Tuesday, February 22, 2005

There's no free lunch 

Via The American Mind, I read that Nobel Laureate Ed Prescott doesn't think Social Security is a problem. Speaking at a Cato Institute conference,

We hear a lot about transition costs. "But I'm going to use some economic jargon, not 'political accounting' jargon. There are no transition costs. Re-labeling debt is not a cost.

Steve Landsburg explains further,

Is Social Security headed for bankruptcy? Sure.

Should we care? Not a bit.

Here's why: We pay lots of taxes. Some of those taxes are called "Social Security taxes." We get lots of government benefits. Some of those benefits are called "Social Security benefits." Bankruptcy means that in 10 to 15 years, Social Security benefits will exceed Social Security taxes.

The looming bankruptcy is both absolutely real and absolutely insignificant. You could reverse it in an instant by changing a definition or two. Keep benefits exactly as they are, but call only half of them "Social Security benefits"; call the rest something else, like, say, "Geezer Pleasers." Social Security taxes would exceed "Social Security benefits." Voil�, no more bankruptcy.

My students learn that the circular flow is a two-way street: money moves in one direction, goods in the other. We have promises that in 2020 so many goods will flow to retirees. We will produce an amount of goods. If we are going to have more to pay them in the future, we have to create new capital, invest in R&D, and move to an economy that can pay them more and leave enough to keep the new generation of workers not worse off than the current generation. You either have to have more capital, or find ways to make each worker more productive. All of this requires more savings.

Landsburg makes the key point:
If you want to address the Social Security crisis of the future, you must adopt laws that encourage saving in the present. There's nothing else you can do.

Personal accounts can do this. Changing the cap for Social Security payments doesn't.
What really matters, though, is not private accounts. It's the saving and pro-growth policies that private accounts will encourage. If we can get the same things in other ways, that's just as good.

Readers might think this contradicts my statement last week that the battle over Social Security is about transition costs. It does not. The battle is there since changing the timing of debt, while having no changes in the allocation of resources, will cause some shifts in the distribution of resources.

Cato is keeping a nice quick fact archive for the rest of you bloggers wishing to arm yourselves.