Social Security Privatization
By Arnold Kling
Peter Ferrara claims that Social Security could be gradually privatized and the future deficit eliminated without reducing benefits. This is a free lunch of staggering dimensions. Among other things, it relies on the following assumption.
The long-term real rate of return on corporate stocks is around 7.5 percent to 8.0 percent, and on corporate bonds around 3 percent or more…
With such long-term real returns, a conservative diversified portfolio with half of each would yield a real return of around 5 percent
In fact, if the economy grows at a rate of 2 percent per year, then the return on a diversified portfolio will be around 2 percent per year. Earnings are going to grow at the same rate as the economy, and the price-earnings ratio is not going to grow explosively.
Social Security’s fundamental problem is demographic. Later on this century, the ratio of dependents to workers will be too high. Because of Social Security, retirees will have such a high claim on output that workers will have difficulty maintaining their standard of living. If Ferrara somehow turns out to be correct, and private portfolios earn returns far in excess of the growth rate of the economy, then retirees will wind up holding claims on output that are worth even more than Social Security. That will leave even less for workers.
Finally, Ferrara’s proposal does not deal with the bigger challenge, which is Medicare. Medicare’s projected growth in costs makes Social Security seem workable by comparison.
Social Security and Medicare face a demographic crisis. Privatization may be a good thing, and it probably would not make the crisis worse, but it is not the solution to the crisis. See Miron and Murphy.
For Discussion. In the past, real returns on stocks and bonds have been in the neighborhood of Ferrara’s assumption. How has this occurred, and is it wrong to dismiss the likelihood that it will occur in the future?