who promise a free lunch are another story.) But I digress...