My second shot

[National Dialogue Moderator <moderator>]

MY SECOND SHOT--by Carolyn L. Weaver

Wow--great discussion!  Given the level of interest and knowledge already 
conveyed, I can see that Bob Reischauer and I are going to have our hands 
full trying to keep the discussion focussed on investing in the stock market. 
 (By the way, that was a great comment, Michael Jones, about how our topic 
should be titled "investing in private markets," not "investing in stocks."  
With private accounts, individuals would--unless prohibited by 
government--naturally invest in stocks and bonds, with the mix varying over 
their lifetimes as they get older and their incomes and other resources, as 
well as their needs, change.)

Let me respond to a couple of points made by Bob in his "second shot."

First of all, on the suggestion that personal accounts would place "an 
unacceptable risk on some individuals who are ill prepared to bear this 
risk," one does have to ask, "compared to what?"  We all agree that investing 
involves financial risks.  With personal accounts, individuals can adjust 
their holdings of stocks and bonds or modify the kind of stock or bond funds 
they hold so as to adjust the amount of risk they take.  With centralized 
investment, where surplus receipts are invested directly in the stock market, 
the government--not individual workers--decides how much risk to take.  This 
risk is then imposed on workers.  Low-income workers are likely to find this 
arrangement most burdensome because they have few financial resources with 
which to buffer unanticipated changes in taxes or benefits. 

Further, as noted by a couple of participants, there are financial risks with 
private investment and other kinds of risks with the status quo--chief among 
them solvency risks.  Solvency risks in a system that is politically 
determined, like social security, imply political risk.  While much is known 
about managing financial risks, how does one manage or hedge against 
political risks?  These risks can be large, as evidenced by the size of the 
benefit cuts--and the resulting "wealth" losses--for young workers as a 
result of social security financing bills passed in 1977 and 1983.  Who knows 
what the future holds for social security, as currently designed, with the 
long-term economic and demographic outlook projected to be much less 
favorable than in decades passed?

Here I must digress and respond to Gerald Leonard's use of the word 
"GUARANTEED" future income.  Social security benefits are not now and never 
have been guaranteed.  Workers and retirees have no claim to a particular 
level of benefits in the future, independent of the law in effect in the 
future.  Future benefits are not secured by real assets or by property 
rights.  Workers and retirees have promises of future benefits that may or 
may not be fulfilled. 

There is also the issue of safety nets, which was raised by Walter Hart.  The 
risk workers ultimately bear under a system of personal accounts depends not 
just on investment choices and performance but also on the size of the 
personal accounts and the nature of the remaining social security system.  In 
a number of proposals being discussed on Capitol Hill, personal accounts 
would be funded with only 2% of earnings, leaving in place a large social 
security system.  In more ambitious proposals, where personal accounts 
ultimately replace the retirement program, there is always a federal safety 
net left if place.  At a minimum, there would be the Supplemental Security 
Income program that now exists.  SSI provides a means-tested benefit for the 
elderly poor.  Proposals generally create a new safety net to supplement SSI. 
 These safety nets are designed to protect workers who retire with inadequate 
resources due to any number of reasons, including unemployment, low wages, 
and poor investment performance.

The reference to people "ill equipped" to handle risk may raise in some 
people's minds a concern that personal accounts would somehow involve today's 
social security recipients, especially those who are very old and may have 
little or no experience with investing.  They would not.  Personal accounts 
would be established only for working-aged Americans.  Ironically, it is 
centralized investment--which attempts to use the stock market as a new 
revenue source for the trust funds--that would expose older Americans to 
unknown risks.  

Hats off to Andre Dermant, Javier Jimenez, Mr. Jones, and Mr. Hart for their 
observations about risks.

Second, on the issue of administrative costs, let me try to clear up some 
confusions.  Bob Reischauer says that big private companies do not manage 
their funds cheaper than the federal government could do under a scheme of 
collective investment.  The problem with this statement is that proponents of 
centralized investment, including Bob, do not argue for letting the 
government manage the funds; they argue for letting big private companies do 
it.  Private companies could manage social security's funds at a lower cost 
than they charge for many mutual funds for any number of reasons, not least 
of which is that they would undoubtedly employ passive investment strategies. 
(Proponents of centralized investment, aware of the concern that investment 
decisions will be politicized, are quick to suggest that investments should 
be passively managed through index funds).  As observed by Mr. Jones, the 
cost of a good equity index fund is much lower than the 100 basis point 
figure cited by Bob. 

Also, if I understood him correctly, Ridgeway was referring to the cost of 
administering our current social security system, not the cost of 
administering a centrally invested fund.  Administering our current system 
means mainly deciding eligibility, paying benefits, and answering a lot of 
phone calls.  There is no investment function at all--at least not one the 
Social Security Administration is involved with.  And there is nothing 
sophisticated about "investing" in special issue government bonds--Treasury 
does this largely on automatic pilot.  In 1998, social security's 
administrative costs were $3.5 billion, which was about 1% of total benefit 
payments of $375 billion.

And Ridgeway is quite right that administrative costs for federal agencies 
are notoriously understated.  They do not provide a measure of economic costs 
or of opportunities foregone.  Measured administrative costs ignore many 
important components of costs, including even costs incurred on behalf of an 
agency by other federal agencies. 

Of course, all this talk about administrative costs obscures the more 
important issue, which is the net benefit--or rate of return net of 
costs--that workers can expect to enjoy under a system of private investment 
accounts.  This is what's meaningful when considering the alternative--a 
patched up pay-as-you-go system, possibly with projected trust-fund income 
increased by stock market investment.

Carolyn Weaver