Krugman on US pensions

Sometimes when I post a comment on Krugman’s blog it does not get added to the comment section. I think maybe sometimes I come up with a worthy counter argument which he may not like.

This time round he posted a comment about what McCain’s adviser said about the US pension system (Social Security). I think Paul Krugman is missing some explanation about the pension system, so I will fill the gap.

The pension system in USA is unfunded and benefits defined. Unfunded means that the next generation pays for the current generation. Benefits defined means that the amount of benefit in real terms is fixed so the contributions have to be manipulated to make sure the benefit payment is of wanted amount.

The current US system is a legacy from Second World War when people wanted to give something back to the people who fought the War.

This is a self sustaining system IF and ONLY if the next generation is the same size or bigger in terms of number of people. If its not and the number of people in every generation is decreasing then the amount the paying-generation has to pay will be ever increasing provided its benefits are defined (fixed) in real terms. This means some time in the future pension payments will rise and rise until one has no disposable income left.

The good thing for Americans is that their population is growing and not ageing, unlike Italy's, Germany's or Japan's. So it is just about self-sustaining.

From a neo-liberal prospective, what one should have is that one pays for what one wants to get when one retires. This is so there is a proper incentive system for people to save as much as possible for their own retirement. What McCain's advisers want is a funded system where one saves one's own pension. At least a hybrid, UK-style where there is a funded and unfunded elements.

This is not a bad idea, why should the younger generation pay for the previous?! Some may argue that the conversion from unfunded to funded is impossible but this not true as Chile did it quite effectively in the 1990s.

Its quite strange that Paul Krugman, an economist, failed to pick up on the McCain to neo-liberal link to McCain's economic advisers wanting a funded system.

The economics of pension systems are complex but centre around having a funded versus unfunded system and whether to define contributions or benefit payment. As always a good place to start is Wikipedia.