Prescott on Social Security Reform

Recent Nobelist Ed Prescott comes out swinging for social security reform in a fine article in the WSJ. 

Some politicians have vilified the idea of giving investment freedom to
citizens, arguing that those citizens will be exposed to risks inherent in the
market. But this is political scaremongering. U.S. citizens already utilize
IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank
you….Consumers already
know how to invest their money — why does the government feel the need to
patronize them when it comes to Social Security?

It would be one thing if the government’s Social Security system
paid a decent return, but as the President’s Commission reported, for a single
male worker born in 2000 with average earnings, the real annual return on his
currently-scheduled contributions to Social Security will be just 0.86%. … A bank would have to offer a pretty fancy toaster to
get depositors at those rates of return.

Further, about two dozen countries have reformed their state-run
retirement programs, including Chile, Sweden, Australia, Peru, the U.K.,
Kazakhstan, China, Croatia and Poland. If citizens in these countries can handle
individual savings accounts, especially citizens in countries without a history
of financial freedom, then U.S. citizens should be equally adept. At a time when
the rest of the world is dropping the vestiges of state control, the United
States should be leading the way and not lagging behind.

Prescott sees two economic benefits of private accounts, higher savings and greater labor supply (see my earlier post).  Brad DeLong has argued that investing in the market makes sense only if the equity premium is a market failure and not a response to risk.  At best, however, the market failure argument is a sufficient but not necessary reason for market investment.  We don’t really understand the equity-premium, however, so Prescott is right to focus on higher savings and greater labor supply – neither of these benefits of private accounts requires a non risk-adjusted premium.  Prescott’s focus is especially revealing because it was he and Rajnish Mehra who first brought the profession’s attention to the equity-premium puzzle.