A while back, I lambasted Matt Bai of The New York Times for saying that the Social Security Trust Fund, because it is invested in Treasuries, is just a pile of worthless IOU’s the government won’t be able to redeem. I made fun of his suggestion that Uncle Sam is teetering on the edge of default, but there is a deeper issue I didn’t address. Bai, despite his economic confusions, is conveying a mainstream sentiment, endorsed by the broad center of American politics, that the drawing down of the Trust Fund is an impending catastrophe for the federal budget and national savings. Every T-bill sold back to the government is seen as another arrow in the heart of fiscal prudence, and we must somehow find a way to keep the fund at its current level by cutting benefits or raising payroll contributions.
Here I want to shed some light on the overall relationship between pensions and savings.
First, imagine a society with no money at all. Suppose it is an isolated fishing community: early each morning, every able-bodied adult sets off in a boat and dips a net into an ever-renewing fishing bank. Then they come home, unload their fish and eat them. This is the entire economy—fish, fish, fish.
Now introduce retirement. When people grow old, they lose the ability to fish, or perhaps they just want to do something different in the years remaining before they die. (Maybe they want to take up surfing.) How can they do this without starving? There is only one answer: their younger compatriots must eat fewer fish than they catch and divert the surplus to their elders. There is simply no way for people to “save” fish when they are working for consumption in future years, since the fish are perishable. This society may have complicated arrangements, perhaps involving pieces of paper (IOU’s) that convey entitlements to various quantities of fish, but in the end there is no escaping the reality that the working population supports the concurrent retired population at whatever level of abundance is agreed upon. If the ratio of retirees to working fishers rises, or if retirees want to eat more fish in their golden years, either the working population has to increase its fishing efficiency (catch more fish per person) or reduce its own consumption, or both.
Now consider the Social Security system. The Trust Fund has accumulated a huge portfolio of government securities, and in a few years it is scheduled to begin a slow process of cashing-in—selling securities for money that can be used to write checks to recipients. This money will come from the Treasury, which can raise it by selling new securities. This will raise the public debt unless non-SS related deficits are brought down by the same amount, since the ownership of Treasuries will have shifted from the government (the Trust Fund) to the public. That is what the SS alarmists are pointing to.
But, for the sake of argument, suppose that we had no Social Security system at all—that all pensions were privately financed out of the personal savings accumulated before retirement. Upon retiring, individuals would stop accumulating savings and begin drawing them down. Say they had bought only private securities, like stocks, corporate bonds and shares in equity funds. To pay for their retirement consumption, they would have to sell this paper, and those still working would have to buy them. The money for these financial purchases could come from either increased savings (less consumption) by the working population, improvements in productivity (increased real income from work), or increased debt (borrowing by issuing new debt in order to purchase retiree debt). In other words, it’s the same set of alternatives faced by the government in dealing with Social Security.
The moral of the story is that, while the system of paper assets that governs wealth and debt is extremely important for distributional issues at the individual level, the overall relationship between retiree consumption, worker savings and productivity is deeper and ultimately determinate. Our fishing community either learns how to fish better, or its working members tighten their belts in order to feed their elders, or they make their elders tighten their belts. If they have a connection to other fishing communities, they can also borrow fish from their neighbors, with the understanding that this may reduce their living standards in the future. If you follow the money in the Social Security case, you find the same factors. Redeeming a bond is like supplying fish and must be financed through either greater productivity, reduced consumption or debt.
At the level of paper assets, Social Security is healthier than it has ever been in its history. At the level of the division of the national product between working and retired people, the political dimension is unavoidable. Overall, productivity growth has tended to exceed the rate of increase in the dependency ratio (retired to working population), but there will always be a tradeoff between the rate of growth in the consumption of workers versus that of retirees. This is less visible in the arena of private savings, since the claims of retirees upon working-age citizens are made in a decentralized way through financial markets. With Social Security, the process is centralized and guided by public decisions. The tradeoffs remain the same.
What people like Matt Bai are saying is that, as the retiree population continues to grow, it will force the rest of us to increase our borrowing because we refuse, on political grounds, to take steps that would impinge on our consumption. To avoid this, we should see to it that the growth in retiree consumption is curtailed. In my earlier post I referred to this as the catfood option, but maybe this was a mistake: cats love to eat fish.