Why We Should Never Privatize Social Security
By Justin Gardner | Related entries in Economy, Money, The World
Privatization sounds sexy in theory, but there’s a reason Social Security is called a safety net, and all you need to do to understand why faith in markets is a recipe for disaster is look to the current situation in Italy.
The global market meltdown has created losses for those who agreed to shift their contributions from a government severance payment plan to private funds meant to yield higher returns. Anger is rising both at the state, which promoted the change, and money managers such as UniCredit SpA and Arca Previdenza, which stood to profit.Prime Minister Silvio Berlusconi’s administration is now considering ways to compensate as many as 1.2 million people who made the switch, giving up a fixed return for private plans linked to financial markets. It’s also letting people delay redemptions on retirement funds to avoid losses after Italy’s benchmark stock index fell 50 percent in 2008, destroying 300 billion euros ($423 billion) in wealth.
“The reform didn’t help anyone,†said Gabriele Fava, who heads the Fava & Associati law firm in Milan and writes about labor law. “Not the government, which was hoping everyone would make the switch to take the strain off its coffers, nor the workers who have not resolved the problem of needing a supplement to their social security pensions.â€
Leave the investing to the 401(k) accounts. Many may not be able to get in on big returns, but they’ll also avoid the big losses too.
This entry was posted on Tuesday, January 6th, 2009 and is filed under Economy, Money, The World. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
January 6th, 2009 at 8:27 am
If today’s retirees had invested their social security dollars into a generic index fund instead, they would retire with more…even with the current contraction.
I would rather entrust my retirement with the private markets than the government’s unsustainable ponzi scheme.
How can you possibly object to giving people the freedom to opt out?
January 6th, 2009 at 8:45 am
Privatization carries with it additional risk. People should have the option to take on additional risk if they choose to. The current financial market would serve as a very clear example of that risk.
January 6th, 2009 at 12:05 pm
I am far too skeptical of human nature to think that privatization makes sense as a wholesale substitution for social security as currently constituted. People who made wise choices would end up getting the tab for those who made poor or risky or uniformed choices.
But there’s really no reason to view the issue of public retirement finance as an either or choice between SS as it is now and 100% personal choice. If the wingier nuts didn’t dominate the dialogue, we could come up with a hybrid managed choice menu that siphoned the majority of contributions to providing the financing for bare-bones essentials and channeled a smaller portion into a vehicle where you got to make choices.
I know that folks who share Tilly’s perspective are bound to ask why the gov’t needs to be involved at all/ I’m not unsympathetic, but m My answer is “to protect the wise and prudent from the short-sighted, near-sighted, and imprudent.”
If you talk to any HR professional about employees managing retirement assets, they’ll all tell you that the single best thing that can be done to get their employees to set aside retirement money is to have the default option be that employees contribute some small fixed fraction. Then, if employees don’t want to do that when they start work, they have to take action to opt out.
There’s a real lesson in that. Involving the government in retirement financing pits the force of the natural human tendency towards inertia in a beneficial direction.
And Tilly, hey, I could be wrong. Maybe you are right that people would follow through and do much better on their own w/ot government involvement. But when will we get a real test? The 2008 crash swept privatizing SS right off the table and down the gutter for let’s face, at least a decade. It’ll be probably be another generation before the test will even be considered again.
That doesn’t make left-minded self-congratulatory post-mortems like Justin’s any easier to take, though.
January 6th, 2009 at 12:49 pm
Kranky – the greatest Ponzi scheme perpetrated so far is not Madoff, but in fact, social security. Privatization will ultimatetly happen because like another Ponzi scheme, it eventually goes bankrupt.
January 6th, 2009 at 1:03 pm
“I am far too skeptical of human nature to think that privatization makes sense”
I think you should stop and think about this statement for a minute. It seems to be the basic assumption behind your argument. You’re essentially saying that citizens cannot be trusted with the freedom to manage their economic resources. I’ve never really understood this distrust of the “unwashed masses.” Who exactly are the unwashed masses if not you and I? I’m not usually one to engage in dramatic hyperbole, but a great deal of misery has been caused by similar arguments.
All I’m saying is that SS, as it’s currently constructed, is an unsustainable system. I should have the right not to participate if I so choose. I guess that’s all I mean by “privatization.” I would rather entrust my nest egg with a seasoned financial adviser, whose livelihood depends on his success, than with a federal IOU. Coincidentally, I also think that this would make the public retirement system more efficient, more successful, because it would have to compete with private providers.
The price of freedom, we should remember, is that we have to live with the consequences of our actions.
January 6th, 2009 at 1:47 pm
Tilly is exactly right to characterize Social Security (not to mention Medicare) as a giant Ponzi scheme. Anybody who is a Baby Boomer or younger is daft if they expect it to see them thru their retirement.
That said, it is a little misleading to simply say that investing that money in a generic index fund would have given a better return. Of course it would have . . . IF people had actually invested the money rather than spent it. But would they have done so? Perhaps the relevant test is to look at the difference between Opt In and Opt Out 401(k) contributions. If people have to take any action at all, they will strongly tend not to.
So to have people investing money for their retirement would require some kind of “You are in unless you Opt out” approach to work at all. Which leads immediately to the question: what is the default investment for those who take no action? Which index in which market? And, not least, who runs the default fund? (Think Bernie Madoff, to see what could go really wrong there. Not to mention the fun of deciding what real managers were allowed to run the funds.)
January 6th, 2009 at 2:07 pm
There’s something of an apples and oranges problem with comparing Italy’s troubled pension system to Social Security. Note the line toward the bottom of the linked Bloomberg story about one pensioner, a construction worker, who gets 40,000 euros from the government system — and that’s no where near the top pension. The most anyone in the US draws today from Social Security — the highest paid people who have paid FICA taxes all their lives — is about $25,000.
Social Security is, indeed. a “safety net.” The vast majority of US retirees have other sources of income — private pensions, 401Ks, IRAs and other savings. If we did have a private investment option, those likely to depend solely or largely on their meager SS incomes would be well advised to stick to the government plan. Others for whom SS may be a quarter or less of retirement income might prefer to take a risk with a portion of the FICA dollars. Of course, you’d have to be an idiot to do this if you;’re already past 55 or even 50, but if you’re 25 or 30, it’s exceedingly unlikely that you’d lose over 40 years.
Bloomber also says that only 10% of eligible Italians chose the private option. It would be interesting to know whether most were younger and more affluent.
In any case, it’s possible to structure a “private” SS option that would both preserve the safety net function and permit some personla initiative. We shouldn’t rule it out categorically.
Government policy already implicitly recognizes the difference between someone 65 or older who relies on the safety net and those who don’t — by taxing SS income at otherwise normal marginal rates.
January 6th, 2009 at 2:37 pm
I think having an opt-out system is totally reasonable.
I was thinking “opt-out” would just mean that the taxpayer would be free to invest in whatever they like…or not invest at all.
If there must be a government approved default investment, fine. But I don’t know how wise that is. There are countless alternative investment plans, portfolios, etc, because there are countless alternative financial circumstances. Sure there can be a couple of different government approved investment funds, run by government approved managers, but I suspect that over time most will find those inadequate as well.
January 6th, 2009 at 2:52 pm
Here’s the problem with social security as it is currently structured – it doesn’t know if it’s a social safety net system or a system of forced savings. If it’s a social safety net system, then there’s no reason to fund it the way we currently fund it, which is effectively as a regressive tax that excessively takes from the working poor while also providing benefits to some wealthy retirees who have no legitimate need for the income. If on the other hand, it’s a system of forced retirement savings, then there’s no reason why we should be forcing those savings into a particular fund – let the individuals choose the best way of investing their savings by providing them with an option to opt-out of the system. A general rule of investment, for instance, is to make riskier, higher reward investments when you’re young and safer, lower return investments when you’re nearing retirement – but the current system insures that everyone is always making a (supposedly) safer, but definitely low return investment, no matter their age.
January 6th, 2009 at 7:27 pm
Somehow, I think most of the people that read this website make above-average income and have a little more time to think about which 401K is better. And yet, I doubt anyone here would do much differently on some old-school Kahneman and Tversky questionnaires.
January 6th, 2009 at 7:56 pm
Anyone who consistently refers to Social Security as a Ponzi scheme that will fail proves that they simply belong to that class of political hyper-partisans that turn their brains off in the name of ideological purity.
January 6th, 2009 at 8:37 pm
Anyone who out of hand rejects any attempt, notion or plan to allow individuals a degree of greater freedom to their own financial future by keeping their own money rather than forcing it into a demonstrably unstainable government program…belongs to that class of political hyper-partisans that turn their brains off in the name of ideological purity…
Look Jim S. — if I were you I’d probably be thankful for the illusion of the safety-net also, and I’m certainly not objecting to you being able to give the federal government your money to safeguard for you until retirement. I say bravo if that is what you want to do. But honestly, I can take much better care of my finances than your heros in D.C. and I should be able to opt-out.
January 6th, 2009 at 11:15 pm
Social Security is one of the most successful federal programs in our history. It has rescued millions of Americans from the clutches of poverty and significantly lessened the hardships that immediate families would have to otherwise bare. Counter to popular misconception, Social Security is not in danger of insolvency. We only need our government to stop “borrowing” from Social Security to pay for unnecessary projects and political pork. Medicare and Medicaid are for worse in terms of their costs and their implementations (i.e. unnecessary waste and inefficiencies.) Republican conservatives have had it out for so-called “entitlements” since their inception. They love to invoke the “Socialist” word in order to taint it with the stigma of the “lazy” and “hand-out free loaders.” Nothing could be further from the truth. FOR THE LAST TIME! SOCIAL SECURITY IS NOT IN DANGER OF INSOLVENCY. What presents a danger to Social Security is propaganda and misinformation from the far right which would love to “privatize” the program in order to flood the financial markets with Social Security funds and supposedly boost Wall Street speculation and somehow in the process net those willing to risk their benefits with hardy returns in the form of interest and maturation. In other words, same old BS spin different decade. Social Security should NEVER, EVER! be “privatized.” Federal benefits are not for gambling. You want to gamble? Go risk your luck at your local casino with your rainy day fund.
January 7th, 2009 at 12:41 pm
“Ponzi scheme” is a phrase that lots of folks are tossing around without precision these days. Blame MADOFF.
Pissing on each other isn’t very productive folks. Here’s the thing: SS is not a Ponzi scheme, but as it is currently (mis)functioning, it’s a lot like one. Basically, it boils down to sustainability.
By its very nature any scheme that is a Ponzi scheme is unsustainable. Sooner or later, due to rapid exponential growth, it MUST fail (presuming a finite number of people and dollars).
SS is not intrinsically unsustainable. But it IS unsustainable with the current eligibility ages and payout promises and collection rates, given current demographic trends. If you adjust the aforementioned variables, there is no reason why SS security is unsustainable. It can be sustained indefinitely, but only if the variables are monitored and managed, and the people democratically consent to such management.
And I mention democratic consent VERY advisedly. Let me go quote Tilly.
Who exactly? The great unwashed masses as you describe them are you, and I, and everyone else as well. This includes folks who will reach retirement age with very little nest egg, still holding substantial mortgages, still working in their late 60s and early 70s, who face becoming destitute should they suffer even a moderate setback in employment or health. I know personally many folks who have spent their entire adult lives living by the same “we’ll get by somehow” ethos that their parents had far less choice about adopting than the next generation.
These folks NEED social security, and that means that they need the money the next generation is required to put in, because it’s a pay-go system. Period. Your money in goes out to those collecting. Contra your assertion that you do have the right or should have the right to opt out if you want to, you don’t currently have that right. And all shoulds aside, the hard fact is that you cannot gain that right without the consent of the governed. Because that is how a democracy works. Any change to grant you this right you claim will not flow from any conception of philosophical righteousness.
Not that there is anything wrong with philosophical righteousness, I’m a bit of a fan myself. It’s just that its not where rights REALLY come from when you live in a democracy. I know how we americans have been brought up loving all that “we hold these truths to be self-evident” and “inalienable rights” jazz. But rights don’t really come about in any concrete form from god or from philosophical elegance. They came about here in America because a group of humans took collective action, declared some rights, and stuck up for them with laws and lawmakers and governments and voters.
Now, you’re free to continue to believe that you SHOULD have this right to opt out. But you don’t get this right unless you convince >50% of voters to make it happen. You’re also free to keep believing that the Americans who function on the “we’ll get by somehow” ethos would set aside 15% of their income and manage it into a vast nest egg if only the government would step aside. As someone else pointed out, many of the people who believe this are generalizing from their personal experience with income above the median and a healthy 401k nest egg. Maybe not you personally, but many. I keep track of WHO makes this argument, and it includes lots of people who say they are “middle class” even though their income puts them in the top 20% or 10%. Which, as we know, is not in the middle, it’s at the top end. If you want to know where you stand, try this. As a ballpark, if your total household income is approaching 6 figures, you are likely in the top quartile (fourth) of households.
My opinion is that if the people who live on “we’ll get by somehow:” were given more income, they’d spend most or all of it improving their daily life conditions, not setting it aside. Then they’d face destitution as they aged. And then, they would vote for politicians sponsoring plans for the government to provide them with a subsistence-level stipend when they got old.
The reason I am confident that this is what would happen? Why, because it already did, when SS was passed all those years ago.
January 7th, 2009 at 1:29 pm
J. Harden,
I really couldn’t care less what you write on this issue, or any other issue to be honest. The truth is that kranky kritter wrote an excellent summary of the reality that led to the creation of Social Security, a reality that political partisans on your end of the spectrum always tries to pretend doesn’t exist now and didn’t exist then. You will ignore it or try to twist history to justify your rants about the evil of government. Rant on. Just don’t expect anyone who has studied history without their goal being to support their prejudices to believe you.
January 7th, 2009 at 4:16 pm
Social Security is one of the most successful U.S. federal programs in history. Counter to popular belief/misconceptions Social Security is not in danger of becoming “insolvent.” These “dire” warnings are trumpeted annually like clockwork by conservatives in an attempt to privatize the program. The reasons goes that by “privatizing” the Social Security insurance program you flood the financial market with Social Security funds which in turn invites speculation and, here’s the sale pitch “gives the fund owner a chance to allow his fund to mature in the marketplace and work for him many times over.” It appeals to a very poor argument indeed. The argument is this: I earned it so why shouldn’t I be able to invest it however I wish?” Well, no. The reasons why are many:
“# Reason #1: Today’s insurance to protect workers and their families against death and disability would be threatened.
# Reason #2: Creating private accounts would make Social Security’s financing problem worse, not better.
# Reason #3: Creating private accounts could dampen economic growth, which would further weaken Social Security’s future finances.
# Reason #4: Privatization has been a disappointment elsewhere.
# Reason #5: The odds are against individuals investing successfully.
# Reason #6: What you get will depend on whether you retire when the market is up or down.
# Reason #7: Wall Street would reap windfalls from your taxes.
# Reason #8: Private accounts would require a new government bureaucracy.
# Reason #9: Young people would be worse off.
# Reason # 10: Women stand to lose the most.
# Reason #11: African Americans and Latin Americans also would become more vulnerable under privatization.
# Reason #12: Retirees will not be protected against inflation.” – http://www.socsec.org/publications.asp?pubid=503
Besides, aren’t we taking our eye off the ball why Wall Street hawks are trying to raid the cookie jar? Far more in danger of insolvency is our health insurance programs i.e. Medicare and Medicaid. Due to institutional inefficiencies and poor bargaining with the mammoth drug industry these two programs are costing the tax payer far more money than they should. So, for the last time, Social Security is not “in danger” of insolvency. The only danger facing the Social Security system is the misinformation propagated by Wall Street speculators and Washington conservatives. Oh, and it would help if the politicos would stop “borrowing” from Social Security in order to pay for their “projects” i.e. political pork.
January 8th, 2009 at 10:18 am
Your example does not hold traction with me because you are talking about Italy.
If you are not familiar with Italy’s culture, government, and how Italians manage their government and economy, then you should know that it is *vastly* different from the way that the US manages itself.
This quote from Wikipedia says it pretty well:
— quote —
According to World Bank data, Italy has high levels of freedom to invest, do business, and trade. On the other hand, Italy has inefficient bureaucracy, relatively low property rights and high levels of corruption (compared to other European countries), heavy taxes, and heavy public consumption at around half of GDP.[36] Italy has been in economic decline compared to most other EU-15 countries. Most raw materials needed by Italian industries, and more than 75% of energy requirements, are imported. Over the past decade, Italy has pursued a tight fiscal policy in order to meet the requirements of the Economic and Monetary Union and has benefited from lower interest and inflation rates. Italy joined the Euro from its introduction in 1999.
Italy’s economic performance has at times lagged behind that of its EU partners, and the current government has enacted numerous short-term reforms aimed at improving competitiveness and long-term growth. It has moved slowly, however, on implementing certain structural reforms favoured by economists, such as lightening the high tax burden and overhauling Italy’s rigid labour market and expensive pension system, because of the economic slowdown and opposition from labour unions.
— end quote —
Since Italy is quite different economically, your comparison is poor at best.
A gli Italiani:
Mi piace Italia molto e non voglio fare male ai vostri sentimenti. Nondimeno, se siete state negli Stati Uniti, sapete che ci sono tanti differenze fra l’Italia e gli Stati Uniti. Parlo come un americano che ha visuto un paio d’anni in Italia.