Pensions, Ponzis and pyramids

Rien de nouveau en soi, mais j’aimais l’illustration.

Vous remarquerez qu’il y a eu une censure entre la version Web et la version papier.

Un graphique vaut mille mots.

Extrait de: Pensions, Ponzis and pyramids, Buttonwood,The Economist, Sep 24th 2011

The retired are always supported by their children

IN OLDEN days it was quite common for families to keep a store of spare cash in a cake tin or cookie jar to save for future expenditure, such as Christmas presents. Just occasionally this petty-cash fund had to be tapped for immediate needs, and raiders would ease their consciences by leaving an IOU for the requisite sum.

Pyramide -2

Version Web



Version papier

One way of viewing the American Social Security Trust fund is as a massive cookie jar filled with IOUs. The assets of the fund are Treasury bonds, in other words promises to pay by the federal government. The scheme is thus dependent on the ability of future taxpayers to keep funding it.

In 1999 the Office for Management and Budget said that the fund’s assets “do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, have any impact on the government’s ability to pay benefits.”

Does this make Social Security a Ponzi scheme, to quote Rick Perry, the governor of Texas and a leading Republican presidential candidate? Not really. The Merriam-Webster dictionary defines a Ponzi scheme as “an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks”. The first part of that definition applies to Social Security but not the second. The scheme’s costs have been monitored and the rules adjusted by raising payroll contributions and extending the retirement age. Such shifts have extended the period before the trust fund runs out of assets, and further shifts are perfectly possible.

A better term for Social Security would be a pyramid scheme: which the same dictionary defines as

“A usually illegal operation in which participants pay to join and profit mainly from payments made by subsequent participants”.

Illegal it isn’t, but future workers do have to generate the tax revenues that pay the benefits of future pensioners, and that is a problem if one generation is smaller than the one before.

Although the term “pyramid” may sound rather pejorative, it is true of all pension schemes. Many European governments do not bother with a formal fund but use pay-as-you-go schemes, funding benefits out of future taxes. The effect is the same. Funded or unfunded, a pension scheme is a claim on a future generation.

Nor would it make much difference were Social Security to be invested in other assets such as equities, investment-grade bonds and property. The value of such assets is dependent on their future cashflows (dividends, interest and rents). But by 2030 or 2040, those cashflows will be generated by our children. If the economy were then in a dire state, equity and property prices would have plunged and the assets would not cover the liability.

Indeed, Social Security is in a rather better financial condition than many state and local funds which have followed the diversified-portfolio route. Thanks to some dubious accounting, a large number of such schemes have not been funded properly.

Some may argue that a funded pension scheme encourages savings, and that higher savings boost economic growth. That sounds good in theory but is hard to spot in practice. Britain and America both have pension-fund assets worth more than 100% of GDP, but very low savings rates. Germany has a high savings rate but pension-fund assets of just 14% of GDP.

Perhaps the existence of a fund makes it easier to monitor the liability and to make needed adjustments accordingly? That seems a little doubtful, too. Even without such a structure, European countries have reduced future pension costs.

Some of the pyramid problems could be avoided if developed-world pension schemes invested in those emerging markets with more favourable demographic trends. Workers in rich countries could accumulate claims on the wealth generated by future Brazilian, Indian and Turkish workers. But America and Britain have done the opposite, running current-account deficits so that central banks in Asia and the Middle East have accumulated claims on them instead.

America’s pyramid is not as shakily constructed as Europe’s, however. The American fertility rate is around the replacement rate of 2.1, compared with 1.4 for Germany and Italy, where populations are in decline. It is health-care costs, rather than pension costs, that are the bigger threat to American finances.