[lbo-talk] Krugman: Many Unhappy Returns

Michael Pollak mpollak at panix.com
Tue Feb 1 10:46:53 PST 2005


[Doug made this argument in 1998:

http://www.leftbusinessobserver.com/AntisocInsec.html

and he was like a voice of reason in the wilderness. When I read it, got excited, and cited it to someone who now writes editorials for the NYT, she looked at me like I was championing cold fusion. Now, 7 years later, it's finally become mainstream:

http://www.nytimes.com/2005/02/01/opinion/01krugman.html

One more reason to subscribe!

But even though he's late to the game, gotta give Krugman his due: even for him, this is a very good column. He's probable only one any editor will let use this many numbers in a family paper.]

The New York Times February 1, 2005

OP-ED COLUMNIST

Many Unhappy Returns

By PAUL KRUGMAN

T he fight over Social Security is, above all, about what kind of

society we want to have. But it's also about numbers. And the numbers

the privatizers use just don't add up.

Let me inflict some of those numbers on you. Sorry, but this is

important.

Schemes for Social Security privatization, like the one described in

the 2004 Economic Report of the President, invariably assume that

investing in stocks will yield a high annual rate of return, 6.5 or 7

percent after inflation, for at least the next 75 years. Without that

assumption, these schemes can't deliver on their promises. Yet a rate

of return that high is mathematically impossible unless the economy

grows much faster than anyone is now expecting.

To explain why, I need to talk about stock returns. The yield on a

stock comes from two components: cash that the company pays out in the

form of dividends and stock buybacks, and capital gains. Right now, if

dividends and buybacks were the whole story, the rate of return on

stocks would be only 3 percent.

To get a 6.5 percent rate of return, you need capital gains: if

dividends yield 3 percent, stock prices have to rise 3.5 percent per

year after inflation. That doesn't sound too unreasonable if you're

thinking only a few years ahead.

But privatizers need that high rate of return for 75 years or more.

And the economic assumptions underlying most projections for Social

Security make that impossible.

The Social Security projections that say the trust fund will be

exhausted by 2042 assume that economic growth will slow as baby

boomers leave the work force. The actuaries predict that economic

growth, which averaged 3.4 percent per year over the last 75 years,

will average only 1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to

get that 6.5 percent rate of return, stock prices would have to keep

rising faster than profits, decade after decade.

The price-earnings ratio - the value of a company's stock, divided by

its profits - is widely used to assess whether a stock is overvalued

or undervalued. Historically, that ratio averaged about 14. Today it's

about 20. Where would it have to go to yield a 6.5 percent rate of

return?

I asked Dean Baker, of the Center for Economic and Policy Research, to

help me out with that calculation (there are some technical details I

won't get into). Here's what we found: by 2050, the price-earnings

ratio would have to rise to about 70. By 2060, it would have to be

more than 100.

In other words, to believe in a privatization-friendly rate of return,

you have to believe that half a century from now, the average stock

will be priced like technology stocks at the height of the Internet

bubble - and that stock prices will nonetheless keep on rising.

Social Security privatizers usually defend their bullishness by saying

that stock investors earned high returns in the past. But stocks are

much more expensive than they used to be, relative to corporate

profits; that means lower dividends per dollar of share value. And

economic growth is expected to be slower.

Which brings us to the privatizers' Catch-22.

They can rescue their happy vision for stock returns by claiming that

the Social Security actuaries are vastly underestimating future

economic growth. But in that case, we don't need to worry about Social

Security's future: if the economy grows fast enough to generate a rate

of return that makes privatization work, it will also yield a bonanza

of payroll tax revenue that will keep the current system sound for

generations to come.

Alternatively, privatizers can unhappily admit that future stock

returns will be much lower than they have been claiming. But without

those high returns, the arithmetic of their schemes collapses.

It really is that stark: any growth projection that would permit the

stock returns the privatizers need to make their schemes work would

put Social Security solidly in the black.

And I suspect that at least some privatizers know that. Mr. Baker has

devised a test he calls "no economist left behind": he challenges

economists to make a projection of economic growth, dividends and

capital gains that will yield a 6.5 percent rate of return over 75

years. Not one economist who supports privatization has been willing

to take the test.

But the offer still stands. Ladies and gentlemen, would you care to

explain your position?

Copyright 2005 The New York Times Company



More information about the lbo-talk mailing list