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Social Security Privatization and Financial Market Risk: Lessons from U.S. Financial History

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  • Gary Burtless

Abstract

A popular proposal for reforming social security is to supplement or replace traditional publicly financed benefits with a new system of mandatory defined-contribution private pensions. Proponents claim that private plans offer better returns than traditional social security. To achieve higher returns, however, contributors are exposed to extra risks associated with financial market fluctuations. This paper offers evidence on the extent of these risks by considering the hypothetical pensions U.S. workers would have obtained between 1911 and 1999 if they had accumulated retirement savings in individual accounts. The 89 hypothetical contributors are assumed to have identical careers and to contribute a fixed percentage of their wages to private investment accounts. Contributors differ only with respect to the stock market returns, bond interest rates, and price inflation they face over their careers. These differences occur because of the differing start and end dates of workers' careers. The analysis demonstrates that returns under private plans would usually have been good, but that financial market risks in a private account system are empirically quite large. Some of these risks are also present in certain types of public retirement system, but a public system has one important advantage over private pensions. Because public social security is backed by the taxing and borrowing authority of the state, it can spread risks over a much larger population of potential contributors and beneficiaries, including contributors and beneficiaries in several generations.

Suggested Citation

  • Gary Burtless, 2000. "Social Security Privatization and Financial Market Risk: Lessons from U.S. Financial History," Discussion Papers of DIW Berlin 211, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp211
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    References listed on IDEAS

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    1. Olivia S. Mitchell, 1999. "New Evidence on the Money's Worth of Individual Annuities," American Economic Review, American Economic Association, vol. 89(5), pages 1299-1318, December.
    2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66(6), pages 467-467.
    3. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March.
    4. Courtney Coile & Jonathan Gruber, 2000. "Social Security and Retirement," NBER Working Papers 7830, National Bureau of Economic Research, Inc.
    5. Jonathan Gruber & David A. Wise, 1999. "Social Security and Retirement around the World," NBER Books, National Bureau of Economic Research, Inc, number grub99-1.
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    Cited by:

    1. Axel Börsch‐Supan & Florian Heiss & Alexander Ludwig & Joachim Winter, 2003. "Pension Reform, Capital Markets and the Rate of Return," German Economic Review, Verein für Socialpolitik, vol. 4(2), pages 151-181, May.
    2. Axel Börsch‐Supan & Florian Heiss & Alexander Ludwig & Joachim Winter, 2003. "Pension Reform, Capital Markets and the Rate of Return," German Economic Review, Verein für Socialpolitik, vol. 4(2), pages 151-181, May.
    3. Pfau, Wade Donald, 2007. "Reforming Social Security: Issues and Challenges for Personal Retirement Accounts," MPRA Paper 19034, University Library of Munich, Germany.
    4. Gollier, Christian, 2008. "Intergenerational risk-sharing and risk-taking of a pension fund," Journal of Public Economics, Elsevier, vol. 92(5-6), pages 1463-1485, June.
    5. Assar Lindbeck & Mats Persson, 2003. "The Gains from Pension Reform," Journal of Economic Literature, American Economic Association, vol. 41(1), pages 74-112, March.
    6. Dirk Krueger & Felix Kubler, 2006. "Pareto-Improving Social Security Reform when Financial Markets are Incomplete!?," American Economic Review, American Economic Association, vol. 96(3), pages 737-755, June.
    7. Gary Burtless, 2007. "International Investment for Retirement Savers: Historical Evidence on Risk and Returns," Working Papers, Center for Retirement Research at Boston College wp2007-05, Center for Retirement Research, revised Feb 2007.
    8. Wade D. Pfau & Vararat Atisophon, 2009. "Impact of the National Pension Fund on the Suitability of Elderly Pensions in Thailand," Asian Economic Journal, East Asian Economic Association, vol. 23(1), pages 41-63, March.
    9. Gary Burtless, 2010. "Lessons of the Financial Crisis for the Design of National Pension Systems," CESifo Economic Studies, CESifo Group, vol. 56(3), pages 323-349, September.
    10. Robert Holzmann & Richard Hinz, 2005. "Old Age Income Support in the 21st century: An International Perspective on Pension Systems and Reform," World Bank Publications - Books, The World Bank Group, number 7336.
    11. Winfried Schmähl, 2000. "Perspektiven der Alterssicherungspolitik in Deutschland –Über Konzeptionen, Vorschläge und einen angestrebten Paradigmenwechsel," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 1(4), pages 407-430, November.
    12. Gary Burtless, 2000. "How Would Financial Risk Affect Retirement Income Under Individual Accounts?," Issues in Brief ib-5, Center for Retirement Research.
    13. Gary Burtless, 2006. "Risk and Reward of International Investing for U.S. Retirement Savers: Historical Evidence," Working Papers, Center for Retirement Research at Boston College wp2006-25, Center for Retirement Research, revised Dec 2006.
    14. Markus M. Grabka & Hanfried H. Andersen & Klaus-Dirk Henke & Katja Borchardt, 2002. "Kapitaldeckung in der Gesetzlichen Krankenversicherung: zur Berechnung der finanziellen Auswirkungen eines Umstiegs vom Umlage auf das Kapitaldeckungssystem," Discussion Papers of DIW Berlin 275, DIW Berlin, German Institute for Economic Research.
    15. Dirk Krueger & Felix Kubler, 2002. "Intergenerational Risk-Sharing via Social Security when Financial Markets Are Incomplete," American Economic Review, American Economic Association, vol. 92(2), pages 407-410, May.
    16. Wehlau, Diana & Sommer, Jörg, 2004. "Pension policies after EU enlargement: Between financial market integration and sustainability of public finances," Working papers of the ZeS 10/2004, University of Bremen, Centre for Social Policy Research (ZeS).
    17. Gary Burtless, 2001. "The Rationale for Fundamental Pension Reform in Germany and the United States: An Assessment," CESifo Working Paper Series 510, CESifo.

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