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Bush-Style Privatization: More and More Problems

Tags U.S. EconomyInterventionismMonetary TheoryMoney and Banking

06/12/2005Robert P. Murphy

In a previous article, I argued that Bush's original proposal to reform Social Security—in which up to one-third of a worker's (and his employer's) “contributions” would be channeled into the stock market, but no one's current benefits would be cut and other taxes would not be raised—would not increase investment or lower interest rates one iota, contrary to the claims of the plan's proponents.

This is because the gross increase in savings made available to the market (from workers who chose to exercise this new option) would be siphoned away by increased government borrowing (made necessary by the reduction in Social Security revenues that the government would otherwise spend); on net there would be no additional funds for investment.

Interest rates would not budge, because the increased supply of loanable funds would be exactly offset by an increased demand. I concluded with a reductio ad absurdum: If the president's plan is sound, then why not extend it to other areas of the budget? Why not take money earmarked for the Pentagon and invest it in the stock market, and fund current defense expenditures through additional borrowing?

Many readers challenged various parts of my argument. Some claimed that I was attacking a strawman, because Bush never said that the government would benefit from the plan, only that the individual workers would. Others claimed that I was overlooking the reduced spending necessary to pay retirement benefits to workers who opted for the privatization plan, and that once this reduction in future government obligations is taken into account, the plan does indeed help the government's fiscal house. (Notice that these critics contradict the first ones I discussed; i.e. I'm certainly not attacking a strawman when people actually email me the argument!) 

Finally, another group of critics took my intended reductio at face value, and said that the plan is obviously feasible since the stock market yields a higher rate of return than the interest rate on government bonds (or the “rate of return” to a worker's investment in Social Security). In the present article I will clarify my view and hopefully answer some of these objections.


Something that Bush supporters need to remember is that any act of investment requires a prior act of saving, and this is true whether we are considering physical goods or money. In the former case, we can use the familiar example of Robinson Crusoe stranded on an island. If Crusoe wants to “invest,” he will devote his resources (such as his labor hours and whatever stocks of food and other supplies he salvaged from his ship) to the satisfaction of future desires.

For example, he may spend several hours collecting vines and tying them into a fishing net. These actions are not helping him at all in the present—indeed they are hurting him because he could have been using his labor to collect berries for immediate gratification. In this sense, then, Crusoe chooses to suffer a reduction in his (potential) level of current consumption of berries—i.e. he saves—in order to greatly increase his future consumption of fish. Without this antecedent saving, of foregoing possible present gratification, Crusoe wouldn't “free up” resources that he could then invest in projects yielding their results in the future.

The same is true, even more obviously, when we move from an isolated individual to a market economy using money. Here, if a woman wants to invest, say, $1000 in a corporation by buying shares of stock, she necessarily must first save $1000 from her current income. In other words, if the woman has $1000 that she uses to buy stock, then she obviously had $1000 that she could have spent on new shoes, elegant dinners, etc. Thus here too, any investment requires an antecedent decision to save; in order to reap higher income in the future, one has to suffer a reduction in (potential) consumption in the present.1

Returning now to the Bush privatization plan:  Under his original proposal, the government was not going to cut current retirees' benefits in order to mitigate the reduction in revenues that were going to be redirected out of government coffers and into the stock market. (Indeed, Bush and the Republicans expressed outrage that Democrats would engage in “scare tactics” among the elderly.)  Further, Bush explicitly denied that Social Security taxes would be increased, and one also got the impression that Bush wasn't going to raise other taxes, or cut other government programs, in order to implement his plan. As I pointed out in my previous article, the only possible way Bush could have achieved all of these promises was to increase government borrowing2 dollar-for-dollar with whatever Social Security revenues were transferred into the stock market.

But in terms of our present discussion, notice that Bush has been promising the future benefits of investment without admitting the necessary reductions in current consumption. In other words, Bush and his supporters have believed that we can increase investment by hundreds of billions of dollars without any additional saving on the part of anyone!

It is tempting to look at the workers who opt for the Bush plan and say, “Wait a second, aren't they saving?  After all, my monthly pay stub shows just how much is deducted by FICA. That's real money that I otherwise could spend on DVDs and baseball outings.”  Yes, these people are saving; they are being forced to by the government. However, as we can clearly see under the status quo, this saving doesn't translate into net investment, because it is borrowed and consumed (spent) by the government. In other words, workers in this respect are forced to live below their means, but this doesn't free up resources for the creation of tractor trailers, cargo jets, drill presses, and other capital goods, because at the same time the government is living beyond its means.3

Now notice that all of this is still true under the Bush plan. Proponents think that they are avoiding the waste of government spending by shunting funds into the stock market. But no, the government is still squandering the (forced) savings of workers under the Bush proposal, just as surely as it does under the status quo—the only difference is that today the Treasury issues IOUs to the “trust fund,” whereas under Bush's plan one-third of those IOUs would be issued to private individuals. Consider it this way:  If no current beneficiaries lose out under the Bush plan, and no worker loses out (in the form of higher taxes), then where is this extra investment coming from?  If no individual is compelled to reduce his or her current consumption by the Bush plan, then it can't possibly foster new investment.


The fundamental difference between true saving and investment, versus the phony analogs of the Social Security arrangement, is that in the former case, current consumption on net is reduced, which frees up real resources that can be used to create capital goods, raising the productivity of future workers. On the other hand, under FDR's Ponzi scheme, overall consumption isn't reduced, it is rather simply taken from one group (the workers) and given to another group (retirees, widows, etc.).

This distinction is clouded by the “rate of return” offered by Social Security; it gives the illusion that one could invest in stocks or the government. But the only reason the government could (during the 20th century) pay more to retirees than they paid into the system is that a larger generation of new workers would always enter the labor force, and could thus finance the generous benefits to the retiring cohort. This is why demographic shifts are so catastrophic to the Social Security scheme—as the age distribution changes, such that a higher percentage of the population will be retired in years to come, the government will have to either cut benefits or increase taxes (or both).

Notice that demography poses no problem to free market pensions, i.e. ones financed by actual saving and investment. In this case, it doesn't matter what happens to the age distribution in the population at large; your retirement benefits aren't being financed by premiums from current workers, but rather are drawn from your assets accumulated during your career.

To switch back to Robinson Crusoe:  He could provide for his old age by setting aside a month of every working year in order to build extra nets, fishing boats, spears, etc., that he wouldn't touch until he became too old to hunt and fish himself. At that point, he could then rent (or sell) these tools to Friday, in exchange for a portion of the catch.  

His consumption during retirement thus wouldn't be a burden on Friday, because Friday's productivity would itself be augmented by the use of the tools Crusoe had accumulated during his career. But again, this would only be true if Crusoe's saving—i.e. his abstention from possible present consumption—had been channeled into investment in such tools. If he had simply lent berries or fish to Friday, then when the latter had to repay these loans, Friday would have to greatly restrict his level of consumption since there would be no tools to augment his own labor.


As we have seen in the above section, it is very misleading to compare the rates of return of the stock market and the Social Security system, because they are fundamentally different arrangements. Indeed, it is precisely this difference that motivates many of Bush's supporters; they think that their system is at least a partial move toward genuine pensions. But this view overlooks the fact that there is still no  increase in saving under the Bush proposal (at least in its original version), and hence it can't generate net investment.

As I alluded to in the beginning of this piece, some people took my reductio ad absurdum at face value and said yes, the government should incur higher deficits in order to allow for investment in the stock market, where the returns will more than cover the costs of servicing the higher debt. There are three problems with this justification of the Bush plan.

First (and I admit that this is a bit of a pedantic quibble), even if it were true, this claim wouldn't really justify the Bush proposal. If the government can ease its fiscal situation by borrowing, say, $100 billion now and investing it in the stock market, then we don't need to “privatize” Social Security to do it. Bush and his supporters should just openly advocate issuing $100 billion in additional Treasury IOUs at 3 percent (or whatever), and investing the money in index funds where the yield will, over time, almost certainly be more than 3 percent. Stated in such naked terms, I think many of the supporters would back off the idea. But for those who would not, I simply point out that this really has nothing intrinsically to do with Social Security.

The second and more fundamental objection is that there is a reason stocks tend to earn a higher rate of return than bonds, namely that stocks are riskier. No, I am not aping Ted Kennedy here, I am simply pointing out the obvious fact that returns from shares of stock are less certain than returns from bonds. If this weren't the case, then why does anybody ever buy bonds?  Do all of my critics have 100 percent of their wealth in stocks, and indeed in those particular stocks that historically have had the highest rate of return?

Third, even if we ignore the increased risk, it would be the crassest Keynesianism to suppose that the historical rates of return (on government bonds versus funds of stocks) would stay the same regardless of government finagling.  In short, if the government redirects hundreds of billions of dollars into the stock market, while borrowing as much from the private sector to cover the shortfall, this will drive down the rate of return in the former and drive up the interest rate offered on Treasury bonds.

If after all of the above, I have still failed to convince the Bush supporter, let me try this:  Why stop with Social Security taxes?  Why not take all income tax revenue and, rather than use it to meet current expenditures, invest it in stocks and earn roughly ten percent?  It's true that this would require a trillion dollar increase in the budget deficit, but so what?  The higher returns in stocks will more than offset this. Over time, the government could gradually reduce the amount “taxed” (i.e. the amount Americans are forced to channel into the stock market) until finally taxation itself will have been completely phased out. George Bush has a reputation of being dull-witted, but he has stumbled upon a way to eliminate the scourge of taxation once and for all, without needing to cut a single penny from the government's budget!  (Perhaps if we abolish term limits Bush will next solve the problem of death.)


Genuine saving is necessary for net investment. Pension plans funded by true saving are not susceptible to demographic crises, because each retiree's payments are financed out of his or her previous accumulation of capital. The Bush plan claims these benefits because of its superficial emphasis on investment, but unless the government cuts current spending (or sells off government assets to raise revenue) it is a total shell game. It is understandable that Bush and other politicians might miss these obvious facts, but it is inexcusable that many free market analysts have also done so.

  • 1. This is true even if the level of consumption rises over time. For example, if a woman gets a $1000 gift, she is still reducing her potential consumption by investing $500 of it.
  • 2. The government could also print money, but inflation is just a hidden tax.
  • 3. To return to the Crusoe scenario, if Crusoe picks a bunch of berries and loans them to Friday, then Crusoe is still saving; he is choosing not to eat berries in the present in exchange for Friday's promise to give him something, perhaps fish, in the future. But because Friday has borrowed in the present, Crusoe's labor is not freed up to work on the fishing net. Crusoe still has to devote his labor to picking berries, because although Crusoe is willing to postpone his gratification, Friday is not.

Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of numerous books: Contra Krugman: Smashing the Errors of America's Most Famous Keynesian; Chaos Theory; Lessons for the Young Economist; Choice: Cooperation, Enterprise, and Human Action; The Politically Incorrect Guide to Capitalism; Understanding Bitcoin (with Silas Barta), among others. He is also host of The Bob Murphy Show.

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