Arnold Kling  

Social Security and Indexing

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Prescott, Time Inconsistency, ... Bell Curve in Medical Care...

William Sterling writes,


Price indexation should save the government trillions of dollars in the long run because of the magic of compound interest. Wage growth has historically outpaced consumer price inflation by about 1.1% per annum. That means that the real value of wage-indexed benefits will be twice as high as price-indexed benefits after 70 years. And that is why a seemingly modest technical change in the benefits formula is a potential "magic bullet" for putting Social Security on a sound financial footing.

As Sterling points out, price indexation would only protect the recipients' absolute living standards, not their living standards relative to current workers. But he questions whether wage indexation is in fact even feasible in the long run.

indexing future retirement benefits to wages is analytically equivalent to indexing them to the overall returns experienced by the owners of capital...the government faces a massive quandary if it tries to guarantee relative living standards via wage indexation while funding the program with less risky investments like short- or intermediate-term government bonds. In doing so, its financial structure essentially becomes that of a doomed hedge fund -- perpetually "short" the stock market and "long" low-yielding government bonds. If stocks continue to provide higher returns than bonds over the next 100 years -- as has been the case over virtually all long-term historical periods -- that financial structure is almost certain to fail.

For Discussion. I wonder if anyone has ever written down a neoclassical growth model with Social Security taken into account. That is, suppose that we include Social Security benefits in labor's share of income. How does labor's share behave if benefits are indexed to prices? to wages?


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CATEGORIES: Social Security



COMMENTS (12 to date)
spencer writes:

Since SS is largely a transfer through time from one set of labor to another set of labor I do not see how the existence of SS makes much difference. The last few years when the SS system was in surplus and so generated savings that were offset by larger federal deficits would be the exception, not the rule. Right? Or should the model be like it was in the 1990s when apparently SS generated extra savings that at least financed part of the capital spending boom. Or do you assume that SS payments would really have been savings in a system without SS? But if that were the case you would also have to assume that some amount of this savings would be used to finance current consumption. So I am not sure what such a model would look like since I am not sure what to assume about the impact of SS on savings, investment and consumption.

JT writes:

"In doing so, its financial structure essentially becomes that of a doomed hedge fund -- perpetually "short" the stock market and "long" low-yielding government bonds."

Fascinating way of putting it.

Dewey Munson writes:
over the next 100 years
Of course the last 100 included 1929.

When the baby boomers start using their savings to live by selling their stocks to the projected small working group, stock will be worth nothing.

Of course by then with high ratio of non-producing consumers to producers, shortages and inflation and will be rampant.

The Market?

I suspect that immigration of people to supply the labor to produce food etc will be much more popular.

Alberto Stanchi writes:

HAPPY NEW YEAR! by an italian econ-blogger for all the people

pragmatist writes:

Dewey Munson wrote:

"[a] high ratio of non-producing consumers
to producers, shortages and inflation and
will be rampant."

uh ... have you ever read or heard about
something called 'agriculture'? Way back
a couple of hundred years ago something like
97% of the population had to do farming.
Now there are something like 97% of us
being 'non-producing consumers'.

No shortages or rampant inflation here. On
the contrary we are all - on average -
becoming increasingly obese.

Try again ...

David Bennett writes:


An often forgotten benefit of social security is the ripppling of wealth. Individuals in an era with few pensions, battered by the depression were supported in old age. This meant a bedroom for the kids and college in many families because the old folks supported themselves. Now those same kids are collecting significantly larger inheritances because their parents saved more because of SS and medicare.

We are getting to the first generation which *may* recieve less than they paid in, but for a significant portion there has already been payback.
The wealth passed from elder to younger.

Dewey Munson writes:

Prag

97% of the population had to do farming.

Read recent $3.00 hr Chinese labor rate.
Certainly they can't be a market for our $20 hr produce.

Right now our facilities are being copied at the $3 labor rate with attendant reduction of cost of capital as well as labor.

Soon we will be reduced to agriculture to eat.

Doubting THomas writes:

Mr. Munson,

I am not really following what you are saying here. The chinese will be able to produce food more cheaply than we do, so why can't we just buy food from them at a lower cost?

How does their lower labor rate imply that we will be forced back to agriculture? If anything by paying the lower rate for food we will have extra assets to be used elsewhere.

p writes:

Mr. Munson wrote:

When the baby boomers start using their savings to live by selling their stocks to the projected small working group, stock will be worth nothing.

Where is this coming from? Please let's use facts and reasoning. Stocks are and will be valued by their cash flows. This is both logically true and empirically substantiated.

One more point is that baby boomers do not even account for 30% of stocks traded. The exact figure escapes me at the moment. I will try and track down the exact number.

To assert that no one will value future cash flows when American Baby Boomers retire is ridiculous at best. Please remember that there will be billions of people on the planet not retiring (in countries like America, China and India) who will be willing and able to buy stocks for their future value. InsertTextHereInsertTextHereInsertTextHere

Jim Glass writes:
...the government faces a massive quandary if it tries to guarantee relative living standards via wage indexation while funding the program with less risky investments like short- or intermediate-term government bonds. In doing so, its financial structure essentially becomes that of a doomed hedge fund -- perpetually "short" the stock market and "long" low-yielding government bonds.

Interesting observation and it's been true enough for the last 69 years, during which SS has already gone broke twice -- but it's really been the least of SS's financing problems over that time. The major problem having been how Congress kept increasing benefits as rapidly as possible, while increasing the taxes needed to pay them as slowly and as far behind as possible. A couple of times they simply got around to doing the latter too late.

pragmatist writes:

American productivity, for the most part,
is the highest in the world. And it is
increasing. Therefore, at some future date,
automated factories here in the US will
become the lowest cost producers.

This is sometimes called "the American
Genius for Management". :-}

But it really did occur in the past and
will quite likely happen again for products
of which we can scarcely now perceive.

But that doesn't mean we will all be on the
dole. E.G. far fewer Americans are needed
to produce far more food than ever in history.

Freeing the rest of us to other things. Most
of the world's elite hate the US because our
culture is so pervasive, for example.

China is not a threat because they are not
free. We would be wise to pay more attention
to India in the coming years. If they can
root out their endemic corruption and
beauracy, the sheer intellectual force of
700 million free minds will astound the world.

Lawrance George Lux writes:

suppose that we include Social Security benefits in labor's share of income. How does labor's share behave if benefits are indexed to prices? to wages?

Labor share of income actually decreases in term of lifetime income, when indexed to prices. Labor income increases in lifetime income when indexed to Wages. The rationale:

Indexing benefits to Wages makes Wages the matrix of Accounting--Social Security benefits are incorporated into the Wage structure. Indexing to Prices for SS benefits only increases Business profits above entrepreuneral profit levels, as Business can cut Wages artifically by suppressing Production Costs ( accomplishible by initial suppression of Wages and Salaries, forcing Retail Profits below market cost, and suppression of Supplier Profitability by injurious long-term Contracts). lgl

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