Paul Krugman writes in his latest New York Times oped:
To get a 6.5 percent rate of return, you need capital gains: if dividends yield 3 percent, stock prices have to rise 3.5 percent per year after inflation. That doesn’t sound too unreasonable if you’re thinking only a few years ahead. But privatizers need that high rate of return for 75 years or more. And the economic assumptions underlying most projections for Social Security make that impossible. 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.
Dr. Krugman credits Dean Baker for this point – more of which I’ll turn to in a moment. So Don Luskin writes:
And in the column today, Krugman betrays a fundamental misunderstanding of the economics of Social Security itself. He write, “we don’t need to worry about Social Security’s future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.” Krugman has forgotten — or chosen to ignore – that under current law Social Security benefits are indexed to wage growth. If the economy grows like Krugman is talking about, yes, payroll tax revenues will grow too – but so will benefits, nearly perfectly proportionately.
The reason the Trustees are forecasting this 1.9% real GDP growth is that they are assuming employment growth will be only 0.3% per year as they assume population growth will be about the same.
(And yes that should read “they assume productivity growth will be about the same”). In other words, Luskin’s argument about differences in real wage growth assumptions has little to do with this as the Trustees are assuming productivity and real wage growth will continue at approximately the pace we have enjoyed for the past 75 years.
But I do have a question for Dean Baker and Dr. Krugman, which is motivated by the Solow growth model. If population growth declines and national savings rates stay the same, the logic has it that we will enjoy capital deepening, which would predict a fell in the return to capital consistent with Dean Baker’s financial modeling. But the big fear over the past generation is that we have suffered a reduction in the national savings rate. If the growth rate of employment and the national savings rate fall proportionately, doesn’t the Solow model suggest that we retain the same return to capital? So my question to them is what is their assumption about the national savings rate and how does it fit into the modeling assuming the big change might be a fall in population growth? I might ask Mr. Luskin and his Club for Growth colleagues, but I fear they’ll get confused and just start tossing more insults. Wise and gentle blogger-scholars are also welcomed to tackle what I’m not quite sure about here.