Arnold Kling  

Risk and Pensions

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Jane Galt takes on Malcolm Gladwell:

he attributes pension problems to higher productivity, which allows manufacturers to make more stuff with fewer people, and thereby increases their dependency ratio. This is daft. Increasing productivity also increases profits, allowing companies to pay more benefits using fewer workers; in fact, by decreasing fixed costs such as health care, it should make it easier to support retirees. GM's problem isn't that it's just too darn productive; it's that it's too darn unprofitable, thanks to foreign competition.

The issue that Gladwell raises is one of risk pooling. He says that if pension plans pool risk, then does it not make sense to have the largest possible risk pool, meaning that Social Security is better than a GM pension plan?

Oy. He is really confused. First of all, what is the risk that a pension is supposed to deal with?

After you retire, there is the risk that the assets you accumulate run out before you die. To deal with this risk, you can annuitize some or all of your assets. Most people prefer not to do this, for a variety of reasons, including some good ones. But that is not the risk that Gladwell has in mind, as far as I can tell.

It seems that the risk that is at issue here is that the money that you set aside for your retirement does not accumulate to the level of assets for which you planned. That is that happened with private pensions that went broke. That is what will happen to Social Security under less-than-optimistic forecast scenarios.

Suppose that the standard retirement plan instead is an IRA or 401(K) type plan, where you invest the money yourself. If you invest in an index fund, then your risk is that the economy does poorly. We know from basic finance theory that this is better than being dependent on one company's financial health. It's also hard to see how it is not at least as good as being dependent on a government system. The government also is "long" the economy, in that it depends on economic activity for its tax base.

For investors, financial markets solve the problem of risk and diversification about as well as it can be solved. Having General Motors or any other company act as an intermediary only adds risk, because now you depend on GM to act responsibly. Having government as an intermediary only adds risk, because now you depend on government to act responsibly.

Gladwell needs to go back to square one and figure out what risk it is that people need to pool in the first place. Otherwise, he is just sowing confusion.

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CATEGORIES: Social Security

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The author at Cafe Hayek in a related article titled Gladwell on Nationalized Health-Care Coverage writes:
    Malcolm Gladwell's most recent New Yorker column is already the target of a good deal of deserved criticism. See Arnold at EconLog and Jane at Asymmetric Information. I here pile on. In his column Gladwell falls for myth du jour [Tracked on August 25, 2006 1:48 PM]
COMMENTS (6 to date)
Kent Gatewood writes:

There is no requirement that productivity gains have to go for benefits.

In my case, our gains went to support more important departments.

Omer K writes:
There is no requirement that productivity gains have to go for benefits.

In my case, our gains went to support more important departments.

There is no requirement. Competition makes it so. Albeit not immediately.

Phil writes:

I can see how some people can think the government is more reliable than the market. For political reasons, government may be willing to go into debt to pay pensions to retirees.

Or, put another way, social security is risk pooling *among all Americans*, using all Americans' assets to pay pensions. If the government makes a credible promise to tax 300 million people to pay your pension, I can see how you might consider that more reliable than even a diversified portfolio.

My private retirement fund is long the market. Government is long millions of people's incomes.

K writes:

Fixed private pensions are in trouble. But not from productivity or growth. Those factors can ease or worsen the problem, they do not cause it.

Pension planning and funding assumed people would die according to actuarial tables. But they are living far longer. And most pension plans were never fully funded anyway so there still wouldn't be enough money unless the company continued to prosper.

The situation is far worse for companies who promised health benefits to retirees. The cost of health care continues to rise faster than inflation. And again, pensioners are drawing that unexpectedly expensive care for years longer.

So we have a situation where a fixed amount of money, which wasn't fully provided anyway, is to pay out for an unknown period at an unknown rate. It was/is a pyramid scheme.

The public pension situation is far, far worse. It is also a different topic.

Allen writes:

Thank you for pointing this out about GM's problems. I've heard others claim this before and it didn't sit right. Now I know why.

Carol writes:

Obviously Dr. Kling does not rely on health benfits as a retired Federal Worker. Federal health benefits have decreased and premiums yearly exceed any COLA that my husband might get. He gets $1143 a month and pays $400 per month for health benefits. Not much to show for 30 years with the Feds huh? What Dr. Kling is purposing is that Federal employees live like those in a third world country. Obviously out of touch with the rank and file employees.

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