Undermining Security: A Warning Against Social Security Privatization

An Interview with Dean Baker

Dean Baker is co-director of the Washington, D.C.-based Center for Economic and Policy Research. With Mark Weisbrot, he is co-author of Social Security: The Phony Crisis. Other work includes Getting Prices Right: The Battle Over the Consumer Price Index (M.E. Sharpe Press, 1997), which was selected for the 1998 Choice Outstanding Academic Book List, and Globalization and Progressive Economic Policy (Cambridge University Press, 1998), edited with Jerry Epstein and Bob Pollin, and The Scorecard on Globalization: Twenty Years of Diminished Progress, which examines performance of countries on indicators of health and education outcomes during the era of globalization, co-authored with Mark Weisbrot. Baker received his Ph.D. in economics from the University of Michigan.

Multinational Monitor: What impact has Social Security had on poverty in the United States?

Dean Baker: Prior to Social Security’s existence in the 1930s, more than half of the elderly were in poverty. Unless you had kids who could support you, or you were one of the rare people who were able to save much in a lifetime, old age likely was lived in poverty.

As a result of Social Security, the poverty rates among the elderly have been reduced to basically the same as the rest of the adult population — about 10 percent. So there has been a huge reduction of poverty among the elderly.

In addition to being a retirement program, Social Security is also an insurance program for workers that are disabled or who die young. It has had a huge impact on the survivors and family members of disabled workers or the families of those that die at an early age.

Social Security is far and away the country’s most important anti-poverty program.

MM: What would it mean to privatize Social Security?

Baker: Usually privatization means that, instead of having a defined benefit that’s guaranteed by a central system or central fund, there will be individual accounts that will be privately managed. There are different ways that can be done. It can be done through a central system managed by the government, or contracted out, or it could be done by people going to banks, brokerage houses, the financial industry in general.

The main distinction is that you’d be reliant on what you get from those individual accounts. You wouldn’t have a guaranteed benefit, or at least the same guaranteed benefit that you have today. It would depend on how well your investments do, or how well they’ve done at the point that you retire.

MM: What’s wrong with the argument that says that if people can do better on their own, they should be able to invest on their own?

Baker: First, we have an awful lot of data coming from the World Bank and other proponents of privatization showing that there’s huge waste associated with privatization. If you have a system administered by the financial industry, the amount of money that they’re going to pull off in commissions and fees comes dollar for dollar out of people’s retirement. If you want people to have individual accounts for some reason, doing it through the financial industry is a really inefficient way. If you had a centralized system that the government could manage or contract out, that would save a huge amount of money.

Second, Social Security is supposed to be a core retirement fund. Privatization would drastically reduce people’s retirement security.

We have a really big crisis of pension coverage in this country, with only half the population even having access to pensions at their workplace, and many of those are very much inadequate. It’s great for people to have money that they can put into the market or invest in different ways. We need to extend pension coverage.

But Social Security is supposed to be the core income that’s there when you retire, no matter what happens. That’s what you know you would have to retire on. Privatization would erode that guarantee, leaving people with a much smaller guaranteed benefit or, in extreme cases, none at all. Under privatization proposals, if you invested your Social Security savings and lost them, you would be out of luck.

The third part of the story — and it illustrates how you can say utter nonsense in Washington and still be taken seriously — is the proposition that you can get much higher returns on the stock market than you can get on government bonds, which is what Social Security currently puts the money into. This whole debate is premised on a really big lie — that you can get much higher returns in the stock market than you can on government bonds. Given both the slow profit growth currently being projected by the Social Security trustees, and the very high current valuations of the stock market, it’s literally not possible.

MM: Obviously a big part of the story told by the people pushing privatization is that the system is facing collapse. What is your assessment of that claim?

Baker: Looking straight at the Social Security trustees’ projections, and taking those conservative numbers that everyone is using at face value, you’re pretty hard-pressed to call what you see there a collapse. What the numbers show is that if we don’t do anything, the system would pay all benefits right through the year 2038. So 36 years into the future, if we don’t do a thing, it could pay every penny of benefits.

After 2038, if we did absolutely nothing, the system could still pay roughly three-quarters of promised benefits — a larger benefit, adjusting for inflation, than what current retirees receive. Not that that would be acceptable or that we would want to cut benefits a quarter from what was promised. But the point is that the idea that there’s not going to be anything there is groundless.

Another way to think about this is that the sort of shortfall that we’re projecting 36 years in the future is roughly comparable to the sort of shortfall the system faced in the 1980s. What that means is, if the trustees’ projections turn out to be accurate, and we see really slow growth –– much slower growth than the nation has ever seen, that is what the projections assume — then 30 years from now we might be looking at the same sort of tax increases that we saw in the 1980s, if we want to maintain the promised benefits.

MM: What about the sentiment that there will be too many old people per working member of the population in the near future to keep the system working?

Baker: That’s where those numbers come from. That’s why we’re facing a projected shortfall. People are going to live longer lives, and as a result, the ratio of retirees-to-workers will rise. At some point, that does put a strain on the system. If the projections on life expectancy and birth rates are correct, and assuming lower immigration rates in the 2010s and the 2020s than we had in the 1990s, as the trustees do, at some point we might have to raise taxes. We did that in the 1980s.

The other point that people have to realize is that the economy does get more productive through time. In the projections, the trustees assume a very slow rate of productivity growth — a much slower rate than what we’ve seen historically in the period since World War II. If productivity increases at the rate that it did in the 1990s as a whole, we could go well into the decade of the 2040s, maybe as long as 2050 without any change in the program whatsoever.

MM: Who are the parties most aggressively advocating privatization?

Baker: There’s an interesting mixture of groups. There are the conservative ideologues like the Cato Institute types that really don’t like government social programs. They don’t like Social Security. Their intellectual ancestors in the 1930s fought the New Deal. Barry Goldwater in 1964 wanted to get rid of Social Security by making it voluntary.

Secondly, you have the financial industry, which realizes that they stand to make a fortune if they can get their hands on that money. The fees and commissions charged by the financial industry are about 1.5 percent of the amount of money in 401(k)s or similar accounts. If they could chip off a chunk of Social Security so that after 10 or 15 years they’ve built somewhere on the order of one and a half or two trillion dollars in individual, private accounts, that comes to as much as $30 billion a year in commissions.

The third part of the story is that professionals, higher-paid workers who don’t get a high rate of return on their money in Social Security. A lot of these people have 401(k)s or money in the stock market, and they watched the market go up 20 percent a year in the late 1990s. A lot of them thought this would continue indefinitely. Many thought that if they could get their hands on the money taken out through Social Security taxes and invest it in the stock market, they would really be rich.

One of the factors that have turned this around in the last two years has been the partial collapse of the stock market bubble. People now realize that the market doesn’t go up 20 percent a year; the market can go down as well as up. I think that’s brought a much greater appreciation of the value of Social Security as a guaranteed benefit that you don’t have to worry about.

MM: Do you see the collapse of the Nasdaq or the implosion of Enron as putting an end to the privatization proposals?

Baker: I wish I could say for sure that it’s putting an end to it, but it’s like a vampire –– just when you think it’s dead, it comes back.

Those events have certainly taken a lot of wind out of the sails. People with PhD’s in economics and other advanced degrees, staffers for members of Congress and people who write newspaper articles on Social Security really believed absurd things about the stock market. They really believed that they could get 20 percent per year returns. Now that they’ve been kicked in the face a bit, they realize that the market does go both ways. There’s much less enthusiasm. It has definitely pushed privatization off the agenda for the moment.

No one’s going to bring privatization up as an issue that they think will get them elected to Congress. My guess is that we won’t hear about it again until at least the end of the first term of the Bush presidency. Whether it comes back after that obviously will depend a lot on the outcome of the 2004 election.

MM: The Democrats now charge that the Republicans are going to drain Social Security. What do you say about that?

Baker: It’s really outrageous. It’s sleazy, focus group politics. They know it isn’t true. The Social Security trust fund is separate from the federal budget. It holds government bonds. By running a deficit or spending a surplus, the Republicans can no more drain Social Security than they can drain the $10,000 worth of government bonds that I have sitting under my bed. It’s really sleazy politics. And it is dangerous. It encourages the notion that something’s wrong with the program, which is not true.

The Democrats are learning from their focus groups that if they can scare people about Social Security, then they’ll vote for them. But the down side is if things go the other way, you’ve put this program on the chopping block when there’s no reason for it to be on the chopping block.

MM: What has been the experience with privatization of social security in other countries?

Baker: From bad to disastrous. One of the things that isn’t in dispute is that, anywhere you look, you find that there have been high administrative costs. In the United States, our administrative expenses are about .6 or .7 percent of what gets paid in each year. By comparison, if you look at Chile, where they privatized their system as a model in the early 1980s, it’s about 15 percent. In Britain, it’s perhaps even a little bit higher. Argentina has a privatized system, as does Mexico. There, too, it’s around 15 to 20 percent. So if you put that in terms of dollars or cents in the United States, instead of paying $7 billion or $8 billion in administrative expenses, you’d be paying $60 billion or $80 billion a year in administrative expenses. So it’s a huge difference in costs that comes directly out of workers’ pockets.

There have been other disastrous examples such as Kazakhstan, where the World Bank promoted a privatization of the system that was very corrupt. Everyone, including the World Bank, acknowledges that it was a complete disaster.

Britain is a good example for the United States. There they had insurers that used very deceptive tactics to sell policies that they couldn’t back up. It turned out that you had all these people who invested in good faith with these insurance companies who couldn’t honor their promises, so the government ended up backing it up. It cost the government billions of dollars.

You find problems everywhere they have privatized programs like Social Security. In the best cases, you have a lot of money that could have gone into people’s retirement that instead went into paying fees and commissions on these accounts. In many cases, you have instances of fraud where money was literally stolen from people’s pockets.

MM: To what extent has the World Bank been advocating privatization?

Baker: The World Bank has been a really big proponent of privatization in the developing world. They have program seminars on how countries can privatize their systems. They’ve strongly encouraged it throughout Latin America, throughout the transition economies in Central and Eastern Europe. They’ve played a very pernicious role here.

I mentioned Kazakhstan before. It should have been easy to see that this is not a country where it was even feasible to have a well-working system of private accounts. Even if you liked the idea, you should have been able to say it doesn’t make sense for Kazakhstan. There are no real established capital markets there. There is no institutional structure to support such a system. It should have been easy for them to see this isn’t going to work. But they insisted on going ahead with it. It just didn’t make any sense.