Thursday, March 04, 2004

Brad DeLong Explained

Brad has an interesting post up about his survey of economists regarding the Larry Lindsey "Free Lunch" Social Security privatization plan. As Brad DeLong explains, what Lindsey wanted to do is borrow a bunch of money at the nice low rates the government can get, and then invest the money in the stock market. Since stocks, on average, have slightly higher returns over the long run (though not quite as high as is sometimes claimed), the government collects the difference. The fascinating (and by fascinating, I mean really screwed up) part is that this little plan would have the beneficiaries bear the entire risk of these investments, but none of the potential rewards. In other words, Larry would take your money, invest it for you, and if your investments made any extra money he'd just take it to finance payments to current SS recipients. Some people tried to claim this plan would be "voluntary." But, only an idiot would sign up for a plan which increased your risk without increasing your expected return. There are plenty of idiots, but not enough to finance Larry's dreams.

But, I thought Brad's fourth paragraph needed a bit of explanation. DeLong says:

I am midway through a survey of serious economists who have thought about the issues seriously, and I now have eight back-of-the-envelope point estimates of the amount of money that could be raised to save Social Security through the Lindsey-Feldstein-Samwick plan for saving Social Security...

...Two more say zero: even though there is compelling evidence that the equity premium is excessively high from the government's perspective--that the government is so risk-tolerant an institution that the expected risk-adjusted profits from the government's going short Treasuries and long stocks--the Lindsey-Feldstein-Samwick plan transfers the risk that the stock market will tank from the government back to Social Security beneficiaries, and there is no compelling reason to think that beneficiaries have enough risk tolerance to make this a good tihng to do.

What this is saying is that even though these two economists believe that if we made a best guess about the outcome, that it would a net benefit revenue wise for the government. However, since people dislike risk, it would, ex ante at least, make them worse off.

But, in any case - the whole thing is just nuts. If Larry and friends are so convinced that investing my social security contributions in the stock market is such a great idea, then the government can bear the risk of those investments. Why the hell would I want to increase my risk without increasing my expected return? I wouldn't. And nor should you. And nor should anyone with a brain.