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Political Pitfals of Social Security Privatization

Dynamic Consistency and Social Security

Since the end of impeachment ordeal, Social
Security reform has been threatening to take center stage. As such
– and since economists have spent enormous amounts of time investigating
the economics of the program – I have been expecting to see, hear, and
read from a parade of economists on the relative merits of various proposals.

Wishful thinking, I suppose.

Instead, it seems as though the debate is on the politics of reform
– which policy is more “politically feasible” or “politically stable”.
My reading comes down to this: politically speaking, if there is any other
option available, you can’t substantially cut benefits or raise taxes.
By process of elimination, this leaves privatization — investing a chunk
of money in the stock market — as the only real political alternative.

Besides, if the privatization plan doesn’t work, the failure will be
many years from now, which means that current policy makers will be able
to claim success today.

However, there are political pitfalls with each of the two main privatization

1) Investing the Social Security Trust Fund

“I doubt if it would be feasible to insulate, over the long
run, the trust funds from political pressures — direct and indirect —
to allocate capital to less than its most productive use.” Alan Greenspan
from 01/28/1999

The president’s plan would invest a portion of the current surplus in the
stock market in order to increase the size of the Social Security trust
fund in the future.

Alan Greenspan, among others, have criticized this plan on political
grounds – arguing that the invested funds would represent a pool of money
that would tempt future lawmakers to either spend the money, or to direct
the investments into politically popular companies or investment areas.

The government run investments, even if they were be invested wisely
now, could not be guaranteed to be invested wisely in the future. The system
would, in this sense, be politically unstable.

Proponents of the plan argue that an independent agency could be set
up to insulate the regulation of the funds from the political process.
(The irony of the situation is that the Chairman of the Federal
is arguing that it would be politically impossible – or at
least unlikely – that such an institution, with qualities nearly identical
to the Federal Reserve, could be set up and maintain its independence.)

2) Individual Accounts

“Early access to individual accounts and the receipt of benefits
as a lump-sum might not preserve adequate benefits for workers and for
surviving spouses.” From the NASI
– Report of the Panel on Privatization of Social Security

It is argued that individual accounts – which would allow individual investors
to make decisions about where the money is invested – would not suffer
the same political stability problems as the above plan. However, individual
accounts are subject to political stability problems also.

There will be winners and losers in the stock market game – a large
number of losers could form enough of a political will to compensate them
for their misfortunes, then we may wind up with a bailout of the social
security system that would make the S&L bailout look like a drop in
the bucket. The program would then have to be reexamined again in the future.

(This point, of course, depends upon the specific individual account
plan adopted – if retirement accounts required are in addition to a base
level of benefits, there would not be as much instability. However, the
higher the base benefits, the lower the gain from investing in the stock
markets higher returns. Also, if guaranteed benefits are high, there is
the obvious and explicit moral hazard problem – people will become extremely
risky in their investment decisions. Even if there are no explicit guaranteed
minimum benefits, there may actually be an implicit guarantee, hence the
political instability.)

A second source of political instability comes from the fact that people
will have an account with their name explicitly written on it. When people
retire, many will demand the cash up front leading to a loss of the benefits
from real annuities – including the implicit insurance on running out of
money before dying. The political demand for leaving the money in the accounts
as bequests will most likely rise also.

The ultimate political consequences of each of these factors is at best

Next on CNN…

I keep hoping to see more economists
on TV
talking about the reforms (hey, we’re not that ugly!),
but if not us, then maybe they can get some political scientists to talk
about how the program might be reformed the next time we have to address
a Social Security crisis.

I won’t hold my breath for that either.


Comment via the Bulletin

See also:

Filed under: Economics

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