Rates of Return and Reischauer, "Some Reactions"

[National Dialogue Moderator <moderator>]

	Rates of Return and Reischauer, "Some Reactions"

One of Bob Reischauer's early statements, "Some Reactions," included
two comments about market rates of return that were factually
correct but misleading or at least subject to misinterpretation.

One comment pertained to gross returns on various investment
portfolios.  Roughly speaking, the gross returns on a portfolio
that is centrally invested by the government is the same as the
gross returns earned by a worker who invests his or her private
account in the same way.  This, of course, is true, ignoring the
possible effects of scale on asset prices.  A dollar invested in
company or stock x, y, or z has the same investment earnings whether
that dollar is invested by citizen a, b, or c or by the trust funds.

But who, for a minute, believes that the government would invest
several hundred billion dollars (even a trillion dollars, under
one leading proposal) the same way as you or I or all of us combined
would invest our funds?  Who believes that you or I or all of us
combined would have the same impact as the government on the behavior
of the companies we invest in?

It would be wrong to conclude from Bob Reischauer's comment that
it makes no difference to gross returns whether the government does
the investing or we do.  We can expect it to make a big difference.
It also would be wrong to then leap to the conclusion that, assuming
administrative fees would be lower for a "collective portfolio"
than for individual accounts, net returns (net of administrative
fees) for a system with centralized investment would be higher.

As an aside, who believes that the cost of administering a "collective
portfolio"--where no services are provided to workers and few costs
are evaluated at market prices--are relevant in determining the
net benefits of a system of personal accounts--where workers purchase
investment services from the company of their choice and do so in
the open market at going prices?

Further, his discussion might be taken to suggest, erroneously,
that the way social security invests and the rate of return earned
by the trust funds somehow affects the implicit rate of return you
earn on your social security taxes.  In fact, the rate of return
on social security's reserves--with or without centralized
investment--has virtually no impact on your rate of return under
the system.  That's because social security is basically pay-as-you-go
financed, with reserves equal to a small fraction of outstanding
liabilities.  The rate of return on social security taxes that can
be earned by younger workers (actually the average rate of return
that can be earned by a cohort of younger workers) is basically
determined by the growth rate of taxable wages in the economy.
Only if social security were fully funded, with assets equal to
accrued liabilities, would its investment return matter directly
to your (or your cohort's) rate of return.

This raises the second comment that can be misinterpreted, which
pertains to the rate of return you can expect under a "new and
improved" system and how it should be properly measured as the
"weighted average" of returns.  In fact, the rate of return you
can expect to earn on your private account is determined by your
investment decisions and investment earnings, net of expenses; it's
not a weighted anything.  (Similarly, the rate of return on trust
fund reserves is not a weighted anything.)  While it is true that
there is an unfunded liability that must be met and that this cannot
be ignored in deciding which reform you prefer, this has no bearing
on the investment return on your personal account.

As a general matter, the real (net of inflation) return on a worker's
implicit tax-"contributions" to our quasi pay-as-you-go system,
with or without centralized investment, is projected to be 1-2%
annually.  The real return to a fully-funded system or a fully-funded
system of small personal accounts (alongside a low-yielding, ongoing
public system) is determined by the real return to private capital,
which is along the lines of 8-9%, pretax.
 The real return on a mixed portfolio of stocks and bonds has
 averaged 5% or so over long sweeps of history, enough to cover
any reasonable administrative fees and still leave substantial room
for wealth creation.


Carolyn Weaver