Social Security: Thinking about Pay As You Go

Robert J. Samuelson has a column in today's Washington Post questioning whether or not Social Security today is the program that Roosevelt wanted. I don't know the history well enough to have an opinion, but his statement that "Roosevelt rejected Social Security as a “pay-as-you-go” system that channeled the taxes of today’s workers to pay today’s retirees. That, he believed, would saddle future generations with huge debts — or higher taxes — as the number of retirees expanded," resulted me thinking about pay as you go systems. My main thought was, for an economy as large as the United States, what could a Social Security system possibly be other than pay as go?

As Samuelson points out, "in 1960, there were five workers per recipient; today, there are three, and by 2025 the ratio will approach two."

This fact remains whether or not Social Security was pay as you go. What difference would it make if it had been saved? We could perhaps have bundled dollar bills paid in into giant bales and stored them in a vault until needed, but this would do nothing but drive inflation when they were taken out. We can do this anyway through monetary mechanisms to drive production and reduce debts without the absurdity of bailing dollar bills.



Alternately, this money could have been invested in capital markets, but capital depreciates and, in aggregate, has diminishing marginal returns. What good would this additional capital have done, it would be depreciated by the time the labor crunch comes. This has the same problem as pay as you go, the labor supply ratio is still less beneficial and the capital is being invested at the wrong time for the wrong labor force conditions. Trying to drive investment beyond its efficient level will result in little more than bridges to nowhere and stock buy-backs. What good would this do?

A more sensible alternative would be foreign exchange reserves. But even here, most countries have demographic problems similar to the US. Accumulating these reserves would involve considerable risk, the stable economies are facing the same labor force problems we are so trade among a group of countries with declining labor force to population ratios doesn't achieve much. Currency reserves in emerging markets might help, but this is gambling with our savings. Go back and read about some of the greatest hopes of the 1950s or 60s, few of these are grand success stories today. This approach would achieve something, but not that much and would have faced substantial political opposition.

Another, rather absurd, approach would be to store commodities to drive prices down and raise output when demographics turned unfavorable. This would have the impact of slowing growth when demographics are favorable and raising it when demographics become unfavorable. However, there is no way to be certain what future resource demand will be, technological shifts may make some resources lose value. Also, it is not certain that current investment would not have a higher payoff than stored commodities.


Ultimately, while this column has some good things to say about the optics, people do feel their Social Security contributions are safely "saved," it retains the flaw that while an individual or small country can defer consumption an economy the size of the US really can't. For the US as a whole we can't defer consumption till later by saving, we can produce whatever current factors of production can produce. We can attempt to invest to increase future production, but this doesn't impact future dependency ratios, the system is still ultimately pay as you go. At an aggregate level all Social Security funds have to be currently spent, there is simply no way to save them. All we can do is choose whether we will spend them to increase our capital stock, increase the quality of our labor force, reduce current obligations to other creditors, or squander the money on useless projects.

Given that the increasing dependency ratio is the major factor here, the most sensible outcome would have been to focus on labor force reproduction and skill levels. However, much of this gets labeled as consumption, despite strong data indicating that spending on healthcare, income security, and early childhood programs are strongly associated with future earnings and income mobility. Unfortunately for us, little thought is given in the US to the merits of the development state, we remain bound to dated 19th century notions of the economy that exaggerate the role of capital while ignoring the tendency to overinvestment when the labor force has failed to keep up with capital spending. The US isn't a household, programs like Social Security can't work for the US as a whole the way a savings account works for a household. We need to increase the factors of production and in the US land is basically fixed, we have an abundance of capital, but our labor force, particularly the future part of it with low income parents, isn't in the best shape. Other countries have done better, the US has been declining in the rankings of labor force quality, such as educational attainment, as our social programs have failed to expand at international rates (50 years ago the US had as strong, or stronger, social programs than other countries). We don't have much time left and thinking about Social Security as saving isn't going to help us. We have to focus on labor and the dependency ratio whose increase is the ultimate source of the problem. Unfortunately, I don't see that happening.