Is social security the mother of all Ponzi schemes?

Ponzi scheme created by New York businessman Bernard Madoff may
result in losses of US$50 billion. This has invited some commentators
to raise the point that America's Social Security system is an even
bigger pyramid scheme. For example, Cliff Mason of CNBC calls Social
Security The
Real "Mother Of All Ponzi Schemes"
(For international readers, let it be noted that Social Security is
what public pension schemes are called in the United States.)

a reply to such claims, Ponzi's biographer, journalist Mitchell
Zuckoff, recently wrote that it
is not accurate to call public pension schemes Ponzi schemes
I agree. However, even if journalists and news commentators sometimes
get overly excited about their opportunity to raise a provocative
point, they are not necessarily entirely mistaken either. Such is the
case here.

significance of the issue becomes clearer when you consider that the
United States Social Security is among the least problematic public
pension schemes in the world. It may not be the best run of such
schemes (I'd say that ours in Finland is), but most US citizens are
not so dependent on governmental assistance in retirement. In most
European countries, the majority of people have virtually nothing
else than the public pensions to rely on.

let us briefly examine the economic and moral nature of public
pension schemes by analyzing three arguments put forward by Zuckoff
in defense of Social Security.

and rates of return

first argument is that "Social Security is exactly what it
claims to be: A mandatory transfer payment system under which current
workers are taxed on their incomes to pay benefits, with no promises
of huge returns."

is correct. Like most public pension schemes, the Social Security is
a pay-as-you-go (PAYG) scheme in which current worker are paying for
the current – not future – retirement benefits.

the true nature of public pension schemes has not always been clear,
and I doubt that it is clear to all today. Many governments make
calculations of workers’ expected retirement benefits, giving the
impression that their retirement wealth is guaranteed and is already
“somewhere out there.” (This is analogous to the way bank
deposits are called “deposits” even though legally they are debt,
and just a small proportion of the money is in the vaults.) Yet in
reality, governments remain free to alter the benefit formulas
unilaterally – there is no contract between taxpayers and
government – and they probably will be forced to do so in the
not-so-distant future.

to say that governmental pension savings entail “no promises of
huge returns” is quite an understatement. Most public pension
schemes offer basically no positive returns whatsoever. In PAYG
schemes, the rule of thumb is that the return rate on contributions
is equal to the growth rate of the labor force plus the growth rate
of productivity. In countries with below-replacement fertility rates,
this may translate into negative rates of return. Moreover,
population ageing is going to require significant reductions in
pension benefits, so that future retirees may receive just a small
proportion of the money they poured into the system. Thus the
situation is particularly alarming in European countries in which
fertility rates are very low and most people have little else to rely
on in old age.

doomed to fail

Zuckoff submits that unlike pyramid schemes, “Social Security isn't
automatically doomed to fail."

But the expression “automatically doomed to fail” sets the
standard rather high. As far as I can tell, human behavior is never
fully predetermined (except in the sense that we cannot but seek
happiness). The relevant question is here is whether, for all
purposes, public pension schemes are viable. In the respect, my
prognosis is dim.

prevent the failure of public pension schemes, benefit formulas will
have to be changed. But – lo and behold – this is not a magic
trick that creates new resources out of thin air: it simply amounts
to telling people they’ve just lost their hard-earned savings.
Besides, the increasing pressures on public pensions will undoubtedly
– I sorrowfully acknowledge – give further support to those that
simply want to kill our elderly parents (or us!) in the name of
forced euthanasia.

speculations aside, can governments change benefit formulas? In a
piece entitled “Grey
Power Time Bomb

Professor Philip Booth argues that it’s easier said than done, at
least in democratic countries. The ageing of populations will make
retirees (and near-retirees) an increasingly powerful section of
voters, who naturally do not wish to give up their benefits. Younger
generations tend to be less interested in pension politics, as
retirement is a faraway notion to them.

do not wish to blame retirees for their demands. But the consequences
are problematic. Politicians are reluctant to confront the issue,
hoping instead that the next generation will solve it. That is
dangerous, because when problems are not faced, they keep growing.

the rich, and other dilemmas

third argument for Social Security is that it is morally worthy. As
Zuckoff frames it: “At the height of the Great Depression, our
society (see "Social") resolved to create a safety net (see
"Security") in the form of a social insurance policy that
would pay modest benefits to retirees, the disabled and the survivors
of deceased workers. By design, that means a certain amount of wealth
transfer, with richer workers subsidizing poorer ones."

do not deny that there is an aspect of solidarity in public pension
policies, especially in their early stages, and that solidarity is an
essential feature of humane societies. But matters are more complex,
and rhetoric is no substitute for truth.

has been disputed whether public pension schemes really subsidize the
poor. In an important study entitled “The
Progressivity of Social Security
economists Coronado, Fullerton and Glass demonstrated that under
reasonable assumptions, the US Social Security is on the whole not
progressive but actually regressive.
In the language of ordinary people, that means that it is the poor
subsidizing the rich, not the other way around. The main reasons for
this are that better-off people spend more time studying (hence they
contribute a smaller number of years), and they tend to live longer
(hence they receive a longer pension). In individual cases Social Security may help the needy, but it does not mean that
it constitutes net
wealth transfers
their favor.

are other moral dilemmas too. Some time ago I argued that large
public pensions tend to promote low fertility rates
The crux of the argument is that the social assistance state has
replaced families, extended families and other primary organizations
as providers of assistance in old age. It has also made it relatively
more expensive to have a large family today. The substitution of the
state for the family seems to have been a conscious goal of the 19th
century German statesman Bismarck – who created the first-ever
public pension scheme – and in that at least he has succeeded.

is also strong evidence that the inappropriate design of public
pension schemes has in many countries persuaded people to retire too
quickly, causing both unnecessary economic burden and psychological
adaptation problems. These are not just economic problems, but moral
ones too.

families first

for criticism: What should be done about public pensions? There is no
simple solution to such a complex issue, but here are my general
ideas based on the classical notion of prudence, or practical

first step of prudent action is to look at the reality as it is. One
implication of this is greater transparency with pension debt. In a
recent paper entitled "A
Bankruptcy Foretold: The UK’s Implicit Pension Debt
actuary Nick Silver calculates that if the government’s
contribution-based pension promises are included, UK Government debt
is now £4,097 billion, or £70,000 per person. That implies a
national debt of 276% of GDP, as opposed to the official figure of
43% of GDP. In light of deteriorating public finances, it is worth
asking how it is going to be paid, if ever.

calculations demonstrate the sheer magnitude of pension promises –
and the increasing difficulty with actually delivering them. If such
is the case in the UK, one can only wonder what the figures would
look like in countries such as France, Germany, Spain and Italy. And
if this is the where we are after less than a century of public
pension schemes, are
they really worth salvaging?

second step of prudence is to compare the strengths and weaknesses of
all the alternatives – not with prejudice and attachment, but
honestly and courageously. The history shows that there are plenty of
non-governmental ways of providing for old age: families and extended
families, mutual
aid societies
charities and other voluntary organizations, part-time work and
personal savings.

fundamental principles are especially pertinent here. The principle
of subsidiarity
demands that these primary organizations and solutions are given
freedom of action without unnecessary government interference – or
replacement. The state should only step in to coordinate and correct
manifest problems, but even then one must not overestimate its
ability to do so without errors.

correlative principle of
requires that all people are taken care of, and for this reason there
may be some scope for government action. But here too one must
remember that the state can only provide coordination and financial
assistance – by its nature it is a legislature and a bureaucracy,
not a substitute family and community.

third and final step of prudence is judgment and action. Sometimes
caution is called for – but not always, and never in excess. It is
not always prudent – let alone just – to wait, like the Swedes
are said to do, until others act first so that we can avoid repeating
their mistakes.

age security is a complex matter, and there is a degree of sheer
choice involved. The following statement by the medieaval Catholic
philosopher Thomas Aquinas is worth keeping in mind by all who are
responsible for the fate of nations – which ultimately includes all
of us: Non potest
certitudo prudentiae tante esse quod omnino solicitudo tollatur

the certitude of
prudence cannot be so great as completely to remove all anxiety.

Juurikkala is author of Pensions,
Population, and Prosperity
(Acton Institute, 2007) and co-editor of Pension
Provision: Government Failure Around the World
(Institute of Economic Affairs, 2008). He is currently working on a
PhD on financial markets regulation.


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