March 4, 2005 | WebMemo on Social Security
Syndicated columnist Michael Kinsley continues to get it wrong on Social Security. A recent column credits actor Rob Reiner with an argument that Kinsley is convinced proves that Social Security personal retirement accounts (PRAs) cannot work. Unfortunately, the argument contained in Kinsley's column collapses in the face of academic studies and actuarial projections.
Quickly summarized, Kinsley and Reiner are convinced that there is no way that a conservative portfolio of stocks and bonds can grow at an average rate of 4.7 percent annually (after inflation) if the economy grows as slowly as the Social Security actuaries predict. Conversely, if the economy grows faster than the actuaries predict, then Social Security's problems will be solved without resorting to personal accounts. Kinsley's column explicitly mentions estimates by The Heritage Foundation that a PRA would earn an average of 4.7 percent after inflation. Although Kinsley does not mention it, the Heritage prediction is based on a portfolio that consists of 50 percent stock index funds and 50 percent government bonds.
Kinsley and Reiner are wrong on both counts. First, a new study shows that stock market returns are actually higher on average in slower growing economies than they are in rapidly growing ones. Earlier studies had made the same point. Second, several studies, including data from the nonpartisan Social Security actuaries, show that there is virtually no chance that faster economic growth could solve Social Security's coming huge deficits.
Stock market growth is not tied to GDP growth.
Four days before Kinsley's column was published, an article in the Financial Times cited a London Business School study showing that there is no clear link between growth of an economy and stock market returns. According to the Financial Times, "The study - covering 53 countries overall and 17 countries using data stretching back to 1900 - suggests that it makes more sense to buy stocks when GDP growth is low than when it is high. Investors made 12 per cent a year buying in markets after a run of low growth and only 6 per cent in markets where growth was in the top 20 per cent."
The London Business School study is only the latest academic study that shows no real link between GDP growth and stock market returns. A major reason for the Social Security Administration's projections of lower long-term U.S. economic growth is the coming reduction in population growth and the resulting slower growth of the workforce. However, that aggregate number masks the fact that a worker's individual productivity is expected to remain high. The aggregate number just reflects the lower number of workers who will be in the workforce. The level of individual productivity, in turn, will fuel higher corporate profits and higher stock prices.
This is one reason why three days before Kinsley's column was published, Stephen C. Goss, the Social Security's chief actuary, used precisely the economic assumptions criticized by Kinsley to project that over the next 75 years, "…the long-term ultimate average annual real yield assumed for equities [stocks] is 6.5 percent." Goss went on to note that this rate is "somewhat lower" than the rate of return in the past, but "A consensus appears to have formed among economists that equity pricing, as indicated by price-to-earnings ratios, may average somewhat higher in the long-term future than in the long-term past. This is consistent with broader access to equity markets and the belief that equities may be viewed as somewhat less 'risky' in the future than in the past."
Goss's numbers are consistent with Congressional Budget Office estimates. An added factor in both estimates is the increasingly global nature of the financial markets. Because an increasing number of investment opportunities exist around the globe, the cost of capital will continue to be set by global demand rather than the economic climate in an individual country.
Higher economic growth does not fix Social Security.
Kinsley and Reiner also fail to understand that increased economic growth would not prevent Social Security's problems. This is due to the fact that higher economic growth would spur higher earnings. While higher earnings would increase the amount of Social Security payroll taxes that would be collected in the short run, they would also increase the amount of retirement benefits that would have to be paid in the longer run.
The SSA actuaries do admit that there is a 2.5 percent chance that the economy could grow fast enough to solve Social Security's problems. Of course that also means that there is a 97.5 percent chance that it won't. Even experienced gamblers would not bet our children's retirement security on such odds.
Among other things, economic growth of the magnitude necessary to save Social Security would require overall productivity growth that is over twice the level seen in the American economy during the 34 years between 1966 and 2000. Over that period, productivity growth was 1.5 percent a year, slightly below the 1.6 percent annual increase projected by the SSA actuaries in the forecasts Kinsley criticizes.
Kinsley does not understand finance.
Most disturbingly, Kinsley also states: "But if free markets work the way they are supposed to - and I would like to hear the Heritage Foundation say that they do not - the effect of the government's announcing that government bonds are a bad investment and officially pushing people to put their money elsewhere will be to make it more expensive for the government to borrow money. So even if private stocks and bonds are a better long-term investment than government bonds (after factoring in risk and so on), they won't stay that way for long."
This makes little sense. No one is saying that government bonds are a bad investment. The Heritage projections are based on PRAs that are 50 percent invested in government bonds. The Bush proposal assumes that 20 percent of PRAs are invested in government bonds. Government bonds are a very fine investment for people who want to avoid risk and can afford the lower returns paid by government bonds.
On the other hand, stocks and other types of bonds pay a higher return in part because they have a higher risk level. This risk is particularly evident in the short-run. Stocks and bonds rise and fall by the day, week, and month. However, over long time horizons, such as 20 years or longer, they almost always rise at a significant annual average rate.
This is what makes stocks and bonds perfect for retirement investing. Holding them for 20 or more years, regardless of their daily rises and falls, guarantees significant profits at a fairly low risk level. A system of PRAs will increase demand for both stocks and government bonds. There is no reason to assume that demand for either will fall or that the risk-based difference between what each pays will significantly change from the SSA or CBO projections.
Michael Kinsley shows little understanding for either the realities of economics or the fine points of finance. Even so, a little more research would have shown him that Reiner's argument proves nothing.
David C. John is Research Fellow in Social Security and Financial Institutions in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
 For younger readers, Rob Reiner played the young liberal son-in-law in TV's "All in the Family," a sitcom that went off the air over 25 years ago. His TV father-in-law, portrayed as an ignorant, opinionated bigot, regularly dismissed Reiner's character as "Meathead."
 "The Meathead Proposition, Another Irrefutable Argument Against Privatizing Social Security," Washington Post, February 13, 2005, p. B7.
 Christopher Brown-Humes, "Slow growth can mask high returns," Financial Times, February 9, 2005, p. 42.
 Memo to Bob Pozen from Stephen C. Goss, Chief Actuary, Social Security Administration, "Estimated Financial Effects of a Comprehensive Social Security Reform Plan Including Progressive Price Indexing," dated February 10, 2005, pp. 5-6.