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April 6, 2005

The leftist professoriate catches 22

America's leftist economists are swarming the media to try to turn back President Bush's initiative to modernize Social Security with personal accounts. Yet for all their seeming brain-power, they are entirely bereft of ideas themselves. What they do offer -- mostly picayune objections to reform dressed up as "papers" and "studies" -- is junk science. And as you'll see, a close look reveals that these junk scientists have, in fact, inadvertently created compelling arguments in favor of reform!

Last week I found myself on a cable talk show opposite Joseph E. Stiglitz -- the leftist economist from Columbia University who won the Nobel Prize in Economics in 2001. I asked him twice -- and the show's host asked him a third time -- how he would apply his economic expertise to bring Social Security into the 21st century. He said "there are alternatives" -- but he could not articulate a single one of them. The best he could do was say we need to increase economic growth by -- you guessed it! -- repealing the Bush tax cuts.

Growth sits at the center of much of the leftist economists' attack against Social Security modernization. They claim the Social Security Administration actuaries have exaggerated the program's solvency problems by using artificially low growth assumptions in their calculations. They use an average real GDP growth rate of about 1.9% to estimate the system's long-term solvency, when the historical average has been about 3.5%.

It's a strange thing for leftist economists to argue that growth forecasts are too low. These are the guys who mope about the "zero sum society," the "crisis of global capitalism," and "depression economics" even during the best of times. But for the Social Security debate, to a man they have all donned rose-colored glasses and are forecasting high growth as far as the eye can see. On television with me, Stiglitz -- the author of the apocalyptic obituary of the bubble economy called The Roaring Nineties -- improvised an argument for why future growth ought of be 3.7%. Why? Because, as Stiglitz told me on TV, with growth that strong "the Social Security problems just disappear."

And, of course, so would President Bush's argument that Social Security faces a crisis. And that's why the dismal scientists of the Left are suddenly cheerleaders for growth. But this isn't just dismal science -- it's junk science. And it matters not a whit that it comes from a Nobel laureate. Yes, faster economic growth means more jobs, higher wages, and bigger payrolls to tax. But Social Security benefits are indexed to wage growth -- so while more taxes are collected today, even more has to be paid out in benefits in the future. Stiglitz is dead wrong.

The Social Security Trustees say just that in their latest Annual Report: "eventually, faster real wage growth, alone, results in an increase in the unfunded obligation of the program." And when the cameras aren't rolling, leftist economists will set aside their growth pompoms and admit the truth. Dean Baker (of the Center for Economic and Policy Research, a Soros-funded think tank -- though Soros' name has recently been excised from the list of funders on their web site) confessed to me in a moment of weakness that "even if you assume much more rapid wage growth, the the [sic] program would still face a shortfall somewhere near the end of this century."

But the leftist economists aren't just banking on a bogus argument about high growth. They've got a bogus argument for low growth, too. This one is tarted up as a "paper" presented last week at the Brookings Institution by Baker along with Brad DeLong (former Clinton administration official, and the self-confessed most Marxist-leaning economist on the UC Berkeley economics faculty) and Paul Krugman (America's most dangerous liberal pundit, who surely needs no further introduction by me).

Though reported in the New York Times as a big story, the "paper" is, at best, nothing more than a trivial "gotcha." It's essence is simply the claim that it's inconsistent to assume slower economic growth in the future at the same time as one assumes that stock market returns will be the same as they have been in the past. On the face of it, hardly controversial. But the political message here -- the "gotcha" -- is one that Baker and Krugman have made before in other venues: that this inconsistency invalidates the Social Security Administration actuaries' forecasts of how well personal accounts holding stocks might perform.

The actuaries, as noted earlier, assume about 1.9% annual real GDP growth over the coming 75 years. That's about 1.5% less that the average rate since 1947 (as far back as modern GDP calculations go). At the same time, the actuaries assume 6.5% annual real total returns to stocks. That's about 1.3% less than their total return since 1947. So the actuaries have forecasted both GDP growth and stock returns that are lower by about the same amount. What's the complaint, then? Where's the inconsistency?

Baker, DeLong and Krugman expend 41 pages of junk science trying to come up with one -- and fail. Acting as the "paper's" discussant at Brookings last week, N. Gregory Mankiw (the widely admired Harvard economist and recent chairman of the Council of Economic Advisors) was merciless. Mankiw called it "the strangest contribution to the equity premium literature I have seen... [it] can be viewed as creative, bizarre, or vacuous..."  He noted it relied "on the level and growth of a variable that, to a first approximation, does not matter." And he declared, "If I took this model seriously, it would do more than inform my view of the equity premium. It would shake my faith in corporate capitalism!"

Mankiw was neither fooled by nor shy about exposing the "paper's" thinly veiled political purpose. He asks the rhetorical question, if the expected returns for stocks doubled -- thus rendering moot the "paper's" whole premise -- "Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform? I suspect they would not."

Indeed. Thus, Mankiw concludes, "while the paper raises some interesting questions about the future of assets returns, as far as the debate over Social Security goes, it is largely a non sequitur." In other words, no matter what anyone may conclude about whether 1.9% growth and 6.5% stock returns go together, one would still feel the same way about Social Security reform, whether for it or against it.

Jim Glass takes Mankiw's judgment one step further on his blog, Scrivener.net. Glass argues that, thanks to this "paper," the leftist economists have become trapped in an inescapable two-pronged Catch-22. Here's the first prong: if economic growth and stock returns go together, then if growth is going to be strong, personal accounts that can invest in stocks are a terrific idea because stock returns will be strong, too.

And there's no escape from this Catch-22 by taking the traditional leftist view that economic growth will be disappointing. If stock returns will be lower than in the past under low growth, then, of necessity, so will be interest rates and bond returns. While high growth can't bail out the Social Security system (no matter what the leftist economists claim to the contrary), low growth surely can sink it like a torpedo. Why? Because lower interest rates mean that the assets the program holds would earn less. So the program would need more assets now -- or would have to renounce more of its obligations in the future -- to make up its underfunding.

Thus the leftist economists are skewered on the second prong of their self-made Catch-22: if economic growth and asset returns go together, then if growth is going to be poor, personal accounts are a terrific idea because they secure workers' benefits against the system's worsened insolvency due to low interest rates.

But wait -- it gets even worse for the leftist economists. Their "paper" claims that, in a low growth environment, real stock returns should be about 4.5% annually. That may be lower than the 6.5% assumed by the actuaries, but it's higher than what a worker can expect to earn from the existing Social Security program. And it's a lot higher than what a worker could expect to earn from the program once its already shaky finances are rocked by the impact of lower economic growth.

So what have we learned from our illustrious leftist economists? First, that it's a wonderful world -- high growth as far as the eye can see. And that's a great world in which to own a Social Security personal account that can invest in stocks. Second, if the world doesn't turn out to be so wonderful, that same account can be your personal lock-box to protect you from benefit cuts -- and stock returns will still probably beat the miserable returns of the current program.

Class dismissed. Professors exit left.

Posted by Don Luskin at April 6, 2005 12:57 AM | Print

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