Social Security Privatization Debated

Just to note that (obviously, ignoring all issues of vintaged capital):

GDPt = GDPt-1 + (GDPt-1 x [Savings ratet-1 – Depreciationt-1] x Return on investmentt-1)

A fairly straightforward difference equation expressing the accounting identity that next period’s GDP is determined by the proportion of this period’s GDP which is invested rather than consumed, and by the return on that investment.

Dividing both sides by GDPt-1 and subtracting 1 from each side, we get the accounting identity:

Growth rate in GDP = Net savings rate x Return on capital

Since the net savings rate has to be below 100% (simply because depreciation is non-negative), we can see that as an accounting identity, the rate of return on capital has to be bigger than the rate of growth of GDP.

But, as Jim Glass pointed out in previous comments (although this shouldn’t be taken as an endorsement of other points he made), this is a one-period “simple” return, not a compound return. Ferrara’s argument is bogus because it (implicitly) relies on comparing a rate of return on capital “well in excess of GDP growth” with the compound rate of return you earn on stocks and bonds. That rate of return assumes that the proceeds of the investment are reinvested in the same asset, and the model above clearly shows that this assumption is not valid at the level of the whole economy; the “rate of return on capital” is higher than the growth of GDP precisely because they’re *not* all reinvested (the savings rate is less than 100%). Assuming that simple-interest returns can be compounded is exactly the confusion which led to Glassman’s notorious “Dow 36,000”, by the way.

This confusion can be seen clearly in the following paragraph, which I hope for its author’s sake Paul Krugman never reads:

“The total capital stock in the economy will earn each year on average the before tax real return to capital determined by these factors. That return will constitute the portion of national income that goes to capital for the year. If there is no economic growth for a year, and the national income consequently remains the same as the previous year, that does not mean the capital stock will earn a zero return for the year. It will continue to earn the full, real, before tax return to capital, again as determined by the above factors.””

In the context of the model above, it is clear that this is nonsense. If the capital stock was returning its “full, real, before tax [but presumably after depreciation -d^2] return”, why would economic growth be zero? It is easiest to see this in a two-period model of the economy, as in a two-period model, the capital invested in T1 has to return the amount spent on it in T0 plus a bit more. In a more realistic model with vintaged and long-lived capital it’s a bit more confusing, but the result holds.

Ferrara also plays fast and loose by switching in the next paragraph from “capital” in the context of the national income accounts to “capital markets”, but this is a minor error compared with the big one (though still big enough to make his argument incoherent independently). Bond traders would also possibly take issue with his assertion that “Rationally, we can only assume that capital market returns, including stock and bond returns, will be the same over the next 75 years as they have been over the last 75 years” given the current yield curve.

I actually have a certain degree of sympathy with Ferrara’s position that we should consider the macroeconomic effects of dismantling Social Security and chucking the money in the stock market. I happen to think that these effects would be disastrous, but there you go. But it is quite clear that the article linked is based on equivocation and ambiguous meanings of important terms. It is far more rewarding to have the discussion about privatising retirement insurance with someone like Arnold who can usually be relied upon to characterise the actual economic issues in a coherent and rigorous manner.

My abject apologies, by the way, if this weblog does not support the “sub” HTML tag and my subscripts above come out garbled ….

>>This fact alone should send up a warning flag that the history of previous investment rates of return, earned at far lower levels of investment, cannot simply be expected to be repeated, or even approached.

>>Contrary to common belief, increased investment levels can easily reduce overall profits, by increasing the level of competition and also reduce the rates of return by spreading the remaining profits over a wider investment base, as well as bidding up initial investment entry points.

” increased investment levels can easily reduce overall profits, by increasing the level of competition ‘

Feldstein has estimated that it would only be by about 15%, which would still dramatically outperform the current system. And, btw, that lost 15% to capital would be labors’ gain.

>>Suppose Crusoe comes ashore in a rowboat, with a fishing pole

Well no. Don’t suppose that. If you’re going to model anything with relevance to the economy, you can’t suppose that capital washes up on the shore.

>>This goes on for two days, two weeks, two months, two years….

Nor can you suppose zero depreciation

Repairing a boat is investment, not consumption. I really do suggest that we stick to simple two-period models in which capital is created in T0 and destroyed in T1 in order to get the stylised facts right before trying anything more complicated.

From Ferrera:

>>The problem is worsened because the baby boom generation had much lower fertility than previous generations, a point that Kling did not mention. So the working generation that is supposed to fund the benefits of the baby boomers through taxes in the pay-as-you-go system is relatively small.

” There are only two periods in the Crusoe example described. In period 1 (Before Fishing Rod), the size of the economy is the value of one fishing rod, consumption is zero and savings are 100%.”

I guess you missed the import of my saying: “This goes on for two days, two weeks, two months, two years….”.

” >>I guess you missed the import of my saying: “This goes on for two days, two weeks, two months, two years….”.

” I thought I said quite clearly why I thought it was a red herring.”

Still don’t see it, huh? Period 1 is the day after the contract is agreed to and the fishing begins, period 2 is the next day, period 3 the day after that….

“Depreciation” is so small as to be zero. Further, as I said, Friday is responsible for any maintenance and repair, not Crusoe. Any reduction in consumption comes from Friday’s leisure time. I.e. it does not effect GDP. So, your question:

“If the capital stock was returning its ‘full, real, before tax [but presumably after depreciation -d^2] return’, why would economic growth be zero? ”

Is answered by my simple example. Also, GDP growth could easily be negative and be an answer too. Suppose Crusoe strikes a bargain that fixes his return at 1/2 fish per day. Friday could meet that obligation by going without eating a day or two per week. In which case, GDP would decline while capital received its “full real return”.

“Any reduction in consumption comes from Friday’s leisure time. I.e. it does not effect GDP. ”

That doesn’t sound right. Maintenance time has to come from somewhere. You’re lowering Friday’s wage to cover depreciation. Either that or you’re investing output, that is, part of his portion of fish is pay for his maintenance work. He gets 40% of a fish for fishing, and 10% for fixing the boat, say. Isn’t the 10% being invested?

Ferrara is right that the *real* problem with SS is that it is a *very bad deal* for today’s young workers compared to the alternatives readily available to them. Just as SS became very popular when it was a very good deal, better than available alternatives, so being a bad deal will make the status quo unpopular in the future — it’s already started, as we can all see. And being that SS is a political creature, political unpopularity will doom the status quo, one way or another.

The “funding crisis” is relevant only in that solving it must of necessity make the deal for today’s young workers even *worse*. Closing the funding gap is easy — trivial even. Just increase taxes or reduce benefits or both. It’s no more difficult than closing a funding gap at the Agriculture Department or Pentagon or wherever.

That our politicians are so loathe to do such a simple thing — in spite of the endless warnings of SS’s trustees that “sooner is much better than later” in doing so — shows the fact that it is *not* the funding gap per se that is the real problem.

The real problem is political — that closing the 25% funding gap by either raising taxes or lowering benefits will *visibly* further reduce the return on contributions to today’s young workers, from the current miserable 2%-to-negative, to 25% below that, giving today’s young workers a much worse deal than prior generations had. Today’s politicians don’t want to take the heat for that, they want to leave that heat for tomorrow’s politicians, who will face a gap larger than 25% as a result.

But when the cash flow on SS goes negative in a time of large overall deficits, around 2018, the politicians won’t be able to dodge any more. Most likely means testing for Bill Gates and all those Boskin IRA millionaires then will become a cost-cutter so that the national deficit won’t be run up to provide extra spending cash to billionaires and millionaires. But that still won’t provide positive returns to SS participants, which is *the* problem.

The *only* way to give meaningfully positive average returns to participants on their SS contributions, which is the political necessity to save SS, is by some form or other of private savings — like the Swedes have done. I mean, the Swedes of all people have faced up to all this and found 2% private accounts the way to go. Something like that really is inevitable. The work to do now is to examine the alternative possibilities and their consequences to make the best choice as to how to do it.

** “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.” **

They have to be looked at together for the reasons above — closing the deficit is fiscally trivial but politically impossible (see today’s politicians) unless some counter is presented to the fact that doing so will give all workers seriously negative returns from SS on 12.4% of pay when they could get positive returns on that same money … well, anywhere. In a money market fund, even. People just aren’t going to be happy to have Social Security impoverish them.

** ” …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.” **

Friedman has pointed out that this argument is a red herring because the liability to retirees is a sunk cost. We have to pay it from taxes anyhow, whatever we do. Thus the net change in cost from putting in a funded “real savings” system for today’s young workers is exactly $0. We’d pay the current benefits from taxes just exactly as we would anyhow — only we could shift them to income taxes, much more progressively, with a lower tax rate over a much larger tax base. Net change in cost $0, with big improvements in both efficiency and equity. And even Krugman has admitted that a funded retirement system would be better for workers if we had set SS up that way. So going forward for young workers, let’s make him happy and set it up that way!

** “We also disagree about the long-run return to capital…. **

I find this whole running argument something of a red herring too.
[] First, as to “stocks” carrying the whole load of privatization, they wouldn’t any more than they do in corporate pension plans and other retirement accounts. There’s a whole world of investments available. Government bonds by *direct* ownership in private accounts would be a big improvement over the SS status quo.
[] Second, re the tie between the return to capital and the US economy, it is the world economy that matters. It is payroll taxes that are tied to the US economy.
[] Third, this whole argument sounds like it could have been made decades ago against corporate pension plans, IRAs, 401(k)s, etc. “There can’t be trillions of dollars of new private retirement savings without driving down the return to capital, etc.” Well, here we are and it hasn’t so far that anybody’s noticed. If SS could have been a funded program to begin with, then it can be one now.
[] Fourth, some increase in private savings must result — however much that is, a lot or a little, it’s got to be a good thing. (How are we going to pay for Medicare, which is a *real* problem?)
[] Fifth, as long as return to capital is *positive* private accounts will be better than what today’s SS will provide to most young workers. Anything positive beats a negative.
[] Sixth, in political reality we are talking only about 2% private accounts, like the Swedes have, or something on that scale — not privatizing all of SS (even if we should). It’s not that big a deal.

dsquared,

“…The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically, or to assume that the rate of return on capital outside the USA is dramatically higher than the rate of return on capital in the USA. Otherwise, you’re pushing a problem that used to be called “taxes” into a problem called “dividends and coupon payments”, and young people still end up getting the raw end of the deal….”

This seems to be substantially correct.

The returns on financial assets cannot, overall and in the long run, exceed the profits that can be realized from the actual real investments that result from the use of the financial assets to produce goods and services.

In the long run, in a closed economy with neither imports nor exports, the total real financial returns and profits cannot grow faster than the population.

When additional marginal investment funds become available, either through increased saving and investment, or through artificial credit expansion, they will eventually increasingly reduce and eliminate profits due to higher levels of competition that overwhelm the carrying capacity of the finite consumption markets.

While there is no limit on the standard of living benefits that can result from increased productivity and lower consumer prices (assuming no monetary expansion that mistakenly attempts to stabilise prices and prevents broad distribution of those benefits), financial returns will stop increasing as the economy fills up all available niches through specialization and the division of labor, and starts to become zero sum as new niches must destroy old ones.

Regards, Don

>>The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically

I would assume that the accounts could invest in any mutual fund. I wouldn’t assume that these only would be stock funds. Bond funds, cash funds, just about any fund that is available to a 401(k) should be assumed to be available to a fully funded national pension system.

And as Larry Kudlow would tell you, a nation of stockholders is going to act differently than a nation of people betting their retirement on a government enforced ponzi scheme.

For example, if we had your system where everyone held IBM and Microsoft, do you think that the Feds would have taken anti-trust actions against MS? I don’t think so.

Eric,

If more people holding more stock resulted in the elimination of the FED, the income tax, and government schools, you might have a point. -grin-

No matter what the investment vehicle, the last marginal investment is far less effective than the first.

If you buy a million dollars of IBM stock, how does this result in increased economic growth or increased business profits?

First of all your investment does nothing for IBM unless it makes a secondary stock offering at a price that has been temporarily bid up by your purchase. For most intents and purposes, stock buyers and sellers on the public markets are merely gambling among themselves while pushing the stock price up and down and varying the actual results that the inside owners produce as they cash out their holdings. There is nothing wrong with this. But it is the existence of the liquid market that motivated them to make initial investments in the past, not the price gyrations in the present, and not in any significant way your decision to buy stock. The effect of your stock purchase depends on the investment decisions of whoever sold you your stock.

But even if your investment were to directly go to IBM for its internal investments, it would be of little or uncertain effect. IBM at any one time has thousands of potential investments under consideration. They will be ranked from best to worst depending on their potential returns and degree of risk. As more investment funds are made available to IBM, they will be sequentially invested in the highest ranked investment. What this likely means is that your late arriving million dollars can only be used by IBM for a relatively low ranked investment, with weak potential returns and high risk. Thus there is little certainty that your million dollar investment will result in increased business profits by IBM or anyone else.

The only way your million dollar investment is likely to help the economy is if you can invest it in something about which you have correct and rare knowledge, possibly your brother-in-law’s small business which needs your money.

The idea that simple, dumb increases in investment levels result in a more productive and profitable economy is unlikely to be anywhere near as true as expected, if at all.

Regards, Don

“What this likely means is that your late arriving million dollars can only be used by IBM for a relatively low ranked investment, with weak potential returns and high risk. Thus there is little certainty that your million dollar investment will result in increased business profits by IBM or anyone else.”

Don,

You are correct up to this point. Remember that IBM is not obliged to accept the million dollars, and will normally do so only if they expect the return on the project they finance with it to exceed its capital cost.

Eric, after all, is unlikely to provide IBM with a million dollars without demanding something in return, most probably a quantity of stock.

” ‘As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees. ‘ ”

“As I have pointed out a countable number of times, this implicitly assumes that the rate of return on capital is higher outside the USA than inside it…”

Nonsense.

“… and also requires under most reasonable assumptions that the USA will run a substantial current account surplus for the next several years.”

So you are saying that I haven’t been able to get the international capital markets’ rate of return in my IRA for the last 20 years because the US has been running trade deficits all that time?

Or are you saying that while I can and will continue to do so in my IRA, some mystical reason of dark magic would keep me from doing so in a comparable ‘SS IRA’?

“I do not see how merely privatising Social Security will affect this.”

Well, it would increase the domestic savings rate by some amount. And that would tend to improve the current account. So it would help.
Though that obviously is hardly necessary for one to get a market rate of return in global investment markets.

“In the long run, in a closed economy with neither imports nor exports, the total real financial returns and profits cannot grow faster than the population.”

Which nicely illustrates the problem with a tax-and-transfer social security system financed solely by payroll taxes imposed on the domestic economy. And why so many nations are adding private investment options to their SS system to escape this limitation.

Sweden has overpromised past benefits relative to the payroll it will have available to tax in the future in its local “closed” economy, so Swedish workers can’t get positive returns on their contributions via such taxes.

But Swedish workers can get positive returns in their privatized 2% SS investment accounts that they invest in companies that are investing in China (and India, and the rest of Asia, and South America, and North America, etc.)

Bernard,

“…I understand your point. I was referring, not too clearly I see upon rereading my post, to the case where money goes directly to IBM for internal investments.

In that instance IBM is free to reject the investment, and wise to do so, if it lacks sufficiently profitable projects.”

There’s no question that IBM will not undertake known negative investments.

However, there is a wide range of projected results and risk involved in the universe of possible positive investments that IBM perceives as available to it. ALL of the investments actually made will tend to produce all of the undesirable consequences of any investment, i.e additional competition for both markets and resources. In large part the last marginal investment that IBM undertakes MAY depend on the investment capital available to it. IBM is probably a bad example in the sense that it probably has virtually unlimited access to capital, if it is willing to pay the price.

However, for smaller companies with limited credit, the marginal ones are more likely to become real drags on profitability as they are actually funded by banks desperate to loan against their fractional rserves.

Regards, Don

Why do I suspect d squared has just returned from one of those three-wines-meals paid for on someone else’s expense account.

” >>As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees.

” As I have pointed out a countable number of times, this implicitly assumes that the rate of return on capital is higher outside the USA than inside it…”

Pretty obviously not. The question you asked was about the demographics. I gave you the answer (there’s a whole wide world out there to exploit), and you are now blindingly thrashing about for a rejoinder. The rate of return on foreign investment could be LOWER than the R of R on domestic investment, and it would still INCREASE the number of workers available to American retirees. Don’t blame me that you asked a stupid question.

Think back to Crusoe and Friday; suppose Crusoe spends his days building a second boat and fishing pole. It’s useless on that island (assuming Crusoe doesn’t want to fish) as Friday can’t use both boats at the same time. But if Crusoe rows it over to East Islandia and contracts with Saturday he’s got another hand feeding him. Even if Saturday catches fewer or smaller fish (i.e. the R of R is lower), Crusoe has solved the “demographics problem” and has more to eat.

[snip]

” Hahahaha. Privatising Social Security will increase the capital stock of the United States of America? How? Will it cause trucks and lathes to magically wash up on the beaches? Will the French send machine tools as a birthday gift in celebration?”

I see you have a keen grasp of the world of commerce. Offer them money, and they will produce.

“If you send an email to Arnold, he might delete your post for you.”

Oh, I wouldn’t think of spoiling my fun.

Jim, there are still a number of fallacies of composition in your argument:

>>Note that with a funded system — even one like FDR’s original Social Security, funded by investments only in gov’t bonds — the “demographic” problem you are talking about never arises, no matter what happens to the worker/retiree ratio, because each worker’s benefits are funded in advance. The worker/retiree ratio is a non-issue.

It is still an issue. In the simple model you look at here, the young end up getting a high tax burden because the government has to pay the interest on the government bonds in the fund. Funding arrangements don’t change the fundamental fact that if some people are going to consume without producing, others must produce more than they consume.

For an individual, it’s a sensible simplifying assumption to just regard a treasury bond as a black box that produces money in ten years time in exchange for money now. When you’re looking at the point of view of the whole economy, you can’t make this assumption.

>>So you are saying that I haven’t been able to get the international capital markets’ rate of return in my IRA for the last 20 years because the US has been running trade deficits all that time?

No, I’m saying that *the* *entire* *US* *economy* can’t be a net investor overseas (rather than a net borrower from overseas) without also running a current account surplus, and I’m getting quite cross that you keep injecting these silly remarks about the investments of a single person.

Sweden is much smaller than the USA.

Patrick: Your example does not illustrate your problem, although it does demonstrate (again) that you’re determined to be confused about capital.

>>It’s useless on that island (assuming Crusoe doesn’t want to fish) as Friday can’t use both boats at the same time. But if Crusoe rows it over to East Islandia and contracts with Saturday he’s got another hand feeding him. Even if Saturday catches fewer or smaller fish (i.e. the R of R is lower)

>>and on the other side I have Milton Friedman, Martin Feldstein, and Tom Sargent saying I’m right. What to do? What to do?

As I’ve told you before, take a bit more tobacco with it.

If the marginal rate of return on capital is higher outside the USA than inside, why is the US private sector not a massive net exporter of capital?

>>Anyway, what does d squared have to say to Tom Sargent

I’d say “Tom, there’s this odd bloke on the internet who’s taking your work in vain to support some pretty weird statements about social security privatisation. I think that the problem is that he’s forgotten that total saving equals private saving plus government saving, but have a look”.

Since some are having trouble with their tenses, I’ll illustrate with another example. At present the worker to retiree ratio on the desert island is 1:1 (Friday to Crusoe).

In the future, Friday can die before Crusoe, reducing the ratio to 0:1. Leaving Crusoe with a demographic problem. One that he can solve by taking the boat and fishing pole over to Saturday’s island, and restoring the ratio to 1:1.

That Crusoe doesn’t engage in “a massive net export” of capital today, doesn’t mean he can’t if circumstances change. Which is d squared’s bogeyman.

Regarding all the arguments along the lines that private accounts in SS “must reduce the rate of return on capital”, or will merely shift the problem from return on “‘taxes’ into a problem called ‘dividends and coupon payments’, with young people still end up getting the raw end of the deal”, it occurred to me that looking at some actual, realistic numbers might give some perspective. Being that they’ve been totally absent so far.

First, let’s imagine that 2% private savings accounts are created in SS, as per the Swedish example, the Moynihan and Feldstein proposals, etc.

If the 2% savings are mandatory and there is zero portfolio shifting (i.e., people saving less elsewhere due to the increase in savings here) this implies an increase in private savings of about $115 billion a year. (SS collects about $700 billion in taxes annually at a 12.4% flat rate, 2/12.4= .161 x $700b ~ $115b)

How much is that? Well, it would increase the personal savings rate from 3.5% to 5%, still well below the historic norm and a rate many economists would think still too low. It would offset just a *small fraction* of the decline in national savings that’s occurred during the last year alone due the swing in the government’s fiscal position. It compares to total net securitized wealth in the US of about $20 trillion and in the world of about $60 trillion, being about 0.0056 and 0.0019 of them respectively. And this full annual increase would occur for only a limited number of years, until people started cashing in their investments.

*This* is supposed to drive down the rate of return on capital in US and world capital markets, and make it impossible for the young to get positive returns from investments?? I am skeptical! 😉

OK, so next let’s go whole hog and do an Extreme Friedman, repealing SS fully and replacing it entirely with private savings. Let’s be conservative and require everyone to save 10%, and while there surely will be portfolio shifting here, let’s say 66% of these savings are real additions to savings.

Now savings increase by 3.3 times as much, $345 billion a year. The personal savings rate goes to 8%, which is about the historic norm. The increase still does *not* come close to covering the decline in national savings in just the past year due to the deficit. The annual increase is about 1.68% of securitized wealth in the US and about 0.56% of world securitized wealth, again for a limited number of years.

OK, *this* is supposed to drive returns on US and global investment markets downward significantly?? I remain skeptical. Quite.

Social Security provides a very bad, low return to the young for one reason and one reason only: the tax-and-benefit *formulas* legislated and repeatedly re-legislated by Congress over time now make it mathematically impossible for it to do anything else.

But there is nothing in economics to prevent the young of the world from expecting to receive healthy positive returns on their real economic investments over their entire lives, whether those investments be in privatized SS accounts or elsewhere.

Jim,

“…How much is that? Well, it would increase the personal savings rate from 3.5% to 5%, still well below the historic norm and a rate many economists would think still too low….”

I need some help in believing that the personal saving rate has any inherent necessary relevence in and of itself for the economy other than assuring that the individual doing the saving is likelier to be able to eat better in the future by sacrificing in the present.

Assume that the government has outlawed the import, export and mining of gold. Nor can gold jewelry be melted down.

Is there any way that an increase in the personal savings rate implemented exclusively by the buying and holding of gold can possibly benefit the economy as a whole?

Regards, Don

Don,

What you are saying is that if savings are stuffed into mattresses they do the economy no good. True. But financial markets exist to make savings available for real investment, so the economy benefits.

If I use my savings to buy a bond, the issuing company then uses the money to buy equipment, etc. They will not do this unless the retrun they expect exceeds the interest they pay me on the bond. The economy comes out ahead.

Bernard and Jim,

My question is why buying shares of IBM or Intel or shares in a SP500 index fund is any better for the economy than buying gold. All of these investments share the possibility of returning a capital gain for the individual investor, but this does not necessarily mean that the overall economy is any better off, as it may just mean that someone else has suffered a capital loss.

With the FED effectively expanding credit at will, is it really logical to expect that new savings will improve the economy, rather than further damage it?

My conjecture is that the economy can only be improved by investments that actually generate business profits and/or reduce the final prices of products by using less of labor and other factor inputs. No segment of business or industry can remain profitable if it is subjected to an increase of investment, and competition, without limit.

Regards, Don

Don,

Or, in a rather shorter response, I could say that the statement …

“No segment of business or industry can remain profitable if it is subjected to an increase of investment, and competition, without limit.”

… does not even imply that an increase in the personal savings rate from 3.5% to 5% (or even 8%) would not be beneficial as per the textbooks, since it is a long, long, way from being “without limit”.

Regards

“The overall economic benefits of a secondary market generally come from the very fact of its existence, not its individual transactions. ”

It would have a hard time existing without the individual transactions.

And while growth in the numbers of individual transactions within them have brought us many good things, significant declines in the numbers of such transactions generally are associated with “not good” things.

Regards

Jim,

“…And while growth in the numbers of individual transactions within them have brought us many good things, significant declines in the numbers of such transactions generally are associated with “not good” things….”

The volume of transactions in IBM or any other stock DOES result in profits for financial services companies in the form of commissions, for example, but I have my doubts as to whether financial services should be considered productive or parasitic.

Regards, Don

Bernard,

“…As I tried to point out earlier, the investment IS self-limiting in the sense that investments do not just appear. They are the result of presumably rational judgments by someone that they will prove profitable. Not all do, of course, but the point is that this is not simply an uncontrolled process….”

Investments are self-limiting largely because at some point it becomes undeniable that expected profits will NOT, in fact, occur. This, in turn will restrict the availability of investment funds as a business will sooner or later cease operations and eliminate the returns to labor and other production factors that could have been invested if there had been a profitable operating business.

Rational judgements aren’t enough as they must be made in advance simultaneously with the judgements of other potential competitors.

Business profits are seldom truly controllable, and are a highly sensitive residual result of many effects.

As investment funds increase in quantity, there are several effects that reduce or eliminate returns.

First, in a finite economy, profits are limited, and often transitory. More investment dollars must share those limited profits, with lower rates of return.

Business investments for productivity enhancement are seldom restricted to a single competitor. Rather than increasing profits, investments in productivity enhancements are often less sources of increased profits than they are a cost of business survival.

Major business problems are seldom the result of minor miscalculations or moderate variations in the cost of capital. Instead major business problems are often the result of three competitors fighting for market share in a market that is only large enough for two. The resulting price collapse quickly turns normal profit levels into enormous losses.

New potential competitors are seldom discouraged by cost of capital considerations, but rather by the availability of capital for their specific use. The cost of capital is primarily an effect, not a cause, of the availability of capital.

Regards, Don

Jim,

“…But even if one wants to make this dubious “dangerous excess personal savings” argument, I don’t really see its practical relevance to a SS proposal that even at its most extreme still wouldn’t get the savings rate up to even its 50-year post WWII average….”

These, of course, are your words, not mine. I am content to merely claim that that expecting to earn the same rate of return as has been experienced over the last 75 years in the face of substantial (by any standard) new mandated savings and investment and a substantial reduction in the rate of population growth is likely to be wishful thinking.

Thanks, Don

Patrick: You have ignored my substantial point in order to make a fairly silly debating point (your sentence about “marginal” only meaning “the next dollar” is embarrassing). Also you ought to remember that I don’t believe that there *is* a demographic problem; only that privatisation doesn’t change demographics.

You haven’t understood my response to your comment on Sargent if you think I was conceding anything; I regarded your misuse of
Sargent’s point (which independently, I disagree with anyway) as “not even wrong”. Total saving equals private saving plus government saving. The implict debt of the government to the SS system has been invested in real capital assets (interstate highways and the like), and changing the balance between private and governmental saving would have very little effect on the capital stock. Unless, of course, you believe that government-owned capital assets aren’t productive, which I suppose is your right.

Your desert island example actually works in its own terms, but to make it analogous to the current USA, you would have to have Crusoe spending most of period 1 building up massive net external liabilities to the inhabitants of Saturday Island. Which makes the whole thing less credible.

Jim: Since you have now decided, on the fourth time of asking, to pretend that the fallacy of composition isn’t a fallacy, and that everyone can buy claims on the future with nobody selling them, I don’t really see much point continuing.

d squared takes time from Appealing to his Own Authority, to finally concede the obvious:

” Your desert island example actually works in its own terms”

Which is to say THEY answer your confused objections about how capital can’t get its return with there being no GDP growth, and the even sillier one about foreign investment not bringing more hands to the matter of feeding more mouths.

Though you throw in an irrelevant smoke screen to save face: ” you would have to have Crusoe spending most of period 1 building up massive net external liabilities to the inhabitants of Saturday Island”.

You would have to do no such thing to change the mix between domestic and foreign investment. Did Nike build up “massive net external liabilities” before opening all those factories in Asia?

But since you now profess no belief in a demographic problem, which is odd in that not too long ago you wrote:

“Given that private savings accounts will neither create more young people nor exterminate old people, I’m assuming that the underlying demographic problem will be unchanged. So how can the economic problem be solved?”

and also:

“Jim: The ‘poor return’ on Social Security for young people is a result of their reduced numbers compared to the number of expected future claimants….”

I think we have something like total and unconditional surrender. A least we do after we dispose of this disingenuous claim:

” The implict debt of the government to the SS system has been invested in real capital assets (interstate highways and the like)….”

Some of it may have been, but a lot more has been SPENT on consumption. And you know it.

Sorry, I don’t see exactly what the desert island example shows other than that, if net savings are zero there is no GDP growth. This is perfectly consistent with d^2’s equation.

In the initial case there is no saving at all, hence no GDP growth.

Now introduce depreciation and have Friday spend time bringing the boat back to its original condition. There is still no net savings.

You’ve lost fishing time, but Friday still gets his wage, so return to capital drops as does GDP.

The only way to increase GDP is to have Friday do more work on the boat than is needed to overcome depreciation. Then returns will rise, and so will GDP.

So what?

If a ponzi scheme is no better than an investment, or vice versa, then why should ponzi schemes be illegal?

SS has great scale, and is mandatory. But it is a ponzi scheme nonetheless. Why should it work where all others have failed?

Bernard, the desert island example destroys this claim of d squared’s

” If the capital stock was returning its “full, real, before tax [but presumably after depreciation -d^2] return”, why would economic growth be zero?”

d squared is conflating two different things, 1. RoR on capital, and 2. economic growth. As are you.

” Now introduce depreciation and have Friday spend time bringing the boat back to its original condition. There is still no net savings.

” You’ve lost fishing time, but Friday still gets his wage, so return to capital drops as does GDP.”

Not true. Fishing time does not drop, only Friday’s leisure (and as I said that’s not in GDP). GDP is still one fish per day, and RoR is one half fish. BTW, you can have GDP growth without any savings and investment at all.

Bottom line is that SS is a “tax” and that privitization of SS is a tax cut and I love tax cuts.

Jim,

“…(You aren’t claiming the rate of return on capital in global investment markets is going to go negative are you? If so, I’d think we should be worrying about some things other than Social Security!)…”

I wasn’t planning on claiming that, but it would seem to me that the majority of US dollars exported are consumption dollars, and the return flow into the US has to be investment dollars. Assuming positive returns, the net profit flow may well be out of the US.

It is rather shocking to realize that current nominal money market yields are about 0.5% at best, and real returns are certainly negative when believeable inflation figures are used. Stock market valuations are generally still so high that earnings yields overall are often in the 3% range when there are earnings, and we know that both inflation and interest rates’ next moves will be higher. Looking forward, real total returns on money market funds, bonds and stocks are all likely to be negative for some time even without private SS accounts and independent of any 401K crowding effects.

Regards, Don

Don will like this:

What This Country Needs Is Higher Savings.
I am sure you have heard more than one economist or politician bemoan low savings rates in the U.S. as if higher savings rates would somehow help the economy. I guess these guys think that increased savings means more capital for business investment. How silly is that! In aggregate, one person’s savings is another person’s income. If I decide to spend less and save more, then someone else won’t have that income. The economy slows as a result and there is less need for capital investment. And banks can lend money unconstrained by the size of their checkbooks, so if businesses want to borrow to increase capital expenditures, there doesn’t have to be a higher level of savings to accomplish that end. However, the most important aspect of savings is deficit spending by the government. When the government runs a budget deficit it creates private sector savings. Or, when the government runs a surplus (another term for government saving) then the non-government or private sector runs a deficit, i.e. less saving. So if the politicians want greater savings, they will have to run a bigger deficit.

http://www.nationalreview.com/nrof_nugent/nugent071503.asp

The quote Eric cites cements NRO’s reputation as a purveyor of economic idiocy. It’s so bad it’s not worth taking apart.

>>I say SS participants might have insured money market investments in private accounts, you invoke the “fallacy of composition” because the entire economy can’t be financed with insured money market funds. 😉

“Who would provide the insurance? Insurance transfers risk from one party to another. If the party which assumes the risk is the state, then all you’ve done is shift around the counters.”
~~~~

Who provides the insurance now? Does the “fallacy of composition” prevent such insurance from existing? Has the “fallacy of composition” prevented such accounts from growing to their existing size? Will it prevent them from growing a little more?

Will the “fallacy of compostion” really prevent people with private SS accounts from having insured money market accounts as one of many investment options available to them, as owners of IRA, Keoghs, 401(k)s do? And as everyone who has a taxable savings account at Citibank does?

Why hasn’t it stopped everyone else from having such accounts already? Because … they are only a SMALL part of a VERY BIG marketplace. And Social Security is only a modest part of a VERY BIG U.S. economy, and a teeny part of the world economy.

So give the “fallacy of composition” arguments re SS a break. They deserve the rest.

And you still haven’t answered the question I asked you three times.

“I wasn’t aware money market funds were insured”

Some are. Not all. That’s just one investment option, for ones that invest in commercial paper. It’s not like they’re the whole economy or anything like that. 😉

Ah, Nugent, one of Warren Mosler’s good buddies: try http://www.mosler.org for more entertainment from both!

“I guess these guys think that increased savings means more capital for business investment. How silly is that! In aggregate, one person’s savings is another person’s income”

Freudian slip! He means: one person’s spending is another person’s income, but as it happens….

“If I decide to spend less and save more, then someone else won’t have that income. The economy slows as a result and there is less need for capital investment.”

Unless the savings are lent out by the bank to, say, finance some capital investment, and so become the *income* of somebody in a capital asset-providing industry while increasing investment in capital goods too. See, he was right!

“And banks can lend money unconstrained by the size of their checkbooks…”

For the three days until the Fed requires them to meet their reserve requirement. 😉

“However, the most important aspect of savings is deficit spending by the government. When the government runs a budget deficit it creates private sector savings. Or, when the government runs a surplus (another term for government saving) then the non-government or private sector runs a deficit, i.e. less saving. So if the politicians want greater savings, they will have to run a bigger deficit.”

For fun, find the coyote pack sized howler in this “most important” part! Obviously the statement is flat wrong, as it is refuted by the national accounts of so many nations year in and year out. But there’s no fun in checking our own keen insights that make us smarter than all the textbook writers against mere facts.

Mosler explains it this way:

“the Washington elite have forgotten (or never knew?) the fundamental economics 101 accounting identity: a government surplus is NECESSARILY equal to the (same period) private sector deficit (including domestic business and individuals, and any foreigners dealing in $US). Therefore, the U.S. surplus of $250 billion reduces private sector savings EXACTLY by the same amount.”
http://www.mosler.org/docs/docs/ten_trillion_tax_cut.htm

See, there’s only a public and private sector — so if one runs a surplus it must be at the expense of the other’s deficit. So public savings can only be increased by a deficit in private savings that reduces them by like amount. QED.

As a friend of Mosler explained it to me once….
E.g: We start with the private sector owning $2X of cash and X$ of gov’t bonds, total private savings = $3x while gov’t debt = $X. But if we redeem the gov’t debt by running a surplus we must tax $X from holders of cash and transfer it to the bondholders while the bonds “go away”. This leaves us with still $2X of cash in private savings but no bonds. So total private savings have dropped from $3X to $2X while the govt’s saving of $X has eliminated the debt. So private and public savings are inverse — an “identity” even.

And this “101 accounting identity” is so simple that the Federal Reserve and Nobel prize economists don’t know about it — because they aren’t as smart as our geniuses Mosler and Nugent at figuring out simple identities!

Ah, but what have our geniuses overlooked???

A: INCOME. They’ve overlooked a mere $8.5 trillion in annual national income, which is what the feds in fact tax a portion of when paying down the debt to run a surplus, while the private sector saves another portion of it to increase total private savings *at the same time*. Taxes collected to pay down the national debt come out of income taxes collected on *income*, not on pre-existing private savings.

Duh.

So the reality is, if the private savings rate is 10% of disposable income, and the gov’t collects $X of that income to pay down $X of bonds, savings grow by $0.1X less than they would have without the tax — but as long as savings rate is positive they *still* grow. And since $0.1X > $X private savings certainly are not reduced by “EXACTLY” $X as an “identity”, and total national savings increase by $0.9X on net.

Why does the National Review have to damage the credibility of conservatives everywhere by publishing such dimwittedness? Couldn’t they pay a few bucks each issue to a real economist of conservative bent for a little fact checking, howler prevention and, if necessary, coyote shooting?

And I wouldn’t be in a hurry to invest my money through PlanMember Financial Corporation.

After all, I posted the link because I though that the argument parralleled that of Don. Is Don a conservative?

“Every dollar spent, taxed, or created by government damages the economy, even if the expenditures happen to be necessary for non-economic reasons. All economic activities not driven by a self-interested, broadly defined, profit and loss motivation, whether monetary or subjective or both, distort the economy.”

Alas, a viable nation must be willing to sometimes “distort the economy.” We regretfully have to make this sacrifice if a greater need arises. I don’t think we really disagree in principle, but my guess is that I’m more favorably inclined toward the public sector than you are.

” Doesn’t matter. Crusoe is hiring him, presumably, in a competitive labor market, so his expected income has to be at a certain level. If he’s at all risk-averse, and is put on commission, it has to go higher.”

This is becoming silly. If half a fish a day is better than the nuts and berries Friday can gather for himself, then that is all his pay has to be. And, since he TOOK THE FISHING JOB, he has revealed his preference already.

” Is Crusoe going to insist he work full-time fishing, even if fishing prospects are poor? Then up goes the commission. If not, then the boat will be idle part of the time. In either case, down goes return.”

All Friday has to do is catch a fish a day. Whether he rows two hours to find a school of fish or four hours (for which he won’t be paid extra either). He’s getting paid for his results, not for his time. You’ve never had a “commission” job, have you.

>>Who provides the insurance now?

In the final analysis, other parts of the personal sector who are willing to provide the capital backing the insurance. That’s why the personal sector *as a whole* can’t be insured against the risks of the economy *as a whole*. And stop pretending that you raised this investment class in a context where it was meant to be “a small part of the economy”; I quite clearly remember that exchange and you were presenting it as an asset that could give *everybody* a positive return *for certain*.

If I haven’t responded to a question of yours, it’s probably because I thought you were pulling some sort of trick like that one.

Jim, not to be Clintonian, but it depends on your definition of credible perspective. Who gets to decide what is credible?

It is a serious question. For example, if you read Scientific American, you know that they believe that the only credible perspective is that global warming is real. They will have you believe that anyone arguing against global warming, for any reason whatsoever, is a crank or worse.

Of course, this is not the case. Global warming has not been proved beyond a shadow of a doubt. There are plenty of credible, contrary perspectives that need to be dealt with honestly and fairly. That is something that SA does not do, for political reasons.

If science can be politically manipulated, anything can be.

I like National Review because it isn’t afraid to publish a contrary perspective on something as even well agreed upon as evolution. They know that their readers AREN’T economically, scientifically, mathematically or whatever illiterate. We conservatives can process any perspective, we don’t need editorial training wheels, like the liberals do.

Curioser and curioser:

” the implicit claim that everyone born between 1972 and 1982 could carry out their retirement saving on a risk-free basis via purely privately provided insurance. Which just isn’t true for any credible assumptions about the financial system. In other words, why doesn’t everybody just put their money in the stock market and hedge their returns by buying put options? Because *everyone* can’t buy put options.”

Why not?

Eric,

I don’t claim that Nugent’s article is typical of “conservative” economic thinking. It’s just total idiocy.

But what it does suggest is that the people at NRO, especially Kudlow, who I think is their economics editor, are unable to identify economic idiocy when it bites them on the nose.

And it raises again the question DeLong has asked before and JIm now repeats: why can’t they find someone who knows something to handle their economics section?

“Jim, not to be Clintonian, but it depends on your definition of credible perspective. Who gets to decide what is credible? It is a serious question”

Well, who decides if alchemy is credible? Flat-earthism? Astrology? Is somebody undemocratically repressing these credible perspectives on how the world works? Is that why they can’t get into Scientific American *or* Nature *or* Science *or* Popular Mechanics *or* the New Ask Mr. Wizard …?

No, as I said, it’s just a matter of basic cultural literacy about reality — which, relative to the sciences, is sorely lacking regarding economics.

“For example, if you read Scientific American, you know that they believe that the only credible perspective is that global warming is real.”

Though there is no shortage of other respectable forums where reputable scientists present differing ideas. But you miss the point. This isn’t at all like global warming, about which the scientifically literate may differ — it is like alchemy and flat-earthism. Nugent, Mosler & Co. are economic cranks.

You don’t even have to know any economics to recognize the crankery here. The warning signs of “crankhood” are well-publicized on the web (such as at http://www.crank.net) because it is so full of them.

Here’s a basic one: The crank says he knows more than all the experts, *not* because he actually knows more than them, which would be very difficult, but because they are so *stupid* that they don’t see what he does. He’s smarter than all of them!! If he says so himself.

Now let’s go back to the explanation of Nugent’s theory of savings as explained by his co-author and collaborator…

“the Washington elite have forgotten (or never knew?) the fundamental economics 101 accounting identity: a government surplus is NECESSARILY equal to the (same period) private sector deficit (including domestic business and individuals, and any foreigners dealing in $US)…”

See? Washington’s elite at the Federal Reserve don’t know a basic 101-accounting identity — they are stupid! — but we know it, so we are smarter than the elite!! (Even though in reality there is no such identity, which is why the elite don’t know it, of course.)

Here’s another basic one: Cranks ignore facts anyone could look up in the almanac. So, continuing:

“…. Therefore, the U.S. surplus of $250 billion reduces private sector savings EXACTLY by the same amount.”

Which is *factually wrong*, you can look it up. But they don’t care about facts.

The editors of the NR wouldn’t publish contributors seriously promoting alchemy or flat-earthism or claiming as a *fact* that water runs uphill, as “credible perspectives”, because they are scientifically literate enough to know that doing so would damage the NRs basic credibility. It’s too bad they aren’t literate enough about economics to realize that publishing economic crankery does the same thing.

Of course, on a larger scale it’s too bad that the general population isn’t literate enough about economics even to realize that price controls don’t cure shortages. (See 60 years of rent controls in NYC). That’s the *real* problem.

>>Are any alternate schools of thought on economics credible? For example, how can a school get away with teaching Marxism (the ultimate crank theory)? In fact, not even get away with it, but BOAST of it on their website. Conceivably, they are an accredited department.

However cranky you believe Marxism to be, it adds up mathematically (mainly because much of it is surprisingly orthodox Ricardianism) and is thus far less cranky than the Mosler and Nugent paper.

In fairness to Mosler, he has done some useful work on the Real Bills doctrine and his paper in the Journal of Post-Keynesian Economics was really quite good (after severe editing from Paul Davidson) but he doesn’t express himself very well, lending himself to misinterpretations, and his choice of co-authors is often unfortunate.

“Also, what constitutes economic literacy?”

Well, you can tell us in a moment.

“I’m sure the NR folks have as much economics training as I have had (an undergraduate minor (with a 4.0 GPA in economics!!!)”

If you have that much, I really doubt that they do.

And if you had a 4.0 in econ then you know what an “identity” is. Not a “theory”, which people may differ about, but an *identity* — it’s hard to differ about an identity. I mean, like the textbook identity for savings is Savings = Income – Taxes – Consumption.

How likely is it that the “elite” in the Federal Reserve and Treasury and such don’t know an *identity* for savings that Mosler and Nugent know? … and that YOU know!!

Yes, you. For they tell us their’s is an “economics 101 accounting identity”, and with your 4.0 in econ you certainly took 101 and must have aced the test on those! So here’s your pop refresher literacy quiz…

Is the 101 accounting identity for private savings that *you* remember from school:

(a) Savings = Income – Taxes – Consumption, or

(b) Savings is the inverse of the government fiscal surplus, “a government surplus is NECESSARILY equal to the (same period) private sector deficit”, or

(c) “What is Truth?”, as per Pontius Pilate and the deconstructionists.

If you remember (a) from school then Nugent’s claim in NR that we need to increase the gov’t deficit to increase private savings should have caught your attention like a thumb in your eye — and you’ve also caught Mosler, um, fibbing about the 101 identity that is taught in school, and your crank detector should be buzzing.

If you remember (b) I’ll be surprised and ask for a reference to the textbook you used.

If (c), well, I’ll just go on my way quietly.

>>Savings = Income – Taxes – Consumption

“We conservatives can process any perspective, we don’t need editorial training wheels, like the liberals do.”

Eric, Eric, Eric,

You’re doing it again. Kill that reflex.

And do you really think highly of a magazine that considers creationism a legitimate point of view, rather than a crank theory?

And you claim a low tolerance for BS!

Eric,

Let me make two points:

1. Your assertion that liberals need “editorial training wheels” is plain silly. It’s just a random insult that has no basis in anything other than your own prejudices, and your notion that those who disagree with you are fools.

2. When NR publishes differing ideas, no matter how foolish, you praise them for presenting different perspectives. But you avoided history, etc., in college (not such a good idea, Ithink, but never mind) because you have a “low tolerance for BS.”) In other words, the silly ideas you imagine you might have heard in an anthropology class are BS to be avoided. The silly ideas in NR are food for thought. And since you don’t know any anthropology , history, etc, how exactly do you know which ideas are BS?

>>Bad news for the theory of evolution by natural selection, which has also been put to bad use …

Just wondering, does anyone OTHER than D^2 think that Marxism is a vallid ECONOMIC point of view? Bernard? Jim? Don? I’m just interested in where you all are comming from.

Bernard and Jim, I just thought of something else.

While I avoid postmodernism like the plauge, it is in vogue among the academic subjects that I don’t like. But doesn’t postmodernism teach that what is “credible” is a function of political power, not what is truthful? The politically powerful decide what is credible.

So creationism is not credible because the power elite does not make it so, not because it is wrong, or so the postmodernist would have you think.

>>You’ve clearly swallowed the brainless claims of conservatism hook line and sinker. The ravings about media, “training wheels,” blackballed conservatives, IQ levels in NY, etc., are sad symptoms

——-quote___________
“Because *everyone* can’t buy put options.

Why not?”

Because somebody has to sell the put options.

Unless you want Friday to do it, along with everything else you’ve burdened him with. Logic doen’t work? Just ignore it and pound your chest about “working on commission.”
——-endquote——-

Oh c’mon Bernard, you snipped the part of d squared’s quote that clearly indicates this was directed at “everybody” in their SS accounts. Even d squared sorta, kinda got the point (he’s been told enough times that SS is only a subset of the American economy as well as the world economy), but I’m wondering if he’s going to be laughing when I point out that Americans investing in privatized SS accounts can very easily buy options from American investors OUTSIDE SS, as well as from foreigners.

Eric wrote:

>>D^2, the death toll of Communism just during the 20th Century has been estimated to be around 100 million (Black Book of Communism).

Have you read the Black Book of Communism, Eric? I have. It estimates the death toll between 60 and 100 million. That’s “around” 80 million, not 100.

Patrick: there are no natural buyers of the risk faced by Social Security investors. Therefore, you’re assuming that the speculative capital available to the USA to take on this risk could be vastly expanded. It’s just not credible.

>>Have you read the Black Book of Communism, Eric? I have. It estimates the death toll between 60 and 100 million. That’s “around” 80 million, not 100.