Arnold Kling  

Pension Bagholders

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Roger Lowenstein writes


The drawback to 401(k)'s, remember, is that people are imperfect savers. They don't save enough, they don't invest wisely what they do save and they don't know what to do with their money once they are free to withdraw it. Quite often, they spend it.

Here there is much the government could do. For instance, it could require that a portion of 401(k) accounts be set aside in a lifelong annuity, with all the security of a pension. Behavioral economists like Richard Thaler have demonstrated that you can change people's behavior even without mandatory rules. For instance, by making a high contribution rate the "default option" for employees, they would tend to deduct (and save) more from their paychecks. If you make an annuity a prominent choice, more people will convert their accounts into annuities.


So his conclusion is that government needs to fix the errors of private individuals. However, the problems that are described in the article all reflect government behavior, which leaves taxpaying citizens holding the bag. Earlier in the article, he writes

The amount of underfunding in corporate pension plans totals a staggering $450 billion. Part of that liability is attributable to otherwise healthy corporations that will most likely, in time, make good on their obligations. But the plans of the companies that fail will become the responsibility of the government's pension insurer, the Pension Benefit Guaranty Corporation. The P.B.G.C., which collects premiums from corporations and, in theory, is supposed to be self-financing, is deeply in the hole, prompting comparisons to the savings-and-loan fiasco of the 1980's. Just as S. & L.'s of that era took foolish risks in part because their deposits were insured, the P.B.G.C.'s guarantee encouraged managements and unions to raise benefits ever higher.

...As bad as that sounds, the problem of state and local government pensions is even worse. Public pensions, which are paid by taxpayers and thus enjoy an implicit form of insurance, are underfunded by a total of at least $300 billion and arguably much more. While governments have been winking at these deficits for years, they are now becoming intolerable burdens for taxpayers. In San Diego, pension abuse has effectively bankrupted the city. Thanks to a history of granting sweeter and sweeter pension deals that it has neglected to fund, the city has been forced to allocate $160 million, or 8 percent of the municipal budget, to the San Diego City Employees Retirement System this year, with similar allocations expected for years to come. San Diego has tabled plans for a downtown library, cut back the hours on swimming pools, gutted the parks and recreation budget, canceled needed water and sewer projects and fallen behind on potholes.


Lowenstein argues that consumers tend to over-spend and under-save for retirement, and he wants government to introduce mechanisms to prevent this. But what mechanism will prevent government from over-spending and over-promising?



COMMENTS (25 to date)
simon writes:

Outstanding observation!!! The obvious often goes unnoticed by those who cannot appreciate that the very logic they employ must be more broadly used to fully comprehend the world around them. Again excellent point!

James writes:

I wonder what would happen if someone asked Lowenstein if any other agency besides government should require (using the same methods as a government) that people buy annuities with a portion of their 401k money. I'd like to think he'd immediately see a problem. Trouble is, he's probably spent a lot of time thinking up ideas of what an imaginary, perfect government should do. When people spend a lot of time doing that, they always have trouble imagining what a real, imperfect government will do, even when its right in front of them.

dearieme writes:

Beware. For years the British government said that you MUST spend most of your pension savings on an annuity as a quid pro quo for the tax advantages you'd been given. Then, after much money had been committed, the present government abolished a large part of the tax advantages.

Robert Schwartz writes:

All purpose Adam Smith Quotation:

AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS;
BY ADAM SMITH, LL.D. AND F.R.S. OF LONDON AND EDINBURGH:
FORMERLY PROFESSOR OF MORAL PHILOSOPHY IN THE UNIVERSITY OF GLASGOW
EDINBURGH: 1776

BOOK II. OF THE NATURE, ACCUMULATION, AND EMPLOYMENT OF STOCK.

CHAPTER III. OF THE ACCUMULATION OF CAPITAL, OR OF PRODUCTIVE AND
UNPRODUCTIVE LABOUR.


But though the profusion of government must, undoubtedly, have retarded the natural progress of England towards wealth and improvement, it has not been able to stop it. The annual produce of its land and labour is, undoubtedly, much greater at present than it was either at the Restoration or at the Revolution. The capital, therefore, annually employed in cultivating this land, and in maintaining this labour, must likewise be much greater. In the midst of all the exactions of government, this capital has been silently and gradually accumulated by the private frugality and good conduct of individuals, by their universal, continual, and uninterrupted effort to better their own condition. It is this effort, protected by law and allowed by liberty to exert itself in the manner that is most advantageous, which has maintained the progress of England towards opulence and improvement in almost all former times, and which, it is to be hoped, will do so in all future times. England, however, as it has never been blessed with a very parsimonious government, so parsimony has at no time been the characteristical virtue of its inhabitants. It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense, either by sumptuary laws, or by prohibiting the importation of foreign luxuries. They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.

[N.B. The quote in context can be found in Smith's Wealth of Nations on Econlib par. II.3.36 -- Econlib Ed.]

Lex Spoon writes:

Why does no one suggest separating the government safety net as a separate institution than pension accounts of all forms (private, public, 401(k), whatever) ?

Most people would agree that there should be some kind of safety net for those who are citizens a sufficient number of decades. But I keep seeing discussion after discussion wanting to entangle otherwise sensible retirement programs with strings to ensure a safety net when things go wrong.

Why do these things need to be tied together? It makes it very difficult to propose a sensible plan because any sensible retirement program is going to have some element of risk. Why not give most every post-60 citizen $10k per year and then leave the rest of retirement handling in private hands? What am I missing?

Randy writes:

The only mechanism that will stop government from over-spending and over-promising, is if they go to far. But they won't. San Diego is having to cut back on other spending. But this is nothing that can't be sorted out by the political process.

Bud1 writes:

Lex makes a good point. Why do we always seek all encompasing solutions? Whay can't we tolerate the concept that some will fail? The social safety net for ill and incapable is a fine idea, but why spread it's provisions to the whole?

Roger McKinney writes:

Why do people seek "all encompassing solutions?" The utopian mentality. Many people honestly believe that the right legislation will create a perfect society with no one left behind.

That said, here's another all encompassing solution: Deflation.

Inflation is a major cause of people saving too little, of businesses not having enough capital to replace worn out equipment, and of governments having too little money to repair infrastructure.

Why should people save when the government punishes such activity with taxes and inflation? If we eliminated any tax on savings (as 401k's do) and implemented mild deflation, retirees would suddenly discover they had saved too much!

Tom writes:

What makes people "imperfect savers"? I suggest that the prospect of a "safety net" has a lot to do with it.

Xellos writes:

Lex,

Depends on which "no one" you're talking about. Politicians -- the ones whose suggestions might actually happen -- will never suggest this because it then becomes too easy to cut the pork without triggering the "poor old people starving in the streets" hysteria. And no politican anywhere can stand having their pork cut, because it comes right out of their power base. So they'll do their best to make sure the emotionally charged issues are tangled up in the irrational excess issues.

Chris Bolts writes:

Great observation, Arnold. That's pretty much all I can say on that.

Steve writes:

Dear Arnold,

Wow, I must be missing something! All of your commenters think that you have just made a brilliant point, while I think you have just identified two things that are essentially not related to one another.

It seems to me that, if there is a problem getting individuals to save enough money in stable enough investments for their retirement, and that certain minor tweaks to tax policy could encourage more prudent saving behavior, then those tweaks are a good idea, regardless of whether the gov't properly funds pensions. So what if there is no mechanism to to require that gov't pensions be properly funded? How does that prevent the tax policy changes that are proposed in Lowenstien's article? What is the connection?

And to James's comment: Why shouldn't a non-gov't entity (i.e., employer) require a portion of your 401k money be put into an annuity? Or for that matter, why shouldn't employers (or the gov't set up high default contribution rates? Apparently it is obvious to James, but I don't see it.

Dewey Munson writes:
with all the security of a pension

First - I am 84 and have lived through the period from Depression to infinite wealth.

So what? Let's look at pensions. The control factor here is time.

Can we agree that a pension is a method of consuming tomorrow what we produced today?

Immediately money with its characteristic as a store of value over time becomes important.

Our money?

My first man job was as a longshoreman at $ .95 per hour ($40/wk). Bread was $ .05 per loaf so I put 10 % or $4 into a box to pay for 80 loaves of bread when I retired in 50 years.

Yesterday, 50 years later, I needed some bread so I opened my box and bought 3 loaves of bread at $1.35 a loaf.

3 loaves not 80 loaves! OUR MONEY SYSTEM IS NOT A STORE OF VALUE.

Pensions which take today's money for a promise to pay with tomorrow's money are one of the greatest distortions in our "system"

It's interesting to me that so many apparently unsophisticated people intuitively understand that the best strategy is to convert money to real goods as soon as possible. Saving is out.

Back to personal math. The same longshoreman job today pays $27/hr.

None of the proposals will work in the face of declining value of money.

Fot the economists a question.

Why doesn't an improvement in efficiency justify a reduction of price?

Lex Spoon writes:

Bud1, that's not what I meant. I very much do want to have some sort of safety net. My point is more, why go goof around with a zillion different government systems? Why not just hand out welfare to those in need, and leave the rest of the systems alone?

If someone saves poorly, or they invest badly or unluckily, or they are injured and lose their job, then sure, give them something to live on. But why do this through pension plans, social security, etc.? The simplest thing is to do it through wellfare and then leave these other systems alone.

Xellos, I agree that simpler plans reduces the demand for politicians and for interest groups and lobbyists and so on. They also make the operations of government comprehensible to the average joe so that people can vote wisely. These are not things politicians of today particularly want, but they are things that politicians of tomorrow could thrive on.

It can happen, but it depensd on the general populace understanding and wanting simplicity and sanity in government. And, alas, it depends on people shedding the idea that Roger describes that I run into very frequently: the idea that any problem not only can be solved by the government, but that it ought to.

Bob Knaus writes:

Deflation! It's not often you hear people advocating THAT as a solution to our savings problem.

Didn't we try that once before, as a corrective to the inflation from the Civil War? As I recall, the backlash against this policy very nearly got William Jennings Bryan elected president.

Why was WJB able to rally so many farmers to the zany cause of bimetallism? Because the farmers owed money on their land. Deflation produced lower land values and lower crop prices, putting the squeeze on indebted farmers. Deflation is always bad for debtors. Even disinflation -- remember the Farm Aid concerts in the early 80s?

If you substitute "homeowner" for "farmer" I think you will see where the nation stands today in terms of an indebted electorate.

Perhaps Bryan could do a post on the inflation rate desired by the median voter :-)

Roger McKinney writes:

Bob,
Yeah, deflation is definately a contrarian view. But before you dismiss it, check out articles on the benefits of deflation on the Mises.org web site. Also, read George Reisner's book Capitalism. Keynesians have trashed deflation and promoted inflation because of their dislike for savings and love of borrowing. Yes, deflation would hurt current borrowers and discourage future borrowing. But guess what? It would encourage saving and investment!

In addition, according to Austrian thinking, inflation benefits banks and government most because they receive the new, inflated, money first, before prices rise. Inflation encourages debt, discourages savings and grows the power of government. It hurts the late receivers of new money, usually working people.

Randy writes:

I posted this over at Jane Galt. One more time here...

Dewey, you're right - our money is not a store of value. That is exactly what inflation does - removes the ability of money to act as a store of value.

But the result is interesting because there is nothing (repeat, nothing) that can replace money as a store of value. If there is no store of value, then our only option is work, because the only wealth we can count on is the wealth from the value we are currently creating. Thus, low rates of inflation drive productivity.

High rates of inflation, on the other hand, decrease productivity. Why? Because high rates of inflation, by removing the ability of money to act as even a short term store of value, remove also its ability to act as a medium of exchange. If you don't believe you're really getting paid, you have no reason to work.

I've always wondered why people would fall for the idea of pensions? - allow themselves to be paid today's wages in tomorrow's money. My belief is that the cause is simple fear. People are willing to believe in a higher power, any higher power, that offers them security. It's a damn shame - but I have a hard time working up any tears.

Roger M writes:

Randy,
I don't follow your logic about inflation raising productivity. Could you explain?

Randy writes:

Roger,

Productivity may not be quite the right word.

But by removing the ability of money to store value in the long term, slow steady inflation demands constant creation of new value. I have to work, to create, to produce - because to stop is to fall behind. Inflation demands a work ethic. In essence, the ability to produce takes over the role of storing value - in a sense, work becomes money. But to be honest, the link between this required ethic and productivity is an assumption.

Lord writes:

If one can't expect individuals to save and invest properly for retirement, and one can't expect government to save and invest properly for retirement, then the solution is actually close to what we have - a pay as you go system. The only difference is, it would be flexible enough to accommodate changing circomstances such as demographic trends. Isn't it great to live in the best of all possible worlds. :-)

Roger M writes:

I think I see what you're saying: Inflation steals our savings so we have to work harder to keep up. That's true. But deliberately inflating the money supply is dishonest; it's theft.

Remember that the Federal Reserve was created to protect banks from default. The Fed still sees protecting banks as their major task. Inflation is their major tool. It makes repayment of loans a little easier, but not as easy as proponents of inflation claim because banks add the expected rate of inflation to the interest rate. But mostly, it helps banks by giving them the inflated money first, before prices rise.

Does inflation hurt anyone? It hurts wage earners, because wages rarely keep up with inflation in the long run. Also, the inflated money reaches wage earners last, after prices have alreday risen. Inflation hurts savings by making them worth less each year. The low savings rate that results then hurts businesses because they have to borrow overseas. Borrowing from foreigners raises our exchange rate, increases the trade deficit and hurts exporters.

Inflation hurts manufacturers because they can't depreciate equipment at a rate fast enough to cover wear on the machinery and inflation. So when the time comes to replace equipment and plants, they don't have the cash and have to borrow, as if starting all over. In addition they have to pay taxes on the inflated dollars as they were real dollars. This is a major reason for manufacturing going overseas.

Low levels of deflation would reverse all of the ill effects of inflation.

Randy writes:

Roger,

I agree with everything you've mentioned, and I'm not going to say that a little inflation is absolutely "good". But I will say that from some perspectives it is good. From a social perspective, we want people working for a number of reasons - not the least of which is that idle hands are truly the devils workshop. If inflation is the ultimate enforcer of the work ethic, then it is a valuable tool in keeping the population gainfully employed. And if my assumption is right that it also drives productivity via that same mechanism, then the drawbacks you mention are not as severe as you imagine, and the final sum may even be positive.

Dewey Munson writes:

Randy
Thanks, but where did I infer DEflation?

If money number was stable as a store of value there would be neither inflation nor deflation. Wealth would then have a fixed measure just like the markings on a carpenter's tape.

Incidentally, tomorrow's real wealth increase will be only what we produce tomorrow - however you measure it.

And money as a store of value? Obviously I have a problem because money certainly is the most upfront subject today. The best I can come up with is the parable of the Emperor's clothes.

The real problem with Soc Sec and pensions is that money is given to non-producers and THE NUT NEVER GOES AWAY - guaranteed inflation.

Randy writes:

Dewey,

Ah, no inflation or deflation. What a wonderful world that would be. The problem is, that in this best of all possible worlds, there is no fixed store of value and never will be, because value itself is subjective. I think we'd agree that the closest we can get to a fixed store of value is productivity. So that which increases general productivity increases general wealth. And if a small amount of inflation drives general productivity...? Well then maybe the downside of inflation to certain individuals is "acceptable".

Daniel writes:

Roger,

take a look at the Japanese economy. They are doing everything they can, to avoid deflation. This is, because businesses won't invest anymore, they would simply save their money, instead of creating jobs and developing new technology. People won't spend their money anymore, businesses cut back their production capacities, jobs get lost, people have less money in their pockets, the economy breaks down.

Substantial deflation is the worst, an economy could encounter.

Here in Germany interest rates are very low, savings are very high, companies invest in Eastern Europe, inflation is low. The link between national savings and national investment doesn't exist anymore in our world of open economies and global markets.

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