Soc Sec XL: Double books and the ‘No Economist Left Behind’ Challenge

In November of 2004 Dean Baker issued his ‘No Economist/Policy Analyst Left Behind’ challenge. In it he asked people to show that they could produce the 6.5% return on stocks assumed by the Council of Economic Advisors under the actual economic projections of the Intermediate Cost alternative. (Oddly enough for an open and public challenge this has been moved behind a CEPR firewall. For those of you who have access the link is here) {Per D R in comments this was just a glitch that will be fixed shortly.}

Baker couldn’t make it work. He came up with something like 4.9% (the actual number being behind that firewall).

Then Krugman and Baker together took a shot at it with Krugman reporting results back as follows: No Economist Left Behind (the link goes to a blog post from Feb 2005 and not to Krugman himself).

The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.

The price-earnings ratio – the value of a company’s stock, divided by its profits – is widely used to assess whether a stock is overvalued or undervalued. Historically, that ratio averaged about 14. Today it’s about 20. Where would it have to go to yield a 6.5 percent rate of return?

I asked Dean Baker, of the Center for Economic and Policy Research, to help me out with that calculation (there are some technical details I won’t get into). Here’s what we found: by 2050, the price-earnings ratio would have to rise to about 70. By 2060, it would have to be more than 100.

And just to put another nail in the coffin Baker and Krugman joined together with DeLong to author Asset Returns and Economic Growth otherwise known as ‘BDK’. Those inclined can read the whole thing. (Beware. What they call ‘Arithmetic’ doesn’t look anything like your fifth grade math class. And what they call ‘Algebra’ doesn’t match my 9th grade experience. But if you like lots of Greek letters and exponents feel free to take a shot at it.) In any event the baseline answer was ‘No’.

I don’t always agree with every single opinion of Baker, DeLong or Krugman. But when they all have their Economist hat on and end up pulling the wagon in the same direction my inclination is to jump on the wagon and not stand in the way and get crushed under the wagon wheels.

The point is that it is pretty clear that most privatization or personal account plans implicitly build in a better set of economic assumptions than the one projected by the Trustees. The problem is that they generally refuse to acknowledge that the NELB challenge exists. Now it is a little unfair to make that charge against the Ferrara Plan, because the version linked is dated a full seven years before the date of Dean’s challenge. But even so you would think the contradiction would be pretty obvious. On the other hand the Liebman, MacGuineas, Samwick Non-Partisan Social Security Reform Plan was published in final form a whole year after NELB. Yet all we see is a vague appeal to an ‘Expected Yield on Mixed Portfolio’. Maybe there is some extended version that actually lays the numbers out and shows them meeting the NELB challenge, all I know is that after years of asking no one actually has been able to point me there.

In running a conventional business having one set of books to show the auditors and tax men and another to show to your investors is a recipe for a little stay in your nearest minimum security Club Fed. But in selling Social Security ‘reform’ it seems to be business as usual.

Since I can’t get access to their numbers there is no way to confirm what I have suspected for years. Not only do these guys know that Low Cost is out there, they are counting on similar numbers to make their PRAs work. The idea being taking ordinary economic growth, growth that would fully fund Social Security anyway, and hijack the results to ‘prove’ that private accounts are superior to traditional Social Security.

Hold their feet to the fire. Demand that they can meet NELB with numbers less than those of Low Cost. Otherwise it is all a game of bait and switch.