Man Without Qualities

Sunday, March 23, 2003

Krugmania At War: Five Million Years To Earth

Paul Krugman's most recent column demonstrates that his famous prediction of January 29, 2002 ("I predict that in the years ahead Enron, not Sept. 11, will come to be seen as the greater turning point in U.S. society.") was in fact correct, if properly construed! Herr Doktorprofessor Krugman now makes clear that he intended his famous prediction to be taken as a statement of his personal policy. That is, Herr Doktorprofessor Krugman was entirely correct on January 29, 2002 to predict that he personally would ignore many of the most important consequences of September 11, while eagerly adopting the accounting and disclosure standards and practices he personally attributes to Enron.

An exquisite sense of timing causes him to assert that "On almost every front the outlook for the United States now seems far bleaker than it did two years ago, on the very the day his own newspaper informs us stocks soared ... sending the Dow Jones industrial average to its best weekly performance in more than 20 years. ... After weeks of gloom about a possible war, investor sentiment has reversed quickly. Of course, because the two-year period to which he draws our attention includes September 11, 2001, one might quibble with, let us say the taste and judgment, of his final triumphant if cliched misquote of Shakespeare: The fault lies not in our stars, but in our leadership. But ascribing blame for September 11 is not what the rest of the column is about, so let's not tarry there.

Herr Doktorprofessor's new column deliberately ignores the very developments which drove the Dow average to its eighth day of gains, a gain of almost 1,000 points since its March 10 low (He says that "all Americans now hope that the foreign front proceeds according to plan. Meanwhile, let's talk about the fiscal front."). Instead, he prefers to discuss a "study" that purports to calculate the "actuarial balance" of Social Security by comparing the amount of federal revenue expected to be "lost" from tax cuts obtained and proposed by the Bush Administration over the coming seventy-five year period with prospective deficits of Social Security and Medicare over that period. It is essentially a simple "discounted present value" exercise based on an assumed discounting interest and various future payments flows. He embraces this "study," which he describes only as "a new study that compares the size of the Bush tax cuts with that of the prospective deficits of Social Security and Medicare ... carried out by the Center on Budget and Policy Priorities" without disclosing that (1) the CBPP is a partisan liberal advocacy group, or (2) at least one author of the "study" is a former senior member of Bill Clinton's economic team, or (3) the "study" surreptitiously employs the long-discredited "lockbox" model of Social Security, or (4) the interest rate employed by the "study" for discounting purposes is likely incorrect and misleading, or (5) the "study" ignores all pro-growth, supply-side effect of the Bush tax cuts, although the debate on this point has concerned the size of that effect or (6) the 75 year period on which the "study" is based makes the effects of the Bush tax cuts seem worse than they really are, or (7) the "actuarial balance" of private insurance companies are not based on a fixed period (such as 75 years) because of exactly such distortions, although Herr Doktorprofessor describe the "study" as performing an estimate the "actuarial balance" of Social Security and Medicare the same way a private insurance company would. Of course, the choice of a 75 year period attracts attention at once. Why 75? Why not, say, 120 - the traditional maximum human life expectancy. Why not 5,000,000?

But Herr Doktorprofessor goes Enron one better - he includes no footnotes to his assertions at all - confusing, incomplete or otherwise.

I would like to add just a few more footnotes that a version of the Securities and Exchange Commission charged with maintaining intellectual honesty in the marketplace of ideas would surely require Herr Doktorprofessor to include in such columns to escape intellectual criminal liability. Perhaps the largest scale and material misrepresentation in this column is that this "study" - even if its methodology were corrected - could serve as significant support for of his assertion that "nothing short of an economic miracle can save us from a fiscal crisis."

Private defined benefit retirement plans - which is what the "study" analogizes to Social Security - have existed for a long time, and calculating their actuarial balance has generally been useful for investors in determining certain solvency risks - that is, the chance that the private pension plan will not be able to pay what it owes. That is not very true of Social Security. For example, unlike COLA-burdened Social Security, a traditional private defined benefit plan pays nominal returns - if inflation occurs, the retiree loses, but the plan's solvency is generally enhanced. Solvency of such plans is generally enhanced because the plan's income from any short-term investments will nominally increase (and nominal income from long-term investments such as long term government bonds will not be generally affected). Of course, the plan may have trouble attracting new members because the real value of the defined benefits it is paying out decline along with the real value of the inflated dollars in those payments. But the current members generally can't pull out - a defined benefit plan is not an open-ended investment company. In contrast, Social Security has no income from any real investment fund to finance its obligations - to the extent Social Security is not funded by taxes it is funded by an "investment pool" of federal government obligations. But Social Security itself is already a federal government obligation.

The actuarial balance for a transfer payment program such as Social Security is not wholly without novelty or interest. But, unlike the private plan case, the actuarial balance of Social Security has something of the novelty and interest of, say, thinking about the burn-out of the sun in 5 billion years (or is it 4 billion?). That's because Social Security's future is largely determined - for good and ill - by factors a private plan does not need to take into account when it calculates its actuarial balance. Consider inflation, for example. Herr Doktorprofessor Krugman has just told us that he is terrified that the federal government is going to start inflating the currency to "pay" the federal debt. But wouldn't a government that is going to do that also likely to limit Social Security COLA bumps, and then inflate away Social Security's obligations, too. As noted above, that's what would happen to the beneficiaries of the typical private defined benefit plan in the event of all that feared inflation - why should Social Security recipients be expected to do better than other people holding government obligations? I'm not saying that inflation is threatened, or that it would "solve" the Social Security mess, but I frankly cannot understand why something that only last week preyed so heavily on Herr Doktorprofessor's mind that he refinanced his mortgage is now just so much dross, not even worth a mention.

The reasons the actuarial balance of a universal public transfer payments retirement program such as Social Security is not that significant compared with the private plan case don't stop with inflation. Seventy-five years ago no one could have usefully predicted the baby-bust of the Depression and Second World War, the Post-War Baby Boom, the new immigration wave (including the education and productivity levels of the new immigrants) - and, of course, wide-spread birth control and the break-down and shrinkage of the family together with the demographic consequences of these developments. All of those developments have profound effects on Social Security. Would it take an "economic miracle" for the birth rate to uptick enough to have seriously positive consequences for Social Security? But, most importantly - nobody could have reliably predicted the extent to which Congress would continually ratchet up Social Security benefits. And the effects of that Congressional tendency, or any countervailing Congressional tendency to modify such benefits rather than demolish the finances of the government, is completely omitted in "doing the math." Those effects are found only in the interstices of the democratic process.

Which may explain why Herr Doktorprofessor misquotes that Shakespeare. The original line from Julius Caesar is much more apposite:

The fault, dear Brutus, is not in our stars, But in ourselves.

That's often the case in a democracy.

UPDATE: Markets continue to be strongly influenced by the results of September 11 - but not Herr Doktoprofessor.

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