(Cross Posted from The Blog Roundup).
Paul Krugman is well known for taking complex financial and economic issues and distilling them down into language that almost anyone can understand. In today's New York Times, he makes a number of of very simple and clear points about the forthcoming White House plan to privatize social security, and the dangers inherent in such a plan. For example, he discusses the grim reality behind the oft-quoted (by Republicans) example of privatized retirement accounts in Chile:
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Buying Into Failure by Paul Krugman, NY Times (subscription)
Information about other countries' experience with privatization isn't hard to find. For example, the Century Foundation, at
www.tcf.org, provides a wide range of links.
Yet, aside from giving the Cato Institute and other organizations promoting Social Security privatization the space to present upbeat tales from Chile, the U.S. news media have provided their readers and viewers with little information about international experience. In particular, the public hasn't been let in on two open secrets:
Privatization dissipates a large fraction of workers' contributions on fees to investment companies.
It leaves many retirees in poverty.
In fact, 41% of Chilean retirees eligible to collect pensions continue to work -- because their private accounts are so much smaller than predicted that they cannot afford to retire.
To me, one of the most important points in the whole social security debate is that in any feasible social security private investment scheme, a significant portion of the money individuals pay into the scheme will be eaten up by the fees which will be paid to the brokerage and investment firms that are now just so eager to promote the concept of private social security accounts.
That started me thinking about Warren Buffett's dictum of the magic of compound interest, and that adding even a little extra cash (or subtracting a little) in the early years of an investment can make a huge difference to the final value of that investment after enough time has passed. So I decided to do a little calculation: I imagined a scenario where two workers both saving for retirement each pay equal amounts for an equal period of time, one into a private social security account and one into social security as we know it today.
Retiree A pays $1,000 a year (roughly 2% of the median national salary) into a private account for 40 years. Let's optimistically assume annual fees and other expenses of 12% (it may even be higher) and a similarly optimistic average annual return of 7% (Krugman predicts 4% is more typical, but let's be generous).
Meanwhile, Retiree B pays the same amount, $1,000 a year into social security for 40 years, with the current annual fees and overhead of 2%, and let's assume a stingy average annual return of 2% from nice, safe, government bonds (which probably would deliver a higher return in practice).
By my calculations, even using these generous assumptions, at the end of 40 years Retiree A has $16,994 in his private account, whereas Retiree B has $40,000 in his government-run social security account, a whopping $23,006 (or 135%) greater than Retiree A. That's because Retiree B only paid $16,000 in fees over the 40 years, compared to Retiree A's $55,214. The fees and other overheads in Retiree A's plan more than eats up the benefits of a higher rate of return.
So ignoring the intricacies of financial models, and all the other arguments against privatization, the winning argument in this debate is the idea that if you put your money into a private social security account, then good luck to you in your old age, because an investment broker will be spending your government pension (and many other people's) on retiring in luxury while you struggle to live off the dregs of what's left.
It's not just a coincidence that in Chile so many retirees live in poverty...
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