Farmers and Parasites
"Arguing in My Spare Time, No. 3.15"
by Arnold Kling

June 5, 2000

Many people, including economists, get hung up over the issue of how social security is financed. Looking at the financial aspects of the program creates considerable confusion, which is evident in the opinion pieces that have been written about Republican Presidential candidate Bush's plan for partial privatization.

Consider an economy with two types of people and only one good, food. Farmers both grow and eat food. Parasites simply eat food. Food cannot be stored. It must be consumed right after it has been produced. Notwithstanding the pejorative name, everyone agrees that feeding the parasites is the just and humane thing to do.

Now, suppose that we can forecast that in twenty years the ratio of parasites to farmers is going to rise sharply. What can we do?

There really are only three ways this situation can be resolved. One or more of the following must occur.

1. Productivity can rise, so that farmers grow enough for everyone.

2. We can cut back on the food given to parasites.

3. There will be less food for the farmers.

To me, the safest and fairest option is to cut back on what we promise the future parasites. In terms of social security, this means reducing future benefits. Of the various ways to do this, the one that I favor is raising the retirement age.

We could raise the retirement age for people currently aged 50 and younger. Each year, we would raise the retirement age further, along with an index of longevity, for people aged 50 and younger at the time of the adjustment.

For example, we might initially raise the retirement age to 72. At that point, people aged 50 would be locked into that retirement age. People aged 49 would have their retirement age go up one year later, based on how much longevity is estimated to have increased in that year. Younger people would face more annual longevity-based increases in the retirement age. However, once you reach 50, your retirement age would be locked in and could not be changed.

If we cannot raise the retirement age, then we can hope for a New Economy bailout. As Bill Sterling pointed out to me, if economic growth really takes off, then there will be so much output to go around in twenty years that the burden of the Baby Boomers on social security will be relatively bearable.

If the New Economy scenario fails to play out, and we do not reduce benefits, then as the Baby Boom retires, the burden on workers is going to be very high. As far as I can tell, there is no financing scheme that can change this. When the Boomers retire, there is going to be a certain amount of output produced, and the more that Boomers consume the less that others can consume.

Candidate Bush's partial privatization plan does not address either (1) - (3) above. Therefore, to a first approximation it is irrelevant. (Candidate Gore is even worse, in that he has explicitly ruled out raising the retirement age, which is the only policy lever worth pushing.)

In our food economy, suppose that the Bush plan were to hand out lottery tickets to Baby Boom parasites. Those lottery tickets will be worth a lot under some scenarios (the stock market goes up) and not worth much under other scenarios (the stock market goes down).

Compared with the status quo, under Bush's plan, in the "optimistic" scenario, the parasites will be able to buy even more food, and there will be even less for the farmers. In the "pessimistic" scenario, the parasites will suffer, but as many commentators have pointed out, this probably would lead to a bailout of the parasites, which would put us back where we started.

So Bush's plan does not solve the problem. Again, assuming that the New Economy scenario fails to play out, what is broken about social security is that there will be too many retired people relative to workers when the Boomers age. Bush's plan does nothing to relieve that scenario.

The various financing plans offered by politicians of both parties are similarly irrelevant. To reiterate, unless we cut future benefits or increase economic growth, young workers are going to have less available to consume.

There is a second-order way in which financing plans could make a difference. That is, they might affect national savings and investment, which in turn would affect economic growth. Other things equal, the more we invest and the more efficiently we invest, the greater will be output in the future. However, it is never easy to determine the effect of a particular financing plan on national savings, and to a first approximation most of the plans have no effect whatsoever.

(One real-world phenomenon that complicates the analysis of the impact of social security on national saving is the fact that to some extent the social security transfer is "undone" by private individuals. When parents transfer wealth to their children, they are in effect undoing social security.)

With Bush's plan, workers will be able to put some money into savings rather than into taxes. How this will affect national savings is unclear. There are all sorts of tricky questions in the background. Will the government raise taxes elsewhere in order to meet its higher cash flow needs, or will it borrow the money? Will individuals see the Bush plan accounts as a substitute for other saving, and therefore reduce that saving, or will they continue to save as much as before outside of the plan?

To a first approximation, if workers do not reduce any of their other savings and the government does not raise any additional taxes, the result is a wash. The government issues $x billion more in bonds, and the private sector will have $x billion more to invest. Essentially, the private sector will end up holding the additional $x billion in bonds. The capital stock is unaffected.

By a slight margin, I support partial privatization. My guess is that the alternative to partial privatization will not be large government surpluses. Instead, we would see some combination of higher spending and lower taxes, depending on whether the Democrats or the Republicans have their way.

I believe that partial privatization may be a way of locking in a higher level of national savings. But that is based on my assessment of the politics of the government budget. The economic analysis is not definitive.