Privatization: Brad Plumer Joins The No Free Lunch Chorus

As Brad was having fun with President Bush’s confusion in Ohio (“Risk, Return, Confusion”) he reasoned:

Okay, so currently every working man and woman puts his or her savings in some combination of Social Security/the bank/the stock market/etc. These investments have total risk X and expected return Y. Now anyone who thinks Y is too low, and is willing to assume a risk greater than X can do so right this very instant. Just take, say, the money you’ve invested in T-Bills and put them in some riskier stock. Or sell of your risky stocks and buy even more riskier stocks. Or take money out of the bank and buy some junk bonds. The point is that almost anyone in America right now, it seems to me, could easily rearrange their current investments to assume an even greater risk and thus hope for an even greater return than they currently expect. If they so chose. The only thing they can’t invest somewhere else are their payroll taxes. Under privatization, people could do that. But if everyone is currently at their optimal level of risk X and return Y (as all perfectly rational people should be, otherwise one ought to take money out of the bank and buy junk bonds, etc.), if that’s true, then reinvesting payroll taxes in a riskier place with higher return shouldn’t make any difference. People will just shift other investments around until they’re back at X and Y.

A commenter to Brad’s post point to a John Quiggin post, which makes the same point. We have also noted that this is the point made by Robert Barro’s 7/3/2000 Business Week op-ed as well as Gary Becker’s 2/22/2005 Wall Street Journal op-ed. Yet, the Cato-Club for Growth crowd continues to argue for a free lunch without ever addressing this question.

Brad also makes the point often put forth by Mark Thoma:

Well, this argument has always been a bit disingenuous—the point of the program is the insurance aspect, not the return

Simply put – increasing diversifiable risk does not increase expected return. An increase in how much systematic risk one bears might increase expected return, but rational people already know that. I guess the fact that the Cato-Club for Growth crowd does not understand basic finance speaks volumes.