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Sunday, March 06, 2005

Brad DeLong and a Dead Parrot debate the effects of private accounts on national savings.

Now I think that Brad may be right that private accounts are likely to be a wash as far as national savings go, but you should point out that you only think that because you assume that Bush, the Cato institute and the CEA are full of it.

They all claim that private savings accounts are a better deal than traditional social security. They even claim that young people will be better off with the reform in spite of price indexing and the 3% offset rate. That is, they claim that the reform will reduce national savings.

This is simple. If the reform means that people are better off, then the reform should make people consume more and save less. Under standard assumptions that means national savings decline. I will explain what I mean by "standard assumptions" below. Now conservatives like to go on and on about how offering a better return on savings will cause increased savings due to the substitution effect. They have noticed that no one has noticed that there is also an income effect so the sign of the total effect is ambiguous. In the case of social security reform, there is no substitution effect. The proposal is to replace one form of forced savings with another. Contributions are FICA which is fixed by law and not voluntary. However if, as claimed by Bush and the Cs, private accounts are a better deal, then there should be an income effect causing increased consumption.

The identity is national savings = GNP - C -G. When discussing the effect of private accounts it is normal to assume that government consumption stays the same. One might hope that private accounts will, in some way, scare the state into spending less because the huge deficits involved will scare people. Oh but wait, the pres. the CEA etc say those deficits aren't deficits, and are nothing to be scared about (not to mention that they don't seem ever to have been scared about deficits, and why should we listen to their ideas about how to starve the beast, they are the beast). In any case, when evaluating the effects of a policy change, one does not normally assume that there will be another policy change (not part of the legislative package) which will undo the damage. So I assume that G is fixed. For any fiscal policy expected GNP is the GNP corresponding to the natural rate of unemployment (usually called full employment GNP but that is silly). That is, in standard analysis of national savings, Keynesian effects are assumed to be temporary and to have unconditional expected value zero. End of story. Give social security participants a better deal and national savings should decline. No pain = no gain. Pleasure = loss.

To argue that social security reform will increase national savings one must argue that it will make participants poorer or will make the accumulation of national debt more terrifying. The President is effectively saying -- trust me don't worry, I'm obviously lying.

Update: I think I understated my case in the post above. I think private accounts will cause reduced national saving even if Bush is totally wrong about returns on private accounts. I slipped into assuming that people have rational expectations (occupational hazard) here

"If the reform means that people are better off, then the reform should make people consume more and save less."

I should have written

"If the reform means that people *think they* are better off, then the reform should make people consume more and save less."

Now price indexing will make people feel poorer and save more. However, at first, private accounts will definitely make some people feel better off and make none feel worse off. That is because they will be volutary. People who think the guaranteed benefit is a better deal will stick with the guaranteed benefit. People who switch to private accounts will think that they have made a sharp move and that they can consume more. Even if private accounts were a terrible deal, the suckers who fall for them will act like they just won a prize in the lottery.

More choice in investment of forced savings means more consumption (in the short run) whether or not a rational person would take advantage of the new option.

Now if the private accounts are a terrible deal, the suckers would eventually notice that they have been had and will consume less. At that point Bush could boast that he has increased private savings. I don't think he would be eager to take credit for having slyly impoverished his fellow citizens, but after 4 years I wouldn't put it past him.


Anonymous said...

Excellent. I thought there were no comment, but now I find there are. Nice :)


Anonymous said...

If you recall the Reagan era attempt to boost savings by offering the higher returning all
saver account, people saved with
the all savers and therefore didn't feel the need to save more.
The income effect reared it's ugly head...

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