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Passive Investor?

January 27, 1999

Investors Business Daily
January 27, 1999
Author: Charles Oliver

Is it the back door to socialism or the only way to keep the Social Security system solvent?

That's what people are asking about President Clinton's proposal to invest a big chunk of the federal budget surplus in the stock market.

Under Clinton's proposal, the feds would pump some $2.7 trillion of general tax revenue into Social Security over the next 15 years. About 25% of that money, nearly $700 billion, would be invested in stocks.

The idea is to take advantage of the higher returns from the stock market to shore up the wobbly Social Security system. That system will go bankrupt by 2032 unless changes are made. The administration claims its plan would cut about half of the system's long-term shortfall.

The only alternatives aren't very attractive: Either raise taxes or cut benefits.

That's why government investment was backed by six of 13 members of the 1994- 96 Advisory Council on Social Security, a commission established by the federal government.

''Clearly, any proposal that adds resources to the Social Security system helps,'' said William Cheney, chief economist at John Hancock Financial Services.

But letting the government invest in stocks would be a giant step toward socialism or fascism, critics warn.

Socialism is state ownership of the means of production. And fascism is state control of the means of production under the fiction of private ownership.

Either way, if government owns a big chunk of the American economy, private ownership will get undermined.

''Government investing is fraught with peril,'' said Paul Kasriel, chief economist at Northern Trust in Chicago.

One troubling aspect of federal investment is the sheer size of the funds it can throw around.

Treasury Secretary Robert Rubin says the amount the administration wants to invest would equal only about 4% of the market.

But that isn't a small share, critics say.

''Experience has shown that even a 2% or 3% block of shares can give an activist shareholder substantial influence over the policies of publicly traded companies,'' wrote Michael Tanner, director of health and welfare studies at the Cato Institute.

And that assumes the investment cash is spread fairly evenly. There's nothing to stop the government from taking much larger stakes in a few companies.

How might the government wield that influence? Some say pension funds for teachers and state workers provide clues.

''These funds have often been forces that help make firms they've invested in more efficient,'' said Jeff Scott an economist at Wells Fargo. ''They've held management's feet to the fire when the stock wasn't performing well, and forced needed changes.

''But probably just as often, they've advocated politically correct policies that don't have anything to do with getting stock prices up or getting the best returns for pensioners,'' he said.

For instance, many pension funds bar investment in firms that are accused of ''unfair'' labor practices, pollution, failing to meet affirmative-action goals, or that sell alcohol, tobacco or weapons.

''Clearly, government managers face a different set of incentives than private managers. They're subject to all sorts of different political pressures,'' said Richard Salsman, senior economist at H.C. Wainwright & Co.

Of course, influence peddling may not flow just in one direction.

''Take the antitrust suit against Microsoft,'' Kasriel said. ''Would the government have pursued that case if Microsoft stock was a big part of the Social Security investment? Would it have been willing to do something that might hurt a stock that has been such a big performer?''

The prospect of government ownership of firms raises fears not only of politically driven investment but of outright corruption.

''That's not a far-fetched worry,'' Kasriel said. ''Whenever there are huge sums of money on the table, people are going to try to get it. And the methods they use may not be the most ethical.''

Kasriel points to Asia as an example of what crony capitalism and politically driven investment can do to an economy.

Yet supporters of government investing say such fears are overblown.

''There's no reason in principle why we can't set up a system that shields investment decisions from political influence,'' said Joel Naroff, an economist at First Union Corp.

The administration, for instance, wants an independent board to manage investments. Board members would serve long terms to guarantee them some independence from political tides. That board might, in turn, contract out the day- to-day management of funds to private firms.

Yet if the government does take a hands-off approach to the firms it invests in, it can still cause problems.

Wells Fargo's Scott says productivity gains in the U.S. economy seen in recent years are due, in part, to the restructuring, downsizing and cost-cutting accomplished over the last 20 years. He wouldn't expect the same zeal for efficiency if the government is the majority shareholder.

''Corporate managers didn't do these things willingly,'' Scott said. ''They did them because shareholders held their feet to the fire.

''Do we think managers will have the will to do these things in the future if a big shareholder, maybe the biggest owner of their firm, is just a passive owner?'' he asked. ''I think it's more likely that management perks will start growing out of control.''

(C) Copyright 1999 Investors Business Daily, Inc.

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