Here is Peter Ferrara’s comeback to me on Social Security privatization and stock market scenarios.

The views advanced by Kling, however, are not peculiar to him. They reflect what personal account reformers are calling these days the “pain caucus” approach to Social Security reform. The pain caucus thinks that the Social Security reform debate is all about the program’s long term deficit and closing it as quickly as possible. They fail to appreciate the true and complete argument for personal accounts, which would by themselves provide broad and powerful economic and social benefits beyond just eliminating the long term Social Security deficits.

He argues that my proposals to cut future benefits are unnecessarily painful. He suggests that privatization would increase national saving, thereby raising the capital stock and future output.

My response is this that if we eliminated some or all of the payroll tax in order to allow workers to put money into their own accounts, then we confront the issue of how to pay current benefits. If we cut wasteful government spending to pay current benefits (which is one of Ferrara’s suggestions), then of course it’s a win-win. On the other hand, if the government borrows to pay current benefits (another of Ferrara’s suggestions), then national saving does not increase.

We also disagree about the long-run return to capital, which he says can be “rationally” expected to exceed the growth rate of the economy by a large amount. Let P be the market value of the stock market. Let E be the earnings of the stock market. Let Y be GDP. Then my argument is this:

P/Y = (P/E)(E/Y)

If the market value of stocks is going to outgrow the economy, then either the price-earnings ratio has to rise or the earnings-to-GDP ratio has to rise. The P/E ratio, which accounts for much of the historical rise in stock prices relative to GDP, is inversely related to the risk premium. In order to believe that P/Y will rise without bound, then you have to believe either that the risk premium has no lower bound (not even zero) or that the earnings-to-GDP ratio has no upper bound (not even 100 percent).

If you concede that the ratio of stock market value to GDP cannot increase without bound, that does not mean that it cannot increase for several years. However, the farther into the future that one projects an increase stock market value that is larger than the growth rate of the economy, the more implausible such a forecast becomes.

For Discussion. I think that there are two separate issues. One issue is dealing with the long-term deficit in Social Security. The other issue is swapping the government program for a private savings program. Is it better to think of those issues as separate or linked?