The real problem

By Megan McArdle

For those of you who haven't noticed, my colleague Clive Crook has joined us in the blogging world. I've been lucky enough to have Clive as a colleague in both places I've worked as a journalist. For those who haven't been fortunate enough to meet him face to face, the blog is a decent proxy for the real thing.

In this post on Paul Krugman and Social Security, Clive, as usual, targets with laser accuracy the real problem with the Social Security system: not that it is bankrupt, but that it encourages people to make extremely bad decisions about providing for their future.

It starts with childbearing: social security systems seem to exert downward pressure on birthrates, in effect undermining their own actuarial base. Social security socializes the benefits of childbearing in providing for retirement, but no one has yet figured out how to socialize the main cost, which is turning your life choices over to a screaming pre-verbal dictator. People are thus tempted to free ride on the childbearing of others, and the more generous benefits are, the more they seem to free ride. This is one reason that Social Security, which used to have more than 30 workers for each retiree, now has only three, headed towards two.

Social Security also encourages people to leave the workforce earlier than they otherwise would. People are healthier than ever at 65, but while in 1950, almost half of all men over the age of 65 worked, that number is now less than 20%. This appears to be highly correlated with the spread of defined benefit pensions such as social security, which offer no advantage to delaying retirement. Indeed, Social Security perversely penalizes anyone who takes early benefit but continues to work, docking a third of their earnings.

Finally, Social Security discourages private savings. This is terrible for two reasons. If future fiscal problems force the government to reduce benefits, the people who didn't save enough because they relied on those promises will be made much worse off than they would otherwise have been.

The other problem is that Social Security is not a productive investment. Privately saved money is mostly lent to corporations that mostly use the money to do things that make the economy more productive, such as R&D and capital equipment upgrades. Social security "contributions" are lent to the government, where they are mostly spent on things that could not be remotely described as improving our economy's productive capacity, such as farm subsidies.

This transaction would actually be neutral (except for deadweight loss on the "contributions") if Congress used the Social Security money to reduce other debt; in effect, they would be doing our national saving for us. But in practice, though it is difficult to tease out cause and effect, the best evidence is that Congress simply spends the extra money as if it were tax revenue. Social security thus reduces national savings.

The demographic transition we are currently undergoing to an older society means that we need policies to increase the workforce and productivity as much as possible. What we have, in Social Security, is a program which actively works against these aims.

This article available online at:

http://www.theatlantic.com/business/archive/2007/11/the-real-problem/2272/