What To Do About Pensions?
The New York Times has an editorial about the state of our 401(k) plans: Editorial – From Here to Retirement – and the issues that are now arising as a whole cohort of workers approach retirement just as their primary saving vehicle has been destroyed.
The issues are worth delving into at length, but here I want to touch on only a few:
First: Americans just don’t save enough. The savings rate in the US has dropped from over 10% of annual wages to practically nothing in the last three decades. This is simply unacceptable. A country that produces no net savings is living precariously and has absolutely no room for maneuver during economic downturns. Savings are not supposed to be just for retirement, but are also to provide a cushion against the potential loss of earnings due to things like unemployment. Instead of saving Americans have used credit as a way to cover expenses: this is disastrous when credit markets tighten and no one is willing to lend. It’s time to ensure that the savings rate goes back up.
Second: the macroeconomic impact of low American savings has been to encourage the flow of cash into the US from abroad. Global credit markets have channeled money from high savings countries like China and Japan into the US. So Americans have become major international debtors. Further, the flow of cash became a flood in the last few years and was a major contributor to the real estate bubble: without the inflow of cash house prices could not have inflated at the rate they did because credit conditions would have been tighter and bulk of the marginal, riskier, lending that fueled the boom would never have taken place. So the lack of savings played a direct role in destabilizing our economy.
Third: Low wage growth is often cited as one reason why Americans felt compelled to borrow so much. This may be true. But we must not avoid the criticism of the use of housing as a savings vehicle. Low wage growth at the same time as massive asset price inflation enabled employers to resist giving solid wage increases because employees who were lucky enough to own a home could augment their lifestyle by using home equity lines. This sounds tenuous, but I think there is a genuine cause and effect worth investigating here: downward pressure on wages produced a market where it was difficult to save a reasonable amount. Normally this would increase agitation in labor markets. It didn’t. One possible contributory factor may have been the so called ‘wealth effect’. People felt wealthy even though their incomes were not rising because their home values were skyrocketing. They felt part of the vaunted ‘ownership’ society, and so opposed industrial action over wages. Now they are left without either wage growth or home value, and so are being forced to retrench even more than the fundamentals of the economy suggest is necessary.
Fourth: Giving tax advantages is a poor way to encourage savings. We have had IRA’s and 401(k) plans for many years and still the savings rate declined. It is not clear, from the record, that tax cuts for savings works. Besides the part of the work force most exposed during any downturn is the low wage group. Tax cuts for people who pay little or no tax provides no incentive for anything, let alone saving.
Fifth: Studies show that ‘forced’ savings are the best possible way forward. The way to accomplish this is by making savings an obligatory deduction from wages unless the employee opts out. Such ‘opt out’ plans are far more effective as a public policy method to encourage savings and should become the norm rather than the exception.
Lastly: I hope that our current predicament puts to an end once and for all the notion that Social Security should be privatized. Anyone who contemplates privatization as serious public policy is clearly deliberately missing the point. Private accounts look wonderful when the stock market is booming and returns are way above the much lower return embedded in Social Security. During prolonged downturns in the stock market, however, the opposite is true. I remain highly skeptical that most Americans are capable of managing a retirement portfolio for themselves: even few professionals have done well over the past year. In order to prevent loss on a privatized account someone would have to employ professional help or would have to be highly limited in the available choices. Either of these cases erodes the argument for privatization: professional fees would largely eliminate the advantage that market returns appear to have; and limited investment opportunities is hardly the kind of choice that privatization is supposed to bring.
Retirement savings, plans, and policy are all going to become significant areas for debate. Especially given the convergence of the baby boom retirement wave which is now upon us, and the collapse of our faith in the private financial system.
This is an important discussion to be having and I think that ‘opt-out’ plans play a significant role in the solution to the problem, along with some form of delivery of better advice for the average investor. Only then can we retrieve our 401(k) plans from the calamity they now have fallen prey to.
