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Pension fund socialism: the illusion that just won't die

comments on Robin Blackburn's Banking on Death

by Doug Henwood

delivered at the conference "Pension Fund Capitalism and the Crisis of Old-Age Security in the United States," sponsored by the New School University, September 11, 2004

I think I was invited here to play the critic, and I'm going to live up to my billing. I have a lot of problems with Robin Blackburn's proposals, both economic and political, so let me lay them out.

My title, "Pension Fund Socialism: The Illusion That Just Won't Die" is something I was asked to provide long ago, well before I knew what I was going to say. I've since learned that Robin doesn't think of his proposal as a form of what used to be called creeping socialism, which is reassuring in some sense. But I'm still not clear on what it is. Karl Marx and Milton Friedman, whatever their differences, at least share the virtues of clarity and intensity. Banking on Death is, appropriately enough, mostly shades of gray. I don't see much of an economic analysis, of pension funds in particular or finance in general, and I also don't see much attention paid to the issue of political agency either.

Let me start with a little economic analysis. Maybe I'm suffering from wounded narcissism, but a few years ago I wrote a book called Wall Street that attempts a comprehensive and systematic analysis of the economic and political role of finance in modern, mostly American, capitalism. Blackburn deals with it rather dismissively in a single footnote. Let me bring the analysis presented in that book to bear on some of the issues that he raises.

Many people - inhabitants of random barstools, New York Stock Exchange press officers, and more than a few economists - think that the whole structure of finance exists to channel savings into investment. Finance does some of that, for sure, but less than many people think. The conventional illusion is especially the case when it comes to the stock market: when you buy a share of stock, you're somehow "investing" in the issuing company, or more grandly, as the NYSE likes to say, in America. In fact, you're almost always buying the stock from a previous stockholder. Or, as the quote from Shakespeare that's a staple of the corporate governance literature put it, a share is like Iago's purse: "'twas mine, 'tis his, and hath been slave to thousands."

Over the long haul, U.S. corporations have funded about 90% of their capital expenditures with internal funds, profits plus depreciation allowances. This is true of most other economies as well. And when firms do turn outside for cash, they go first to banks, then the bond market, and only last to the stock market. There are individual exceptions to this rule, of course; for some individual companies, a share flotation is a crucial coming-of-age ritual - though typically the proceeds are used to cash out the initial investors rather than funding investment and hiring. Occasionally, there are historical periods, like the late 1990s, when IPOs do channel large amounts of money to corporations. But even in the peak year of the recent gusher, 2000, IPOs totaled just 5% of nonresidential fixed investment. In the less frenzied environments of the 1970s and 1980s, they averaged just 1% of investment. But even during the bubble years, IPOs were massively overshadowed by retirements of shares, through buybacks and takeovers. For example, in the U.S. from 1994 to 2000, one of the most vivid periods in the history of stock markets, buybacks exceeded IPOs by a ratio of nearly five to one. Over the same period, mergers and acquisitions exceeded IPOs by a ratio of twenty-two to one. In other words, U.S. corporations were shoveling out twenty-seven times as much cash to shareholders as investors were supplying to corporations via IPOs. And I'll bet that more than few of those IPO buyers have come down with severe cases of buyer's remorse.

Venture capital does provide important funds to young firms, but the quantities are remarkably small - an average of 2% of nonresidential fixed investment (more like 1% if you leave out the bubble years of 1999 and 2000), and 0.2% of GDP.

All-in-all, U.S. nonfinancial corporations retired a net of $1.3 trillion in stock between 1982, when the great bull market began, and 2000, the year of the market peak. They've retired another $250 billion from 2001 onwards, for a total of $1.5 trillion over the last 22 years. Interestingly, private pension funds have been net sellers of stock over the last two decades - $534 billion worth from 1982 to 2000, and $93 billion since, a total of $627 billion. State and local government funds were net buyers, $351 billion over the last 22 years, but that's considerably less than their private counterparts sold, making the pension sector net stock sellers throughout the two decade bull market and its unpleasant aftermath.

Social security privatizers like to circulate the idea that prefunded pension systems raise national savings and investment rates (and public systems conversely lower them). And though often unstated, the privatizers rely on the assumption that a stock-market centered system is especially suited to the job. Robin Blackburn isn't a member of the evil party of privatizers, but he does seem to share some of these views, in his call for some kind of public prefunded system. But prefunded systems seem not to have that effect.

UBS recently issued a research note that gathered statistics from seven rich countries on the size (relative to GDP) and investment allocations of pension funds. When combined with World Bank data on savings and investment rates some interesting results emerge. A ranking of the seven countries (Australia, Japan, Netherlands, Sweden, Switzerland, the UK, and the U.S.) by pension fund size shows an unimpressive correlation of .35 with national savings rates, and just .03 with gross fixed capital formation. When ranked by the stockholdings of pension funds, the signs change: -.89 for savings and -.46 for capital formation: that is, the bigger the wad of pension money committed to the stock market, the lower the level of national savings and investment. The sample size is small, for sure, but it does make the economic case for prefunded pensions a little harder to prove.

As a form of worker savings (or deferred wages, if you prefer, since individual pensioners are likely to draw them down toward zero as they shuffle towards the grave), the pension fund looks like a relatively modern innovation, but the appropriation of such pools for the enrichment of professionals isn't really all that new. In thinking about pensions, it's worth keeping this unpolished observation of Marx's, from volume three of Capital, in mind: ""What the speculating trader risks is social property, not his own. Equally absurd now is the saying that the origin of capital is saving, since what this speculator demands is precisely that others should save for him."

So if finance in general, and the stock market in particular, play a less significant role in funding real investment than a lot of people think, what is the sector really all about? The prominence of M&A in the stock landscape is a clue: it's about trading in entire corporations or pieces of them. It's about arranging ownership and control, about allowing the upper classes to organize and exercise their claims over production. Financial markets are at the heart of class formation. And that means it's not a function to be intruded on lightly. I was stunned to hear Robin Blackburn say yesterday morning that what we used to call the ruling class wouldn't object to the accumulation of shares by public pension entities. The reviewers of Banking on Death in the TLS and The Economist were onto something when they said that the scheme would not be popular with execs or financiers. And aside from that very broad point, it's nonsense to assert that existing stockholders wouldn't object to the dilution of their interests by fresh share issues. They would - and especially if it were for such nefarious purposes.

Of course, they might not object if they could run the funds. State and local government retirement funds, despite their public-sector parentage, are mostly run on orthodox principles. In his book, Robin Blackburn cites university endowments and philanthropies as possible models for his pension scheme, but they too are mostly run on orthodox principles, some with more skill than others. My favorite example is the asymmetrical experiences of the Enron failure. The University of California system, whose endowment is run on indexing principles by a small staff of civil servants, was long the stock and lost a bundle. Harvard, whose endowment is run by a large staff of professionals paid on a Wall Street scale, made a bundle through shorting. Which example should our public funds emulate?

Blackburn doesn't delve very deeply into the relationship between holding shares and running corporations, but it's not a simple thing. From the 1930s through the 1960s, from Berle and Means through Galbraith, it was thought that stockholders were vestigial creatures and firms were run by managers. As profits slumped in the 1970s, shareholders got increasingly restless, and began searching for ways to get profits and stock prices up. And thus we were treated to the leveraging mania of the 1980s, associated with names like Henry Kravis and Carl Icahn. (And it's important to point out that Kravis, and his partners Kohlberg and Roberts, were legitimated on Wall Street by a commitment of funds from the Oregon public pension fund.) That ended badly, in debt crisis and a long economic slump, and stockholders moved on to the strategy of pension fund activism, led by Calpers, the California Public Employees Retirement System. Activism sounds nice; Blackburn uses it in his book modified by the word "shareholder" as if shareholder activists had something in common with environmental activists or peace activists, but in reality shareholder activists were behind the relentless downsizing and cost controls of the 1990s. When I interviewed Calpers' former chief counsel, Richard Koppes, I asked him to comment on the propriety of public worker money being used to pursue an antiworker agenda. He told me they didn't care about the details, they just wanted results. Which is sometimes the flaw of many kinds of activists, but it's really not something we can get behind, is it?

So if Blackburn's scheme ends up as a variation of that kind of shareholder activism, I'm sure Wall Street and the Fortune 500 could live with it. But I doubt that's what he has in mind. So what is the model, really?

A few more words about the economics of the proposal before we get to politics. Robin Blackburn cites only to dismiss an observation from Keynes that I think is quite profound. In the General Theory, Keynes wrote:

We cannot, as a community, provide for future consumption by financial expedients but only by current physical output. In so far as our social and business organisation separates financial provision for the future from physical provision for the future so that efforts to secure the former do not necessarily carry the latter with them, financial prudence will be liable to destroy effective demand and thus impair well-being....

Individuals may be able to set aside money for the future, but not a society as a whole; a society as a whole guarantees its future only by real physical and social investments. What could stock investments contribute to this? For retirees to live, they'd have to cash their dividend checks - cash flows created, distributed, and consumed in real time - or sell their shares for cash. In either case, the money released is valuable only because it's a claim on real resources produced and available in the present. Most of the long-term estimates of stock market returns assume that capital gains aren't realized and that dividends are reinvested (and there's no such thing as taxes or commissions, either). Theoretical returns are of theoretical interest, but you can't eat them. In the real world, pension funds don't cover their benefit checks with theoretical returns; they are, on balance, as I noted above, sellers of shares. Both public and private pension plans rely on current contributions for about two-thirds of what they pay out, meaning that they have a very substantial pay-as-you-go component.

For financing retirement, the stock market is like a giant revolving fund, much like the public system, that finances net sales by one set of parties with fresh purchases by another. Were the Boomers to start selling stocks to finance their retirement, prices would fall unless there's even more comes in from Generations X, Y, and Z. And of course any time between now and then, if one has the bad luck to retire in the midst of a bear market, then he or she may face a fairly miserable retirement.

It's a mystery why the stock market should do any better at solving the demographic problem of Baby Boomer retirement - if it is as serous a problem as is claimed - than the public system. Over the long term, the stock market should grow roughly in line with the overall economy; the only way it could greatly exceed the underlying growth rate is if the profit share of GDP were to increase continuously, or valuations were to grow to Ponzi-like levels.

And now a few words about the politics of the scheme. Blackburn cites the example of the Swedish wage-earner funds, and experience that should be chastening to pension-fund reformers. The funds were originally conceived by social democratic economists as a scheme for socializing ownership of corporations. In the original mid-1970s proposal, firms would have been required to issue new shares, in amounts equal to 20% of their annual profits, to funds representing wage-earners as a collective. In the space of a decade or two, these funds would acquire dominant, and eventually controlling, interests in corporate Sweden.

This idea scandalized business, which launched a great campaign to discredit it - a task that was greatly simplified by the fact that the funds never attracted broad popular support. The Social Democrats and the unions watered the plan down, and a weak version was adopted in the early 1980s. The funds quickly began behaving like ordinary pension funds; their managers, in a vain attempt at legitimation, began trading stocks in an effort to beat the market averages. Eventually, late in the decade, the wage earner funds were euthanized.

Why did they fail? For at least two reasons. First, business correctly saw the initial version as a challenge to capitalist ownership, a reminder that finance is central to the constitution of a corporate ruling class. And second, they never attracted popular support - essential to any serious challenge to a corporate ruling class - because they were so abstract. As Jonas Pontusson put it, "when collective shareholding funds are reduced to deciding whether to buy shares in Volvo or Saab," it's hard to muster popular enthusiasm. More direct interventions are required - active public industrial policy and greater worker control at the firm level - if ordinary people are to get excited. The stock market, on the other hand, is the home turf of financiers, and any games played on their turf usually end up being played by their rules.

And that was in Sweden, with a capitalist class far milder than ours, and one of the best-organized working classes in the world. How it could happen in a market-saturated society like the U.S. (or the slightly less saturated UK) is a mystery to me. Blackburn does little to reduce the mystery.

That political issue is closely related to another issue of power, how corporations would be governed under the Blackburn model. As I said earlier, the shareholder revolution of the 1980s and 1990s succeeded in restoring profit maximization to the forefront of the managterial mind. The instrument of that transformation was the share price; with CEOs paid mainly in stock and options, their material interest is aligned with that of the outside shareholders. We've seen profits recover smartly in this cycle under the influence of the new incentive structure - a lot more quickly than employment or wages.

But that incentive structure can be perverse; it gives managers a strong incentive to cook the books, as we discovered through the now largely forgotten corporate scandals of several years ago. Shareholders have proven a lot less successful in monitoring managerial behavior. Blackburn's faith in the power of social auditors to uncover fraud and the like is touching, but not based on much real-world experience. Would his model penetrate the veil of corporate secrecy? If so, that would be a major transformation of how things are done. Which is fine with me, but it's not easy to conjure up how we can get from here to there. Just look how hard it is to organize a union at a supposedly progressive place like the New School.

Aside from the incentive structure, shareholders increased their power by intensifying the rule of what's been called the liquid market for corporate control. An underperforming corporation is vulnerable to takeover, a threat that typically forces managers to pay attention to the share price. Would that system still exist in Blackburn's world? If it would, that wouldn't be too friendly to worker interests. If not, what purpose would the stock market serve, especially if trading were discouraged? Blackburn seems to think that stock prices send economically valuable signals. But they're not much like the prices of real goods and services, which are oscillate around our old friend SNALT, socially necessary abstract labor time - or costs of production, if you prefer the bourgeois terminology. Stock prices are determined by expectations of future profits, which are unknowable - but the expectations themselves are heavily shaped by mob psychology. As such, they're prone to extended periods of over- and under-valuation, and typically exaggerate changes in the underlying fundamentals. Would they do the same in Blackburn's world? We don't know, because he doesn't really tell us.

Would the public pension funds power over corporations be ultimately backed by broader working class power? We should remember that pension funds control about 20% of the U.S. stock market - significantly less than they did 20 years ago, by the way - meaning that there are would be a lot of other shareholders to contend with. But if the organized working class were strong enough to challenge rentier control, the Dow would be trading somewhere around 200, not 10,313.07. And if the working class were that strong, why stop with pension fund non-socialism? Why not worker election of managers and some kind of planning regime? Or maybe he conceives of the pension funds as run by enlightened technocrats. If so, recall that Keynes conceived of the IMF with a similar set of political assumptions - and look what happened to the IMF.

Only about a third of Americans over age 65 have pension income, and about 43% of today's workers are covered by a pension plan of any kind. For most retirees, social security is their principal source of income. That doesn't fund a comfy retirement - average benefits are just over $10,000 a year. About two-thirds of retirees supplement this with investment income - but that averages just $5,000 a year. Robin Blackburn is right that we need to boost the earnings of our elderly, but the way to do that is by focusing on social security, not by universalizing prefunded pensions. If we want to decommodify retirement - and decommodify life as much as possible - the way to do that is with a clean public program, not by expanding the scope of that great fetish, the stock market.

Social security is one of the few public programs in this country that isn't an embarrassment; it's enormously successful and popular. A major propaganda campaign has succeeded in sowing doubts about its longevity - a campaign that has relied heavily on dodgy projections, innuendo, and the occasional lie. The projections of the social security system's bankruptcy are based on stunningly bearish assumptions about growth in productivity, population, the labor force, and GDP. They're so pessimistic as to be not conservative but actually reckless. Despite signing the trustees' annual reports during the years he was Secretary of Labor, Robert Reich told me the projections are "foolish," and bankruptcy a "nonissue."

It seems to me that the most urgent task politically is defending it - not apologetically, but aggressively, pushing to expand it, not contract it or privatize it. Blackburn's scheming lends credibility, however innocently, to the privatizers' campaign: you could imagine the Cato Institute saying, "Even the former editor of New Left Review concedes...." We should be defending one of the few good things that exist rather than wasting time and our scarce and dwindling political capital on phantasmic campaigns.

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