Wednesday, May 18, 2011

Alternatives to Social Security

Matthew Ygelesias tackles the difficult question of what is the alternative to a government run universal pension plan. After all, if we want to replace the current system of government run pensions then it makes sense to have an alternative.

The results are pretty dismal.

So where else does the money come from? Well:

— Defined benefit pensions.
— Labor income.
— Private savings.

These three alternatives are all deeply problematic. The problems with defined benefit pensions in the public sector (chronic underfunding, etc.) are well-known, and in the private sector those problems are even more severe. Labor income is not a realistic option for people over a certain age. And private savings are, frankly, a disaster. As a country, we’ve tried to deal with the decline of defined benefit pensions by encouraging the mass middle class to engage in private retirement savings with 401(k) plans, IRAs, etc. And it doesn’t work. On the one hand, people don’t save enough. On the second hand, the tax policy is deeply regressive. On the third hand, virtually 100 percent of the management fees extracted from customers through these vehicles are value-destroying rents. On the fourth hand, it’s extraordinarily difficult for a middle class person to properly diversify his portfolio. And on the fifth hand, widespread ownership of index funds and mutual funds undermines corporate governance.

I think the drawbacks to the first two approaches are well known. But the concerns about the government savings vehicles are very thought provoking. Instead of a single (fatal objection), like the first two options, he lists a series of smaller problems that add up to a big issue. That being said, the issue of people not saving enough is always a concern.

I'd say that there is one more issue, though, that we should consider. Older adults are more easily subject to fraud on the part of either third parties or their money managers. It's not always clear that they have strong advocates. So even if people saved enough, the third option has the sixth downside of being vulnerable to theft in a way that pensions and labor income are not.

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