By Carolyn L. Weaver
Like the bottom feeders on Wall Street poised to strike at underpriced stocks, these opponents of market-based reforms stand ready to capitalize on a downturn. Their argument for clinging to the status quo is deceptively simple: The stock market is risky; Social Security is safe. The security of our retirement incomes, they say, is too important to leave to the vagaries of the marketplace. Their complaint is with proposals to give workers personal retirement accounts that they own and can invest in private stocks and bonds.
Just as budding investors are advised to keep their eye on fundamentals, policymakers will need to keep their eye on fundamentals too as they sort through the false premises thrown up to obscure the powerful case for privatization. Four fundamentals are worth particular note.
First, when all the smoke has lifted and the mirrors are gone, our pay-as-you-go, income-transfer system can be substantially outperformed by a fully funded system built on real saving and capital accumulation. This is because, as Nobel Laureate Paul Samuelson taught us 40 years ago, the best a mature pay-as-you-go system can offer in the way of return on taxes is determined by the growth rate of wages in the economy; projected to be only about 1.5 percent annually, net of inflation. By contrast, the contribution of a saving-based system to the economic well-being of the nation is determined by the real, pre-tax return to private capital investment, which is on the order of 8 percent to 9 percent annually.
To this general conclusion, it matters not a whit what the stock market does next Tuesday or next year. What matters is long-term fundamentals -- in this case, the marginal productivity of capital relative to the marginal productivity of labor and the wide gap between the two. There is widespread agreement among economists that prefunding Social Security and investing in private equity would result in significant improvements in economic well-being.
Second, Social Security is risky. Benefits are not, as some imply, legally enforceable obligations to pay workers a stated sum of money, comparable to a U.S. government bond. Rather, they are long-term promises by the government to be made good by future taxpayers -- promises subject to considerable political and demographic risk. The government can renege on benefit promises in the future as easily as it has in the past. (Remember the 1987 and 1988 legislation?) And the tax cost of meeting future benefits is hardly set in stone, having been on an uphill course since Social Security was enacted. What makes political risks so problematic is that, unlike financial risks, there is no way to hedge against them.
Under official projections, benefits must be reduced 25 percent across-the-board in 2030 to close the financing gap. Permanent reductions in lifetime benefits of this size would result in wealth losses for future retirees that rival anything sustained by investors as a result of periodic stock market corrections.
Third, protracted declines in equities values, such as experienced in the 1970s, have typically gone hand in hand with a sustained period of poor economic performance -- a combination of events that is a powerful blow to any pension plan -- public or private, pay-as-you-go or fully funded. To be sure, such a blow spells a decline in the value of personal investments. However, workers' retirement accounts would remain fully funded and invested at all times, ready to capture the gains of a rising market. For a pay-as-you-go system, such a blow spells insolvency, as was the case in 1977, with permanent wealth losses sustained by workers.
Further, nothing about privatization would suggest that workers must invest entirely or even heavily in stocks. Those concerned with security would be free to invest more heavily in fixed-income instruments. (This is precisely what workers are observed to do with their 401k plans as they near retirement.)
Finally, all privatization proposals retain a basic safety net for the elderly. That safety net can take various forms. In Chile, for example, the government "tops up" investment accounts for older workers with small lifetime accumulations to ensure a minimum retirement annuity. A comprehensive regulatory structure also protects workers from underperforming pension funds. More generous "guarantees" are possible, but at a greater cost to workers.
It is an irony that many of those who argue most forcefully that workers should be denied personal accounts because of the riskiness of the stock market, Henry Aaron and Robert Reischauer among them, are out peddling the idea that the government should be investing in the stock market -- to the tune of a trillion dollars or more under one leading proposal.
Anyone who thinks that would be a good idea -- unleashing the federal government to stomp around U.S. capital markets while failing to disclose to workers the risks they would bear -- probably should brush up on the fundamentals of public choice, not to mention corporate finance.
American workers would be substantially better off if they were permitted to invest a portion of their Social Security taxes in private stocks and bonds. The sooner Congress gets around to fashioning the appropriate regulatory safeguards and making this possibility a reality, the better for all concerned.
The writer is director of Social Security and pension studies at the American Enterprise Institute for Public Policy Research.
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