A pointy-head post about issues

“Under the EMH, neither of the reforms will make a difference. If the Social Security fund shifts into equities, individuals will reduce their own holding of equity until the desired balance is restored. Moreover, individuals will be entirely indifferent about personal accounts. If forced to open them, they will, initially at least, invest entirely in bonds, so restoring their (by hypothesis, optimal) status quo ante.”

Isn’t this assuming an awful lot? Social Security is (like it or not) an intervention into the securities market. EMH would not seem at all to predict that individuals will act to sustain the ratios of investment created by what is, after all, a giant artificial intervention. How on earth can we assume that the present system is the most efficient?

For example, given credit constraints, it’s generally desirable to increase the consumption of the young…

It’s a modest proposal, but I fear that it might have unbeneficial long-term consequences.

How does moving Social Security from government bonds to investment capital not help the economy. Doesn’t cheaper investment capital make it easier to fund new projects and businesses?

Unless the Fed govt cuts spending, then the investment in the capital market by the SS system (personal accts or govt fund) will be offset by the govt borrowing the same amount from the worldwide public. So there would be no net increase in the capital stock.

Jet, yes, you did miss the point. If privatizing Social Security leads to money being shifted out of government bonds into equities, then the EMH has been violated. EMH suggests that the current distribution is the correct one because the markets are the most efficient possible way of determining the correct values.

The preferences of Investor A are irrelevant to the post. EMH doesn’t say anything about whether a particular person has their optimal mix; it just says that on the whole, the markets achieve as close to an optimal mix as theoretically possible.

Kevin, I don’t see how the preferences of an individual investor are irrelevant. EMH, by John’s own account, says that “each individual hold[s] their own optimal mix of risk and expected return at the prevailing market prices” (emphasis obviously mine). Different individuals have different levels of risk tolerance and will pick different mixes. My point is that if SS constrains the mixes available to more risk-tolerant individuals– and it does– then it is an obstacle to markets’ achieving as close to an optimal mix as possible.

And also, even though in reality credit availability is certainly constrained, John’s final point is still wrong unless you implicitly assume a sort of EGH, an Efficient Government Hypothesis. From the premise that an all-knowing and perfectly public-interested government *could* calculate a level of (e.g.) education subsidy that would improve people’s preference-satisfaction ability, it does not remotely follow that government should be given the power to subsidize education.

It seems to me that Kevin D is right in the first instance, and introducing the EMH is an unnecessary and confusing elaboration.

In 2025 or 2050, there will be a GDP, and the national income will get divvied up. If domestic savings has increased sufficiently to displace foreign ownership of stuff, then domestic claims on national income will be proportionally larger.

If policy has forced larger sums into the equity markets, per se, it is reasonable to suppose those larger sums will have simply disappeared into bad investments (i.e. investments with a negative present value at the time they were made). Unlike the SS trust fund, the NYSE is no lockbox. If you forcefeed it enough money, it just spills the excess.

A reasonable interpretation of Bush’s vague proposals is that he plans to “steal” the accumulated trust fund. The middle class will trade its claims on future tax revenue for the “choice” of purchasing currently overvalued equities from wealthy people, who, in turn, will be given the opportunity to 1.) collect “management” fees from the middle class, and 2.) use the proceeds of their stock sales to buy up trillions of new Federal debt issued to “cover” the transition costs.

All the unnecessary nonsense about the EMT becomes so much smoke to cover a plan for a trillion-dollar heist; a future generation of Americans will wake up in a world where the wealthy are being paid a enormous share of Federal revenue in debt interest, and the retired middle class is eating cat food (but may have the dubious honor of “owning” the cat food maker).

On reflection, my Investor A example concedes both too little and too much. In a narrow sense, John and Kevin D. are right: if the EMH is correct and this implies people can borrow costlessly and SS really just forced A to invest 12% of her income in Treasury bonds paying a market rate of interest, she could borrow 4% of her income at that same market rate, use her forced bonds to pay the interest, put the principal in equities and be no worse off.

But of course in any remotely realistic world A can’t do that, and the reason is not just that real markets have borrowing costs, it’s because of the nature of SS itself. Both John’s footnote and my parenthetical “(effectively)” ignore too much.

In fact SS is not the same as people being forced to put 12% of their income into government bonds, not even close. One reason is of course that SS has a large redistributionist component. But even ignoring that, there’s still the fact that SS benefits are set by the grace of Congress and can be changed arbitrarily at any time. When you buy a Treasury bond you’re buying a contractual promise from the government to pay you, the bondholder, a specific rate of return over a specific term. Paying SS taxes gets you no such promise.

Now SS defenders will respond that simply abolishing SS tomorrow is politically unfeasible, perhaps almost as unfeasible as defaulting on the debt. But significant changes in SS benefits and/or taxes, and thus changes to the “effective rate of return” to SS taxpayers, are not only feasible but, as John’s footnote notes, almost certain to occur. And the likelihood of these changes means that SS itself creates uncertainty that raises the cost of getting one’s optimal debt-equity mix.

Nicholas: cuts are a different kettle of fish. Abolishing both payroll taxes and payments to retirees increases the incentive to work, both for those currently employed and for the luckless retirees. We don’t need the EMH to tell us that. It is a much different proposition from swapping debt for equity, which is just shuffling paper claims.

As for SS creating uncertainty, that’s true of any government policy and it is a useful argument against too-big government. It is also an argument against too-small government; there is a lot of uncertainty in failed states. The debate about the right size for government will never end. It seems to me there is a good case for some form of safety-net but there is a trade-off between generosity and preserving incentives.

John Quiggin,

‘“But of course in any remotely realistic world A can’t do that [borrow at the real bond rate to finance her desired equity position]”

which is why EMH is false and you need to look at the credit-constrained case.’

What difference does it make if they can or cannot?

Even at a 1 – 3 % interest rate the return is significantly reduced? I mean how large an EP is being claimed? Presumablely stocks must pay some premium for the risk?

Jack,

I don’t believe in much of an EP. (Data I saw did not seem to take transaction costs into account) So for me all investors are credit constrained when taking advantage of a snall or non-existent EP.

So I pretty much agree with you. The argument for privatization is based on secondary fators. Less government spending and other factors. (I am really not a fan of private accounts.)

Which is maybe what John was saying? If you have an EM you cannot have an EP. It seems to me that is true by definition.

Jet (to Kevin Brennan):

“Government bonds are just a substitute for increased taxes, while investments in the market do real work in that they create wealth.”

The first part of this statement is true if taxpayers are very far-sighted. They treat a tax cut which is not matched by a spending cut as merely a postponement of the tax-bill (Ricardian equivalence). Hardly anyone believes this is empirically true. Still, there may be a good case for assuming something of the sort when it comes to a topic like SS. It helps to underline the principle that there is no such thing as a free lunch.

The statement that investments in the market create wealth confuses two meanings of the word investment. Stockbrokers refer to the purchases of equities as investment. Economists do not. No wealth is created – all that happens is a transfer of title to existing assets.

There is no point to doing thorough and comprehensive widescale experiments in social engineering through central control if we do not follow up the severe problems we create with even more stringent controls imposed on the already overcontrolled marketplace. The point of instituting central control in the first place is to cause enough sheer hell resulting to justify further controls. One of my primary beefs is that people should be willing to accept that if a management class is willing to accept the enormous burden of the greater good of mankind by drawing up virtually infinite lists of rules for others to follow, they have got to have legislative access to the best looking and most fertile young females during their off hours. That’s not me talking, that’s economics, damn it.