A peculiar and dangerous feature of the Social Security privatization movement is how it proposes to create a new forced saving program to run parallel with the old one, rather than simply trusting people to manage their own money. The privatizers rarely discuss this openly but it’s pretty clear why they want to do this: they do not trust the free market to manage people’s savings habits.
But in Today’s WSJ we see a frank discussion of this by Edward Prescott (2004 Nobel Prize). His justification for forced savings seems to assume the existence of a publicly provided safey net. It runs this way:
Why mandatory accounts? Because without mandatory savings accounts we will not solve the time inconsistency problem of people under-saving and becoming a welfare burden. Readers of this page will recall that I have made this proposal in a previous essay, but readers may also recall a letter that questioned an assumption I made about consumer behavior.
In effect, the reader asked how, on the one hand, I consider people so irrational that they have to be forced to save, and, on the other hand, I consider people rational enough to manage their own retirement accounts. But this question reveals a misunderstanding of the time inconsistency problem. The reason we need to have mandatory retirement accounts is not because people are irrational, but precisely because they are perfectly rational — they know exactly what they are doing. If, for example, somebody knows that they will be cared for in old age — even if they don’t save a nickel — then what is their incentive to save that nickel? Wouldn’t it be rational to spend that nickel instead? So, indeed, people are acting rationally when they choose not to save.
We have rational people making choices based on the rules. The trick is to get the rules right. A mandatory retirement system, properly designed, would establish effective rules. I have given additional thought to those rules, and won’t take the time here to describe a new program, but suffice to say that such a proposal might involve graduated input to a retirement program that would offer investment choices. The reason for graduated input is because young workers often need their limited resources to “get started” in their adult lives; that is, they may need to make investments in human capital, like education or families, or to finance a home or a car.
