Angry Bear poses a question related to this passage from Ed Prescott's editorial in Wednesday's Wall Street Journal (also discussed here and here).
Some politicians have vilified the idea of giving investment freedom to citizens, arguing that those citizens will be exposed to risks inherent in the market. But this is political scaremongering. U.S. citizens already utilize IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank you. If some people are conservative investors or managing for the short term, they direct their funds accordingly; if others are more inclined to take risks or looking at the long run, they make appropriate decisions. Consumers already know how to invest their money -- why does the government feel the need to patronize them when it comes to Social Security?
AB asks:
Of course, consumers are ALREADY investing their 401Ks in stocks and bonds fully aware that their Social Security funds are investing in bonds. So might Dr. Prescott please explain how putting them their Social Security funds into a 401K will CHANGE their allocation?
Well, I'm no Ed Prescott, and the question is actually rhetorical -- the next two sentences in the Angry Bear post read:
Answer � it will not.
But I'll bite anyway. Privatization that converts mandatory "contributions" into "IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options" will leave private behavior unaffected under one condition: Savers choose exactly the same saving vehicles after privatization as they do now under the current social security system. And they have to choose them in exactly the same quantities. This seems, to me, a highly dubious proposition.
AB's argument seems to rest on the notion that the Social Security trust fund's "investment" of Treasury securities just replaces purchases of same by private savers. Even assuming that private savers would freely choose to hold the same fraction of Treasury securities in their portfolios, the argument still has problems. My (and your) payments into social security are not promised the rate of return on Treasury securities. We are promised whatever the payment/benefit formulas of the system indicate.
If you were born in 1975, for example, estimates of the average inflation-adjusted internal rate of return to social security under current law run at just under 2 percent. (See, for example, Table 1 of this paper.) The average inflation-adjusted yield on 10-year Treasuries since 1975 was about 4-1/2 percent. (Assuming that a person born in 1975 started working at age 18, the average return over their working life to this point has been about 3-3/4 percent. The average return since the mid-1950s has been about the same.)
It seems to me there is a pretty big difference between 4 percent and 2 percent. At this point we can start arguing about the interest-sensitivity of saving behavior, the additional tax burdens implied by the transition costs of privatization versus those required to maintain the existing system, and so on. But it is not much of a stretch to claim that the two worlds -- privatized versus not -- might be very far from equivalent.