Risk and Pensions
By Arnold Kling
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.