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The following articles appeared in Left Business Observer #67, December 1994. They were written by Doug Henwood, editor and publisher. They retain their copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
Is Social Security going bust?
When LBO last visited the pension issue (issue #28), it was to argue that the push to cut back on Social Security in the U.S. was part of a generalized attack on public retirement systems around the world. Calling it a plot may be a bit conspiratorial, but that's in fact what it is though the plotters occasionally show their hand in tedious technical documents that few but the like-minded read.
As the Organisation for Economic Cooperation and Development (OECD) put it in a 1988 report, "what was onceconsidered as a central achievement of the welfare state is now being evaluated differently." That is, systems that now provide a secure and dignified retirement, even in the nor mally stingy U.S., must be scaled back sharply in the interests of fiscal prudence. Or, as the Interna tional Monetary Fund put it in its 1986 take on pension reform, "to assume that real 1980 benefit levels can be held constant is not realistic." "Realism," like "reasonableness," is a term often de ployed to lend an air of inevitability to what are really political decisions. And over the last decade, most of the rich countries have cut back on their public pension systems, typically through raising the retirement age or cutting the level of benefits relative to pre-retirement wages (the "replacement rate"). The U.S. has done both, as well as boosting the Social Security tax rate.
Two events prompt a revisit to the pension reform issue: the largely failed attempt by the Kerrey Commission to agree on a plan for hacking away at the U.S. Social Security system, and a report published early this fall by the World Bank, Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth (Oxford University Press). Though the Kerrey Commission couldn't agree on a set of recommendations, the issues they raised will stick around for years to come.
The development that the World Bank calls a crisis is that people are living longer, and the share of the population over 60, or 65, or whatever age you want to use, is growing rapidly and will continue to do so almost everywhere in the world. According to the U.S. Census Bureau, between 1991 and 2020, the number of over-60s will grow by 59% in the rich industrial countries, and by 159% in the "less-developed" ones though, of course, shorter life expectancies and higher birth rates assure that the elderly's share of the population in poorer countries, present and future, is and will be much smaller than that of the rich countries (see nearby chart for some examples). Barring a plague or an epidemic of suicides, this is about as certain a projection as can be made in the social sciences, though the exact numbers may prove to be off the mark.
There's no question that the population's aging is of major importance, and that it will change the whole tenor of social life health care, the consumer culture, architecture, living arrangements, and even population sex ratios, since women live longer than men. The crisis that the World Bank and its colleagues worry about is that the costs of health care and pensions will grow, something that's usually presented as a "burden" on the nonelderly members of society. Older people are not to be cared for, even cherished they're a cost that has to be minimized in the name of fiscal prudence, growth, and productivity.
But let's leave aside softheaded words like "care" and "cherish" and confront the Bank's arguments head-on. Unless older people are to starve, some provision for their income must be made. In pre -industrial societies, where life is short, people tend to work until they can no longer, and then their families take over. With industrialization, despite all the wishes of Newt Gingrich and Phyllis Schlafly, families break apart, and such informal arrangements can no longer be relied on.
In the early 19th century, industrial workers banded together to form "friendly societies," mutual relief schemes to which workers contributed modest sums in return for assistance in the case of failing health. But they were too small to accomplish much, and the funds were often badly man aged. Troublemakers had long been agitating for more formal systems. As the World Bank report puts it, "In 1889 German chancellor Otto von Bismarck seized a political opportunity to mollify industrial workers and lure them away from the socialists by creating the first national contributory old age insurance system, giving workers a stake in the central government." It not surprising that when the socialist threat collapsed, the ruling orders felt liberated to launch an attack on pensions.
According to the Bank, there are many faults to existing pension systems, objections that will be familiar to students of the attack on Social Security in the U.S. Too many of the benefits go to affluent retirees, funds that could be better targeted to the poor; public pensions crowd out spending on other worthy public purposes, like education and infrastructure development; the assurance of a reasonably generous income at retirement discourages personal saving; and the retired are essentially a parasitic layer of geezers feeding off the nonold. While a public system may work well when it's young, when the number of contributors greatly outweighs the number of retirees drawing on it, as the system matures, the rate of outgo rises to match the rate of income.
The Bank has two missions reforming established systems, and influencing the design of new pensions being freshly established in the "developing" countries. As its ideal it proposes a three -pillared system. The first is a mandatory public system, financed by tax contributions on a pay-as -you go basis, to provide a minimum floor income for the elderly possibly a single, flat-rate benefit for all, rather than one tied to income. (Pay-as-you-go plans finance today's benefits with today's taxes. The alternative is funded schemes, which accumulate reserves and invest them in the financial markets; today's pensions are financed with yesterday's investment profits, if the markets deliver them, as well as the day before yesterday's contributions.) The second is a mandatory pri vately managed system, financed by contributions from either employers, workers, or both a form of forced saving with the accumulating balances invested. Private management is essential, the Bank notes, in order to prevent the "backdoor nationalization of the private sector" that could occur if public entities invested their boodle in the stock market. And the third is a system of similarly invested voluntary savings, also financed by worker and/or employer contributions, but not required by law.
This triadic system is meant to serve several purposes. The public pillar would assure a minimum income in old age, but nothing terribly comfortable. Comfort could only be achieved through the second and third pillars, the mandatory and voluntary savings parts. The virtue of the savings' pillars is that they will "deepen" the capital markets, especially in developing countries, by offering them a fat and ready pool of cash to play with.
While the U.S. Social Security system and similar plans elsewhere do redistribute some income from rich to poor, the Bank argues that there is less redistribution than might appear. Across generations, the working poor are effectively transferring income to present retirees, some of whom are quite comfortable, but this criticism could be addressed by making the system of taxation more progres sive than it is now. The Bank also argues that pension systems are less redistributive than they look at first glance, since the rich typically live longer than the poor, meaning that the poor often don't live to collect all their promised benefits. It never occurs to the Bank that this is a better argument for poverty reduction than it is for pension "reform."
Having argued that public pension systems are less redistributive than they appear, the rest of its multipillar agenda is likely to make things even worse. Increasing reliance on private savings, forced or voluntary, to fund retirement, guarantees that the rich will do far better than the poor, since the rich have a lot more money to save. And it assumes that private schemes won't really face the same fundamental demographic problem more old people that public ones do. It takes it on faith that funds invested in the stock and bond markets will magically grow to meet rising needs.
But this makes no sense. The wages that finance existing public systems grow roughly in line with the overall economy; why should financial markets grow any faster unless you're hoping that the financial markets will grow ever fatter at the expense of what Wall Street calls the "real sector"? Over the very long term, interest rates on long-term bonds average about the same as economic growth rates. Stocks do better than this, but it seems economically unwise to bet that financial asset prices can forever grow more rapidly than the value of the underlying real assets the present and future profits of private corporations they're a claim on. Having probed deeply the financial risks of public systems, the Bank and other like-minded souls are blind to the Ponzi economics of private ones.
Though the rich countries haven't yet overhauled their pension systems radically in line with the World Bank's agenda, the debt crisis of the 1980s did allow the Bank to push its reforms in Latin America, where many countries had well-developed public pension systems. These plans were under great pressure for a number of reasons, including mismanagement, tax evasion, and the debt-induced depression.
The Bank's favorite model is Chile. In 1981, the Pinochet regime scrapped the old system and replaced it with a system of forced saving that requires employers to contribute 10% of workers' earnings into savings schemes, whose assets are invested in the domestic and foreign financial markets. This is an excellent real-world test of the Bank's multipillar model.
As Susanne Paul and James Paul show in a forthcoming occasional paper from Global Action on Aging, the Chilean system fails to live up to the Bank's promises, though you'd never know that from reading Averting the Old Age Crisis. The new system reinforces, rather than corrects, for income inequality, which is to be expected from any system that relies on savings, whether forced or voluntary. The poorest, supposedly protected by a "safety net," get a check equivalent to a loaf of bread and a cup of coffee per day. Less poor workers are hardly well taken care of by the new sys tem; it's likely that about half of all retired workers will fall under the official poverty line. Women, with lower wages and longer lives than men, come up particularly short. Administrative costs are far higher than the old public system; investment managers are a lot more expensive than public sector bureaucrats. As with most private pension funds, workers have no say over how their savings are used; fund managers cast the stockholders' votes by their own lights, even though they're really only the workers' agents.
The Bank's goal of turning the public pension check into a minimal grant rather than a life-support ing sum spreading the Chilean system around the world is shared by the OECD and the IMF. They're all quite explicit about it, once you get past some of the jargon. Pundits and politicians in the U.S. are much cagier about their intentions. Take, for example, the long and tedious piece by investment banker Peter Peterson in the April 7, 1994, New York Review of Books. He never reveals that something like the World Bank program is his fondest goal. Nor does he reveal that he and his Wall Street colleagues are lusting to get their hands on a bigger piece of the retirement kitty, and a generous public system is blocking their access. Instead, he speaks of "entitlement reform" as the only way "to eliminate the deficit."
Entitlements is a loaded word, appropriated from budget jargon. In its original context it refers to programs like Social Security, Medicare, Medicaid, Food Stamps, and unemployment insurance that don't need to be explicitly funded every year by Congress, but are automatically open to all those who qualify for them. But thrust into a polemical context, it reeks of an indisciplined gimme mental ity. The con job is highly successful; 59% of respondents to a recent Wall Street Journal/NBC News poll favored cuts in entitlement spending, but support sank to 23% when the programs were actually named. Lumping them together also confuses Social Security, whose share of GDP has been rock steady for a decade and is likely to stay so for another decade, with health spending, which is zoom ing out of control. But medical inflation is a problem all its own that can't be solved through mere budgetary manipulation ("Paying for health," LBO #57).
Peterson's economic argument and don't expect any noneconomic arguments from him, like the simple notion that a public retirement system promotes social solidarity runs like this. Investment is the key to a prosperous future, and a higher savings rate the key to more investment. Unfortu nately, Washington is hogging a huge portion of our already too-low national savings to fund its deficits, and the principal villain behind all the red ink is the growth in "entitlements." Cut entitle ments, the deficit will shrink, savings will swell, investment will rise a happy sequence leading to a brighter future for all. The only things in its way are intellectual misunderstanding and lobbyists for the grayheads.
Wrong almost from the start. Investment is the key to a more prosperous future, leaving aside all questions of investment in what, and how you define investment. But let's stay conventional, just for argument's sake, and define prosperity as GDP growth and investment as funds plowed into machin ery and equipment. First, a look at 21 rich industrial countries shows no meaningful relationship between the size of government deficits, or the share of GDP devoted to social spending, and the levels of savings or investment. And second, there is no simple relationship between savings and investment; classical economics held that savings had to precede investment, since surplus funds had to be available to finance projects with long payback periods, but Keynes argued that new invest ment created new savings, by creating new incomes. Though the dispute can turn almost theological at times, it seems most likely that savings and investment determine each other in a complex inter play. But it's certain that conventional austerity policies designed to increase savings attacks on public spending, cuts in wages and public benefits, tight money and high interest rates typically end up depressing investment, since they lead to the kind of economic collapse seen in much of the Third World during the 1980s.
Peterson argues that since poverty rates for the elderly are about half that for children, this proves that our retirement system is too generous, and that some of the money funneled to the old should be spent on the young. Actually, U.S. poverty rates for the elderly are two to four times that of other rich countries. And anyone who thinks that money saved in pension cutting will be spent on poor youngsters, with the air as thick with anti-welfare rhetoric as it is, is either dreaming or deliberately trying to deceive. Beware of bankers when they wax egalitarian; it's likely they're scheming to get their hands on your money.
Pension cutters always talk about cutting benefits, especially at the top. This is necessary, of course, to avert the Social Security system's bankruptcy, a projection based on some extremely questionable economic assumptions (see box, this page). But even if the system should run low on money, there's plenty of untapped taxing power left. Salaries above a fixed amount $55,500 in 1992 are exempt from Social Security taxes, as is investment income. (The logic behind this is that the system should be financed only by taxes on labor, not capital.) Lifting the cap and taxing capital income would keep the system solvent indefinitely under all but the gloomiest scenarios.
Stepping beyond the technocratic realm, there are more radical issues here as well. Talk of boosting the retirement age to 70 is common, and there's some merit to this. When Social Security was estab lished in the 1930s, average U.S. life expectancies were around 62 years, meaning that you were lucky to hit 65; now the average is 76, meaning that 80 would be a comparable retirement age today.
Though not even Peterson would suggest forcing people to work into their late 70s, and God knows much of American society is ragged from overwork, it still seems unfair to impose retirement on the unwilling; many people would like to continue working, assuming their jobs aren't too awful, if only to counter the tendency toward social isolation that often comes with aging. But there's no way the U.S. economy could generate enough employment to keep people working if they really wanted. In that sense, retirement can be seen as a form of disguised unemployment. Thankfully you can finesse all those heavy issues by just looking at work and retirement as fiscal problems.
The eventual bankruptcy of the U.S. Social Security system is taken for granted by nearly everyone, virtually without challenge. In part, that's understandable; who really wants to delve into the annual reports of the system's trustees?
But the reports repay study. Of some interest is the news, for example, that the higher the rate of immigration, the sounder the system is, since immigrants (legal or not) tend to be young, and swell the ranks of those paying into the system rather than drawing it down.
Immigration, however, won't make or break the Social Security's finances. GDP growth will, since the size of the economy decades hence will determine how much money is available to pay retirees. The bankruptcy scenario is based on an assumption that GDP will grow at a rate seen only in depression decades.
As is common in the work of official seers, the trustees present three sets of forecasts, an official guess, an optimistic one, and a pessimistic one. The official scenario assumes the economy will grow an average of 1.5% a year over the next 75 years half the rate seen in the last 75 (2.9%), and a rate matched only in one decade of the last century, 1910-20's 1.4% rate. The economy grew more quickly even during the 1930s, 1.9% (1930-40). The growth rate for the trustees' optimistic vision, 2.2%, is only slightly bouncier than the 1930s rate. The pessimistic guess is 0.7%, slower than population growth, and a rate so torpid as to guarantee a war of each against all. As the graph shows, the system will go bust only if you assume decades of stagnation. If the economy grows in line with the 197394 average of 2.4%, still slower than the 75-year average of 2.9%, it will run a big surplus.
Either the trustees are deliberately projecting slow growth to feed the pension-cutting mania, or they're expressing a deep pessimism about the U.S. economy's future. Big news, whichever it is.
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