Thursday, June 17, 2010

The Evolution of the Retirement System and the Macroeconomy

Bernard Girard argues that the proposed reform of the system will lead to a lower level of replacement income for everyone, simply because it will not be possible for most people to meet the requirements for full benefits. This is because we enter the work force later and leave earlier (even though we live longer), and nothing can be done to reverse these tendencies (despite the common rhetorical suggestion that the ultimate departure from the work force is generally voluntary). The result will be a gradual shift to various supplementary sources of pension income such as investments, annuities, etc. Where such programs exist, they tend to favor those higher up in the workplace hierarchy.

The prospect of such a dual system may shock French sensibilities, but in the United States we are used to it, for better and for worse. Social Security income is supplemented for most people by a private (employer-, union-, or association-administered) pension, an IRA, a 401k, etc. The tax concessions that help to sustain this dual system also help to disguise the cost to the government and the actual amounts of transfer from one social group to another.

There has been much discussion lately (by behavioral economists in particular) of perverse incentives in the US system and of how to change those incentives in order to encourage people to take advantage of opportunities to provide for their future. There has been less discussion of the macroeconomic effects of the large private pension system. For example, one source of the demand for AAA-rated securities (which encouraged banks to fabricate such securities out of less secure mortgages, thus setting the stage for the collapse) was the requirement of many pension funds to hold only such securities. Government pensions are countercyclical: they act as automatic stabilizers in a downturn. Private pension investments, as we have seen, are procylical: everyone with investments feels poorer in a recession, and the wealth effect of a negative shock to GDP is multiplied by the widespread ownership of corporate equities.

Perversely, the Great Recession is driving France, in a panic over the size of its public deficit, toward a more procyclical pension system. Hence "the fire next time?" This is a question that no one wants to ask.

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