Post-Keynesian Observations

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Archive for February 2011

Why It’s Logically Impossible for Social Security to Go Bankrupt

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The belief that Social Security may not be there when we retire is one that comes up on a pretty regular basis and the program itself is currently a potential target for cost cutting in an effort to balance the budget (something that is totally unnecessary, but that’s a separate issue addressed in other posts). However, those who think that it could go bankrupt simply do not understand how it works. It’s a logical impossibility and the confusion comes from trying to think of it from a micro (individual) rather than a macro (economy-wide) perspective. Social Security, indeed, retirement in general, is all about productivity.

To understand how this works, imagine the following. Let’s say there has been some sort of M. Night Shyamalan “Happening,” and everyone in the world has been killed but the following individuals (recycled from my debt and deficit example):


Further say that we have set about erecting a society in the post-Happening world, including an economy. We all have various jobs growing food, making clothes, et cetera, and in our primitive stage of development each person makes roughly enough for one person to live. Call the latter a “bundle o’ goods,” such that ten people produce ten bundles o’ goods, allowing ten people to survive.

How many people can retire in this situation? Obviously, zero. If one did, then the remaining nine would be producing only nine bundles o’ goods, which they would presumably keep for themselves. The one retiree would starve.

What if Adam, during an expedition to find canned food at the local Kroger’s, discovered that a Brink’s truck had been in the middle of unloading precisely when the Happening occurred? Can he now retire on the cash he found lying about? Of course not, because as soon as one person quits working, we are down to nine bundles o’ goods. The ultimate limiting factor is productivity, not money. The latter is absolutely irrelevant if we can’t make enough stuff (and it is almost trivial if we can).

Moving from M. Night to the real world, is our productivity sufficient? Right now, it obviously is or we couldn’t do what we are doing (granted we are in the midst of >9% unemployment–so take just four years ago, when it was 4.4%). As for the future, even if productivity rose as slowly as its slowest rate since WWII, we should still have no problem allowing the baby boomers to retire AND having enough goods and services for them and ourselves (at an even higher standard of living). Productivity, barring a natural disaster of some sort, is not an issue, so that bullet is dodged. And, to be honest, it’s the only real economic bullet. The rest is just politics.

Now let’s start raising productivity in the post-Happening world and see what happens once you allow for retirees. Let’s make the math easy and suddenly allow each person to make two bundles o’ goods per year. Now we have some real options. At one extreme, we could have everyone could keep working and just enjoy twice as much stuff. At the other, five of the survivors could retire and those still working would share half of what they produce, leaving them all at the same standard of living as before. In between, we can actually have retirees AND more output/person. This last option is basically what we do in the real world. Nice!

But how do we accomplish that? It’s easy in the post-Happening economy since we all know each other and can just agree to do it. In reality, it’s more complex. Note that there are two things we need to make sure of:

1. Workers don’t simply consume all bundles o’ goods themselves;

2. Retirees get the bundles o’ goods not consumed by workers.

Note that the entire economy cannot “save,” incidentally. This is one of the places where people get micro and macro mixed up. While you can take your $1000 pay check and put $200 in the bank for later, the US doesn’t earn a salary and can’t do that. It produces goods and services (or bundles o’ goods). I suppose it would be possible on some extremely limited basis, but in general we can’t produce 10 TVs in 2011 and put 2 aside for 2030–hell, they probably wouldn’t even work any more. Or build 50 houses, but “save” 5 for later. Or 100 haircuts, but put 20 on the shelf. For all intents and purposes, all goods and services produced today are consumed today, period. The United States of American can’t save.

So, if the ten people make twenty bundles o’ goods, all twenty must be consumed today. We can’t save them. What can be saved, however, is the revenue from producing the bundles, and if workers do that then they can’t buy all the bundles–which is what we are after according to point 1 above. Meanwhile, if the retirees have cash left over from back when they worked, they can use it to buy the bundles the workers didn’t consume–point 2.

Notice that this isn’t going to be neat and tidy since the amount workers choose to save is not necessarily equal to the amount retirees spend from their pension funds. In particular, retirees may find themselves able to buy more or less than they had expected compared to 20-30 years ago when they started saving. This can create some real problems, particularly if the pension had been held in financial assets whose value had collapsed (like, for example, you had the bad luck of retiring in November of 1929!). We then end up with the capacity to support the retirees–because, remember, this is always a function of productivity and we still have 20 bundles o’ goods–but they don’t have the income to buy the output. Ironically, even if the workers still only want to consume half the bundles, it doesn’t matter and retirees are screwed. And what would actually happen is that the macroeconomy would contract since retirees demand for goods and services dropped off. We would see workers becoming unemployed and bundles o’ goods production falling. Not good, and no underlying productivity reason for it.

This is one of the reasons we have Social Security, so this sort of scenario can be avoided. People can argue that they know better than the government how to invest their money, but:

1) no, they don’t–there have been many studies on how consistently even professional investors can beat the market, and the answer is they can’t;

2) in the event of a market collapse, everyone is screwed and we will have to deal with it as we aren’t going to leave the retirees to starve (particularly as it wasn’t their fault);

3) most importantly, it’s not being invested, anyway, it’s being handed over directly to retirees!!!

Social Security is not an investment fund. It is not now and it never was, and I hope it’s becoming clear why that’s true. What would be the point of taking tax dollars from today’s workers and “investing” them? The goal is to lower worker income sufficiently to make sure they can’t buy all the bundles, while transferring income to retirees so they can buy the remainder. And therefore the Social Security tax you pay today is going directly to your parents.

The effect of this (in that it reduces the consumption of current workers and raises that of retirees) is no different from what would happen if it were voluntary, except that it avoids the “oh my God, the stock market crashed and I have no retirement money left!” scenario. And this was, not surprisingly, a real issue back when Social Security was invented (and obviously remains so today). The transformation of American society also played a big role. In the days when agriculture dominated, aged members of the family lived on the farm with their children and grandchildren (and great grandchildren). This represented an informal and widespread social security system. However, as America industrialized, it wasn’t always as convenient or even possible to have grandma and grandpa move into the apartment in Brooklyn with the rest of the family. And so, the elderly became a poverty-stricken segment of society (particularly once the Depression hit). Social Security was intended to solve that by re-instituting an institution that had already existed, but in a formal way and without requiring that your parents move in with you once they get older. Funny, but when I explain it that way in class, I notice that students are very quickly strong supporters of the idea!

To reiterate, what Social Security does is take money from workers today to prevent them from buying as much as giving it to retirees so they can have the remainder. Of course, workers get to play that game, too, once they hit retirement age. And this is no different from a private system, except that it sets guaranteed levels. A financial-market crisis can’t wipe out your savings. And remember, so long as we have the productivity, we can afford it. It’s a question of how many bundles o’ goods we can make, not how much money we have.

At present, we do have money in a fund that we use to supplement the tax dollars we take from workers, but that doesn’t mean the workers are getting to keep more because there are still only twenty bundles o’ goods. The difference is that instead of taxing the income away directly, we give retirees enough money from the fund to bid bundles o’ goods away from workers. But I think you can see how that it’s really irrelevant. If that money ran out entirely, all we have to do is raise taxes to the point that gave us the same effective outcome in terms of bundles o’ goods transferred from workers to retirees. People would, of course, complain, but that’s because they ain’t smart like you! They wouldn’t realize that the outcome is identical and that it doesn’t matter how we finance Social Security. So long as we have the requisite productivity, we could create new money or tax to put ourselves in the position we want and only our own stupidity could stop us. America doesn’t need to save for Social Security because America can’t save anyway.

Written by rommeldak

February 21, 2011 at 10:11 pm

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