I'm not going to waste my time talking about Madoff - that is not what this post is about. Rather, I'd like to clue everyone in to the largest Ponzi Scheme of all time and that is Social Security. When I sat down to write this post I was hoping to answer the following questions: what is the economic justification for Social Security and does it make economic sense to have Social Security in its current form?
A Ponzi scheme is basically an investment that pays returns from subsequent investor's money rather than profit stemming from your own investment. Ponzi schemes are not sustainable, i.e. at one point there will be losers as new investors are harder to come by.
Is this not the definition of Social Security? Instead of giving our money to the government for safe keeping and eventual return, we are financing people who have already paid into the scheme whose money has been given to someone else.
In creating Social Security, the government wasn't trying to defraud Americans. Theoretically, Social Security is a great idea given certain assumptions. One the of largest assumptions a government must make is to have a population growth greater than or equal to the baseline year when the system starts and further, to maintain the same age structure in the economy. If this were true then there would be a never ending, ever increasing base from which to extract payouts to elders. Unfortunatley this is an assumption which we know to be false and this has caused the deterioation of the Social Security system in recent years.
The first hurdle is why have Social Security at all? For this I'm going to reference my Law and Economics background and argue self paternalism. Self paternalism is basically the idea of saving ourselves from ourselves. It is creating institutions to prevent individuals from "yeilding to momentary temptations which they deem harmful to themselves." In the case of Social Security, government creates an institution in which individuals are forced to pay into so that they do not yeild to excessive consumption and leave themselves destitute in their later years.
There definitely are many economic arguments against Social Security, the one that comes first to mind is the deadweight loss that occurs when a tax is administered due to lost and delayed transactions. This means that there is a net social loss from having a Social Security Tax.
The next question which I feel will be more difficult to answer is why Social Security has taken the form of a public retirement fund rather than a system of privatized accounts. I believe that the current system was based on very little economic logic and moreso on a social objective which was to insure people against a defined risk. Due to excessive need during the depression era, a system of private accounts would not have satisfied the objective of the day which was to provide to elders what they could no longer provide to themselves.
The economics behind Social Security was risk pooling to minimize the individual cost of elderly unemployment by spreading that cost over a large tax base. We see this same concept applied frequently in insurance, joint land ownership, joint-ventures, etc. The idea is simply to spread a fixed risk over many people to reduce the risk, and therefore cost, to any one person.
But today the objective of Social Security has changed. It is no longer for those in need but those who are 65 years old. It is now a retirement plan and as so, should be treated like one. We are no longer providing social insurance but we are still using the same system from which stems inefficiencies. Though the issue of this post was not to argue the fate of Social Security, I do believe that establishing an Employees Provident Fund, such as exists in Malaysia, is the best alternative.
*The above quote is taken from Guido Calabresi's Law and Economics Anthology, page 197.
A Ponzi scheme is basically an investment that pays returns from subsequent investor's money rather than profit stemming from your own investment. Ponzi schemes are not sustainable, i.e. at one point there will be losers as new investors are harder to come by.
Is this not the definition of Social Security? Instead of giving our money to the government for safe keeping and eventual return, we are financing people who have already paid into the scheme whose money has been given to someone else.
In creating Social Security, the government wasn't trying to defraud Americans. Theoretically, Social Security is a great idea given certain assumptions. One the of largest assumptions a government must make is to have a population growth greater than or equal to the baseline year when the system starts and further, to maintain the same age structure in the economy. If this were true then there would be a never ending, ever increasing base from which to extract payouts to elders. Unfortunatley this is an assumption which we know to be false and this has caused the deterioation of the Social Security system in recent years.
The first hurdle is why have Social Security at all? For this I'm going to reference my Law and Economics background and argue self paternalism. Self paternalism is basically the idea of saving ourselves from ourselves. It is creating institutions to prevent individuals from "yeilding to momentary temptations which they deem harmful to themselves." In the case of Social Security, government creates an institution in which individuals are forced to pay into so that they do not yeild to excessive consumption and leave themselves destitute in their later years.
There definitely are many economic arguments against Social Security, the one that comes first to mind is the deadweight loss that occurs when a tax is administered due to lost and delayed transactions. This means that there is a net social loss from having a Social Security Tax.
The next question which I feel will be more difficult to answer is why Social Security has taken the form of a public retirement fund rather than a system of privatized accounts. I believe that the current system was based on very little economic logic and moreso on a social objective which was to insure people against a defined risk. Due to excessive need during the depression era, a system of private accounts would not have satisfied the objective of the day which was to provide to elders what they could no longer provide to themselves.
The economics behind Social Security was risk pooling to minimize the individual cost of elderly unemployment by spreading that cost over a large tax base. We see this same concept applied frequently in insurance, joint land ownership, joint-ventures, etc. The idea is simply to spread a fixed risk over many people to reduce the risk, and therefore cost, to any one person.
But today the objective of Social Security has changed. It is no longer for those in need but those who are 65 years old. It is now a retirement plan and as so, should be treated like one. We are no longer providing social insurance but we are still using the same system from which stems inefficiencies. Though the issue of this post was not to argue the fate of Social Security, I do believe that establishing an Employees Provident Fund, such as exists in Malaysia, is the best alternative.
*The above quote is taken from Guido Calabresi's Law and Economics Anthology, page 197.
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