Another Irrefutable Argument Against Privatizing Social Security

Michael Kinsley brings us The Meathead Proposition from one of the great economic minds of the time, actor and liberal activist Rob Reiner. There is nothing that Krugman and Kinsley himself haven't said already but it's written in a way that we of little knowledge can understand.

......even if these private investments do better than the government bonds in which the current Social Security surplus is invested, this won't change the total amount being invested in the private economy, or increase the economic growth that comes from private investment, because the government will just have to go out and borrow elsewhere to replace the dollars it isn't able to borrow from Social Security. And that means that every time someone puts a Social Security dollar into a private account, someone else must be persuaded to take a dollar currently invested in the private economy and put it in government bonds.

To get the scheme enacted, Bush must convince Americans of the exact opposite: that private-sector investment will make them better off than fuddy-duddy old government bonds. Basically, privatization schemes assume that the alleged inferiority of government bonds can be our little secret for the next few decades -- just us folks in the Social Security system. And so we can just unload a few trillion in government bonds on all those two or three Americans who aren't in Social Security, plus maybe some hapless foreigners.

So the pro privatization people have a big job. They have to convince some that Treasury Bonds are a bad deal while convincing others they are a good deal. Does that make sense to you? In effect, they are using two conflicting scenarios to sell one privitiztion package.

Privatization schemes assume that this will have no effect on how much interest the government will have to pay, or what kind of long-term return you can expect on investments in the private economy. For example the right-wing Heritage Foundation, a major thumper for privatization, assumes that private accounts can earn a long-term, risk-free return of 4.7 percent after inflation, which they say is based on history.

But if free markets work the way they are supposed to -- and I would like to hear the Heritage Foundation say that they do not -- the effect of the government's announcing that government bonds are a bad investment and officially pushing people to put their money elsewhere will be to make it more expensive for the government to borrow money. So even if private stocks and bonds are a better long-term investment than government bonds (after factoring in risk and so on), they won't stay that way for long. Meanwhile, in their latest report, the Social Security trustees assume that growth in the nation's gross domestic product will slow from 4.4 percent to 1.8 percent in 2015 and will stay there for the next six decades. They predict productivity growth of 1.6 percent and average unemployment of 5.5 percent. From this and other data, the trustees predict that the trust fund will earn 3 percent a year (5.8 percent interest minus 2.8 percent inflation). This is their "intermediate" assumption, from which Bush concludes that the shortfall will hit the fan in 2042.

These assumptions about the unknowable are not unreasonable. Nor are the assumptions of the Heritage Foundation. What is unreasonable is using both sets of assumptions at the same time. Can a conservative investment in stocks and bonds grow by 4.7 percent a year, for decades, while productivity is growing by 1.6 percent and the economy by 1.8 percent? Theoretically possible, perhaps. But likely? On average?

If you start by assuming that one investment pays better than another, it's not very surprising (or persuasive) if this is also your conclusion. A dollar a year invested for 37 years (now until 2042) at 3 percent interest produces $66. At 4.7 percent, it's $95.

What these all means is

If the Heritage Foundation is right, there is no crisis to fix. And if the Social Security trustees are right, the Heritage fix won't work.

Now we can see why the administration couldn't get a real economist to take John Snow's place and why no one but administration shills are pushing Bush's privitization plan.