Michael Kinsley doesn't think that privatization of Social Security will work, and sent his theory on the matter to a few famous bloggers, among them Andrew Sullivan. A number of people have responded to Kinsley's theory, impressing him with their level of sophistication. An article is apparently forthcoming.
It's worth remembering, though, that Bush's principle has to do with something he calls the "ownership society," and this translates to the idea that those who contribute to Social Security own their account there. "Privatizing" really means giving these accountholders the right to decide how their money is invested. This is not to promise better future benefits, but rather to create a sense of ownership over the future. This is appealing, but there are lots of wrinkles:
- It's (supposed to be) a defined benefit plan, in which the government has promised you a certain amount of cash income in return for your contribution. In private defined benefit plans, the provider assumes the risk that your contributions won't cover the cost of providing the benefits (you may live longer than expected, their investments may not return as much as they hoped, etc.), which is why they usually make conservative assumptions in pricing the plans. This means that they are collecting an insurance premium on your life - in this case, an inverse insurance agains the eventuality that outlive their estimates. And you're paying for that premium.
- The problem, as many have pointed out, is that Social Security isn't managed that way. The government happily collects the Social Security taxes and pays Social Security benefits almost as if the two had no relationship with each other. The whole discussion about insolvency is because the outflows will outweigh the inflows at some point, and the government isn't saving money for that rainy day, or rather rainy decades.
- Kinsley's point is that if Social Security inflows need to be invested, the investment managers are looking at the same set of options as any institutional investor - equity and debt of various kinds. An infusion of capital into equity markets will effectively increase the price on equities (owing to supply and demand dynamics), reducing the return that was supposed to be superior to the alternative.
- The problem with this argument is that investing all of it in (government) bonds would have the same effect on those capital markets. If the money is "extra," as Kinsley suggests, then anything that it buys would increase the price.
- The argument then becomes whether "privatizing" would improve capital market efficiency. It seems to me that the mere availability of more cash would do no such thing, and there's little reason to believe that more market participants will make much of a difference, either.
- On the other hand, the effect of all this "extra" money would be more evenly spread if it didn't all have to go into government bonds. It may not create a portfolio effect for the individual accountholder, but it would for the Social Security system as a whole.
- Ultimately, this may be a question of what Social Security really is. Volokh asserts that Social Security isn't a "stupidity insurance," nor is it a welfare program. Your benefits are at least somewhat related to your contributions. So it's sort of governmentally-sponsored pension plan with mandatory participation for anyone with a taxable income.
- But it appears that the intention is to make it a stupidity insurance, with not just you but also the government as the beneficiary. By forcing many of us to participate in a savings program, the government is reducing the probability and magnitude that some of us will arrive at old age without having money to buy food and pay for lodging. It's not perfect or watertight for an individual, but it probably helps in the aggregate by reducing the public burden of caring for indigent old people.
- The objection that investment decisions should be left to professionals brings a bit of a smile to my face, and Paul Krugman (possibly unwittingly) supports my reasons why: most money managers do a lousy job, and hardly any outperform the market over time. Yes, there's a chance that grandpa will invest his entire Social Security balance in a bulletin board stock, but this is because he doesn't understand risk; not because he's a lousy stock-picker.
- The macroeconomic effects of Social Security are complex, and I'm not up on all the models to describe them. In theory, it should increase the US savings rate, but that may not hold if the government simply spends the money individuals save.
- If this is true - that Social Security proceeds are simply spent by the government for general purposes - then the reality is that the government is borrowing money from taxpayers in return for a promise of future cash benefits. We buy a number of bonds through the years that mature when we retire, paying out money for as long as we live.
- At this point, it may be worth unbundling the program to look at its component parts. We have:
- A mandatory savings program for wage and salary earners
- An insurance policy against people becoming indigent at a point when they can't make a living any more
- A supplemental revenue stream for the US treasury
- A more or less funded set of obligations by the US government
- I don't like 1); am favorable to 2) because I think we live in a society that wouldn't let old people live in poverty even if it was their own fault; am very concerned about 3) and 4). None of these are resolved by the privatization scheme, though I suppose there will be a psychological effect of creating transparency in individuals' social security account.