August 16, 2012

Bryan R. Lawrence is founder of Oakcliff Capital, a New York-based investment partnership.

Singapore’s paternalistic government is unappealing to many Americans — media restrictions, one-party rule, harsh penalties for gum-chewing. But Singapore’s retirement system is a model of honesty and transparency compared with Medicare and Social Security.

In 1984, then-Prime Minister Lee Kuan Yew redesigned his country’s retirement system to, as he later wrote, “avoid placing the burden of the present generation’s welfare costs onto the next generation.” Singapore makes no promises but instead requires all citizens to save up to 36 percent of their income for their own retirement and health care. The government invests the savings in stocks and bonds; the money is not used for current expenditures.

The result? Singaporeans have comfortable retirements. Their health-care system delivers better outcomes while costing 80 percent less than ours, according to 2010 findings from the World Health Organization, and all of it is financed without imposing debt on the next generation. Singapore even reported an uptick in medical tourism last year.

Now, compare Singapore’s system to our own. When Medicare was debated and enacted, Paul Samuelson was America’s most influential economist. He was an adviser to presidents Kennedy and Johnson, author of the nation’s best-selling economics textbook and a soon-to-be Nobel laureate. In 1967, Samuelson wrote in Newsweek about the funding mechanism for Medicare and Social Security: “The beauty about social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in. . . . Always there are more youths than old folks in a growing population. More important, with real incomes growing at some 3 per cent per year, the taxable base upon which benefits rest in any period are much greater than the taxes paid historically by the generation now retired. . . . A growing nation is the greatest Ponzi game ever contrived.”

But the baby boom was ending as Samuelson wrote those words. Births per woman had fallen from 3.7 in 1960 to 2.6 by 1967 and then to 1.8 by 1975. By 1990, births were back to 2.0 per woman, but the demographics of the next century had been determined: The rapidly growing population needed to make up for insufficient savings by each generation of Americans was no more.

Anyone could see that this would mean trouble for Medicare and Social Security when the boomers began to retire. But our leaders chose to protect the programs rather than restructure them, and they have used dubious accounting standards to hide the burden placed on younger Americans.

China’s leaders made different choices. With a one-child policy, they could not rely on children to pay for their retirement. Instead, they have designed a system much like Singapore’s: The government makes few retirement promises, and Chinese citizens save significant portions of their income — the average household socked away 38 percent in 2010, Bloomberg Businessweek reported, compared with 3.9 percent for U.S. households. Much of those savings are invested by China’s state-owned banks into U.S. Treasury bonds, which our government sells to finance Americans’ retirements.

Of the $11.2 trillion of U.S. public debt — this doesn’t count the $4.8 trillion held by our government, largely in IOUs to itself for Social Security — the Chinese own $1.2 trillion, making them the largest holder of U.S. Treasurys after the Federal Reserve.

This situation is as dangerous as it is ironic. The Treasury Department’s 2011 annual report shows U.S. debt as a share of the economy (gross domestic product) rising — to 125 percent of gross domestic product by 2042 and 287 percent by 2086 — as retirement promises turn into cash outflows. And if Medicare’s costs per beneficiary grow at historical rates, as the Medicare trustees fear is likely, the U.S. debt-to-GDP ratio will eventually exceed 500 percent. Recall that Greece was pushed into crisis with a debt-to-GDP ratio of 113 percent.

How long will foreign investors, who own half of outstanding Treasurys, be willing to use their savings to finance our promises? In December, the head of China’s sovereign wealth fund, which invests $400 billion of his country’s savings, criticized Europe’s welfare system in blunt terms, saying that it induces “sloth, indolence.” What do the Chinese think of our system?

In the States, the investment management firm Pimco, the largest private buyer of Treasurys, said last month that our retirement promises have “similar characteristics” to Bernie Madoff’s scheme and predicted a Greek-like crisis if the system is not reformed. Meanwhile, the Federal Reserve bought 60 percent of Treasurys issued last year. This rate of purchases cannot continue indefinitely.

Today’s leaders did not design Medicare and Social Security as an intergenerational transfer, and they did not choose the government’s misleading accounting standards. But because these bad choices have not been corrected, many Americans believe that a cut to Medicare or Social Security is a confiscation of money they paid into a trust fund. This misconception greatly complicates our politics.

The good news is that Americans know changes are needed. And our health-care system can be reformed to reduce the burden on our children. We need better information to have this critical national discussion.

Will our leaders give us an honest accounting and discussion of our choices, or will we have to wait for a debt crisis to force the issue?