Sunday, December 26, 2004

Thinking About Social Security

Brad Delong writes
Marty's[Feldstein] argument these days is much more likely to be the claim (with which I have a lot of sympathy) that the stock market does a lousy job of mobilizing society's risk-bearing resources. Stocks appear to be priced as though the marginal investor is a rich 62-year old with some clogged arteries and a fifteen-year life expectancy who is not expecting to leave a fortune to his descendants. But if the stock market were working well, the marginal investor would be a 40-year old in his or her peak earning years looking out to retirement spending 40 years in the future--an investor much less averse to risk than the 62-year old.
Turning Social Security into a forced-equity-savings program would, Marty believes, not only produce huge profits for the system but also materially improve the efficiency of U.S. financial markets.
The Feldstein argument had never quite made sense to me, but in this formulation it does: our society doesn't save early enough so if we make people save their social security money in private accounts invested in the stock market, then they have to. Thus, we get people saving younger . Younger meaning risk seeking. Risk seeking meaning we make the U.S. economy more innovative. At least in theory I buy it, to a degree.

The interesting thing about the argument, though, is that it rests on people not saving sufficiently when they are younger which means that any model incorporating a life-cycle consumption hypothesis (that people smooth out spending, and saving, at any given time to reflect their entire income stream) has major empirical problems.

It does clarify what is at stake in the theoretical privatization debate (Bush's actual proposal, whatever it is, wouldn't accomplish anything productive, guaranteed): a desire to raise investment requires a rise in savings and economists think that saving is too low (who are they to make such a normative claim?), so to raise saving you force people to save. You could mandate more private saving, but you already see it in social security. By Ricardian equivalence, it shouldn't matter if it's public or private, shifting that savings to the private sector from the public sector shouldn't change anything in the economy, but some economists think that it will be invested more aggressively (in a risk seeking way) by the private sector than by the government. If it is invested in a more risk seeking way, then that spurs innovation and is good for long term growth. However, this confuses the purpose of social security: it isn't really supposed to be about forced saving (and thus of generating investment) in the economy, but is really meant as a security blanket. And if that money is thrown back into the private sector, then it becomes risky and some people might lose their money, sort of defeating the purpose.

I agree with economists like Feldstein that the saving rate in the U.S. is scandalously low and that this cannot have good long-term effects and that we should do something about it. Yes, more 40 year olds should be heavy in the stock market. But playing with social security does not seem like a good mechanism to resolve this problem.

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