Originally published in THE BOSTON GLOBE
Tuesday, February 2, 1999
POLITICAL INFLUENCES WOULD HURT PERFORMANCE, ECONOMY
US, STOCKS NOT A GOOD MIX
"The president's proposal is a dangerous and unnecessary intrusion of the government in the private economy"
By Martin and Kathleen Feldstein
The day after President Clinton delivered his State of the Union address, Federal Reserve chairman Alan Greenspan testified to Congress and was asked to comment on one of the presidents key proposals. In sharp contrast to his customary oblique responses, Greenspan was clear and direct in criticizing the proposal to invest Social Security Trust Fund balances in the stock market. Greenspan was right to draw attention to the serious risks of such a proposal.
The Social Security Trust Fund is now expected to run out by the year 2032, forcing a major tax increase if promised benefits are to be maintained. The fund is invested in US Treasury bonds, which historically earn a much lower return than investments in corporate stocks.
Despite ups and downs in the stock market, over long periods of time stocks have yielded an average return of more than 7 percent after inflation. By contrast, the government projects that the bonds in the trust fund will yield less than 3 percent after inflation. Investing some of the trust fund in the stock market would postpone for about twenty years the time when the trust fund runs out of money. Investing the trust fund in stocks would, of course, not raise any individual retirees benefit since the level of benefits is defined by law.
The presidents proposal would make the government a major shareholder in the US stock market with an initial commitment to put about $700 billion of Social Security funds into stocks. Increasing share prices and dividend reinvestments could soon bring that to more than a trillion dollars. And investment success might lead to even more additions to the governments stock funds. The government would be the 500 pound gorilla of the stock market.
Thats a bad idea any way we look at it. Government ownership of stocks would mean politically influenced investment decisions that weaken investment performance and that give the government inappropriate influence over the private economy. While the president did not specify how the funds invested in the stock market would be administered, some central agency would be charged with oversight, even if actual investment choices were made by professional money managers. Opportunities for political temptations to meddle would abound.
We disagree with proponents of the presidents plan who claim that an independent authority modeled on the Federal Reserve System could ensure complete independence from governmental abuse of the power that would accompany this level of stock ownership. It should be evident that, since this agency would be created by legislative action, ultimate authority would reside with the Congress. Indeed, the Federal Reserve does report to Congress regularly. And although in recent years the Fed has operated quite independently, there have been periods in the past when political pressure has been successfully applied to Federal Reserve policy, resulting for example in the double digit inflation of the late 1970s.
From the start there might be political influences on the choice of the portfolio managers. Even if management fees were artificially low, the public relations value of managing Social Security assets would make this a valuable contract. Losing such a contract would not look good either. If money managers worried about political influences on their reappointment, they might become too focused on avoiding losses and thus sacrifice the potential gains they might achieve in a less political environment.
More troublesome would be political influences on investment decisions. The most obvious risk would be political prohibitions on certain kinds of investments, including companies that make certain products like cigarettes, companies that dont have politically correct environmental rules, companies that organized labor finds objectionable, and so on. Tying the hands of investment managers would reduce the return they can earn.
Another possible misallocation thats all too easy to imagine would be pressure for a broad geographic distribution of the companies in the investment portfolio. Were thinking of the kind of implicit requirements that cause the defense budget and other public works to be distributed among states and congressional districts in response to political considerations rather than economic efficiency.
An even more important concern about the presidents proposal is that government ownership of corporate stocks would bring with it control over corporations through the right to vote shares. Even if this power were initially disavowed, there would always be the possibility that the government might later assume that right, as many state pension agencies now do. Then we would have the government taking positions on issues like mergers, foreign ownership, the quality of management, and labor relations.
In the past, congressional leaders of both parties, including Democratic Senators Daniel Moynihan and Bob Kerrey, have rejected the notion of government investment of Social Security Trust Funds in the stock market. And leading Republicans have now strongly denounced the presidents proposal.
To the president and his advisers, this proposal is a costless way to put off true reform of Social Security. To us it is a dangerous and unnecessary intrusion of the government in the private economy. We believe that equity investments can help to protect future retirement incomes but only through individually owned retirement accounts.
Properly structured, such accounts can supplement Social Security benefits and achieve the level of future retirement income called for in current law. The government could guarantee such benefits while avoiding the political problems of government control over a major portion of the stock market and the American economy. Its not too late for Congress and the president to start negotiating a better plan.Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.