Crises of Capitalism

After the end of Cold War, a least or less-regulated market economy model seems having defeated a centrally planned economy.  However, due to inherently market failures, such an economic system "never solves its crisis problems, instead it moves them around geographically."  If a nation's policy innovations and political progress failed to adapt a more efficient economic system, the nation itself would become a part of history.

Holding excessive power of capital, financial industry needs to revolve itself around recapitalization or reinvestment in real economy rather than pursuing return in financial markets.

Source: RSA

An Inevitable Reform for Social Security

After serving citizens of the United States for 75 years, Social Security, the federal government’s largest single program, is being strained by the demographic and financial changes in this country.  In order to save the program which millions of Americans rely on for their retirement years, an inevitable change has to be introduced into the program.


The goal of this paper is to provide a package of possible alternative solutions to reform Social Security under a fair social justice, actuarial balance and sustainable financial solvency.  This paper first introduces a brief history of the program.  In the second part, this paper lists benefits of the program, and analyzes pertinent problems which Social Security is facing.  Finally, an outline of possible solutions and a heavy comparison between existing policies and possible alternative policies in a package will be provided.

The Social Security Program was created under the Social Security Act, passed by Congress as part of the New Deal.  The program was originally drafted to reduce the poverty of the aged.  The act included the “Old Age and Survivors Insurance (OASI)” was first signed by President Roosevelt in 1935 to cover workers in across all commerce and industries from poverty.  It also introduced the Federal Insurance Contributions Act (FICA) tax as the means to pay for Social Security.  Since then, the provision of Social Security has been constantly changing through expansion of the coverage.  In 1939, the coverage of the program expanded to cover dependents and survivors.  In 1956, Disability Insurance (DI) was created, and passed in the following years.  Since then, Social Security is complete with two most important separate entities, the “Old Age and Survivors Insurance (OASI)” and the “Disability Insurance (DI)” program.  Automatic cost-of-living-adjustments (COLA), which index benefits to consumer price index (CPI), were introduced in 1973.  As the program gradually moved towards universal coverage, the benefits payouts rose significantly.  With increasing benefits payouts, Social Security tax rate rose from 2% in 1937 to 12.4% in 1993 – which is what it is today.  In the long run, resources dedicated to the most expensive program in the nation are predicted to become  incapable of paying full benefits in 2039 (Office 2010).

Even though Social Security is now the greatest expenditure in the federal budget (Adiministration 2010), it is a program that provides the majority of American families with financial protection.  Mainly composed of OASI and DI, Social Security provides benefits to retired workers and people with disabilities, and their families.  Since Social Security is a state scheme, more specifically, a defined-benefit or pay-as-you-go (PAYG) scheme where every worker is treated as an individual contributor, who is promised to be given a certain amount of pension in the future if he/she pays contribution now.   Contributions are paid by the currently employed population in the form of a payroll tax (FICA tax), therefore, the calculation takes the Social Security taxes paid by the worker into account, yet does not consider inflation rates and expected retirement age.  In the case of disability benefits, a recipient receives benefits, which is based on his/her average lifetime earnings (Administration 2008).

Acknowledging the previous points, if current laws remain in place, Social Security will not remain financially sustainable.  Starting in 2018, at latest, Social Security will spend more each year than it receives.  CBO estimates that, unless changes are made to the system, the trust funds combined (OASI trust fund and DI trust fund) will be exhausted in 2039 (Office 2010). The actuarial discontinuity is the major concern regarding this highly popular government program among the public. The actuarial imbalance and unsustainable financial solvency of Social Security is not caused by a single flaw, but complex economic and social problems.

 First is the actuarial principle.  When workers retire and begin to collect benefits, those benefits are protected against inflation by adjusting them annually to the CPI, which overstates inflation.   An absence of a rational US GDP growth rate brings an overoptimistic forecast on a real value of pensions.

 Secondly, as a PAYG or defined-contribution plan, Social Security is naturally sensitive to any change in the age structure.  As more baby boomers begin collecting benefits, a lower dependency ratio (number of pensioners divided by number of workers) unbalances Social Security payouts and collections.

Thirdly, the government failure in Social Security contributes to its financially unsustainable future.  A government failure occurs when a government intervention causes a more inefficient allocation of goods and recourses than would occur without intervention.  In this case, goods and recourses are pensions and private spending.  Social Security pensions are contributed by FICA taxes. FICA taxes, paid by employed workers and their employers, have already caused disincentive in private spending and dead weight loss in the economy.  The Treasury printed special bonds in the exchange for excessive cash surplus in Social Security trust funds, which can only be redeemed by collecting additional taxes from the public in the future.  This accelerates the exhaustion of both trust funds by crowding out more private spending in the economy.  Political pollution is another government failure.  Bush administration politicized the Social Security Administration and used taxpayers’ money to promote a partisan agenda (Krugman 2005).   Social Security reform is not making any progress largely due to non-cooperation between Republicans and Democrats in Congress, or so-called ideological conflicts.  Also, powerful lobby groups are another obstruction in the way of Social Security reform.

Last but not least, the private sector fails to provide an alternative.  Although, corporate pensions are available in most private firms, they fail to meet the efficient market assumptions which are no market failure and perfect information.  Defects in bankruptcy law, underfunded corporate pension plans, and asymmetric information between managers and workers are three main contributors to private sector failure.   Of the $2.3 billion in U.S. corporate pension plans, $500 billion sits in so-called frozen pensions that cap their employees’ benefits and/or no longer accept new employees or contributions.  Corporate pension plans sometimes end up as worthless papers for employees who have invested a large proportion of their retirement savings into.

Since Social Security is facing a major crisis against its longevity, a major Social Security reform is inevitable.  In order to reform Social Security, three broad objectives of the reform must be defined before the package of solutions.  They are a fair social justice, actuarial balance and sustainable financial solvency.

Fair social justice is to keep the majority of American citizens from poverty with financial protection provided by Social Security.  Even though social justice can be evaluated by different categories of social efficiencies, Rawlsian improvement is the social efficiency in this paper for its accordance with the definition of a fair social justice.

Actuarial balance is a balanced figure that measures the long-term difference between the recourses dedicated to Social Security and the program’s costs over a 75-year timescale.  Sustainable financial solvency is the tenable ability of Social Security trust funds balancing its payouts and benefits independently.

In most cases, the easiest way to sustain a financial solvency of a problematic governmental program for a policy maker is to either cut its benefits or to increase tax revenue. However, the package of solutions brought up by this paper does not include any of these. Instead, it brings a close actuarial balance and a sustainable financial solution under a fair social justice.

The package of alternative resolutions includes a reform defined-benefit pension plan by a defined-contribution pension plan, a national trust fund portfolio, reform of residual estate tax and actuarial accuracy.

First, the current defined-benefit pension plan (PAYG) for OASI is suggested to switch to a defined-contribution plan for each citizen with his/her own compulsory national account, or so-called pay-as-you-earn (PAYE).  A defined-contribution plan under state scheme is a plan where the United States government withholds FICA taxes from employees and employers as a contribution to the pension plan which will be backed up by US government credit.  In order to maintain a fair social justice, the tax rate has to be progressive.  Under the definition of a defined-contribution plan, each individual contributor has a national account which is entitled to his/her own name.  The benefits for a contributor are directly linked to his/her own lifetime earnings.  This strong link between lifetime earnings and benefits would keep a citizen in the work force as long as he/she wants to earn a higher pension after retirement. PAYE has some major advantages over PAYG.  First, it is less insensitive to demographic change than PAYG, since an aging demographic picture is the biggest challenge to Social Security.  The nation is facing a double-aging phenomenon - steadily decreasing birth rates coupled with ever increasing life span.  As more baby boomers begin collecting benefits, spending for the program will climb from 4.8 percent of GDP in 2010 to 6.2 percent of GDP in 2035 (Office 2010).  Such a double-aging phenomenon will have a smaller impact on PAYE than PAYG since everyone is earning for his/her own retirement pension.   PAYG’s second advantage is the ability to keep more positive work ethics for individuals than PAYE, which eventually enhances the whole production level in the economy.   This could generally increase the value of pensions in the line with a potential higher economic growth.

However, a gradual transition analogous to Swedish Social Security reform is strongly recommended.  Although the old PAYG pension would no longer exist, current retirees and older workers will continue to receive all or some of their retirement income based on the old PAYG rules.  In a common analytical convention, if legislation combines DI trust fund and OASI trust fund, CBO projects that, the combined OASDI trust funds would be exhausted in 2039 (Office 2010).  Consequently, a combined trust fund itself could sustain payouts for current and promised beneficiaries.

Before set up of a new national trust fund begins, this paper highly discourages lending excessive cash to the Treasury in exchange for Treasury bonds.  In order to redeem those bonds into cash, the government will have to collect additional taxes from the public in the future.  This action could crowd out private spending in the economy, which could lead to a government failure.

Social Security would be a defined-contribution pension plan with amount of pension entitled to every citizen. A new national trust fund portfolio could be set up by all the new tax collections.  It is essential for the decision maker to invest Social Security trust fund rather than sitting the trust fund on cash.  The fundamental rule of investment is to simply buy and hold well-diversified index exchange traded-funds (ETFs) and fixed income ETFs. 

Recognizing that most cash flows into the new national trust fund will not be paid out until the entitled contributor claims to be retired in 25 years on average, a 25-year investment is considered.  A 25-year investment in an index ETF can yield 2020% profit (Malkiel 2007).  Most ETFs only charge a lower one-time flat-rate fee compared to higher administrative fees in trust funds.  Furthermore, under this solution, Social Security would be prohibited from voting any stock or in any other way influencing the policies or practices of any company or industry whose stock is held by the index or fixed income ETFs.

The new PAYE pension system could discourage workers from dropping out of the labor force beyond PAYG’s ability because pensions are determined by workers’ lifetime earnings.  A flexible retirement age would be introduced, as well.  Workers could retire as early as age 65 or stay in the workforce as long as they choose.  Nonetheless, each year of gainful employment will have a positive impact on future pension benefits, and each year of retirement postponed will yield a higher rate of return on past pension accumulation.  Those two trends would keep more skilled, aged workers in the economy, which means a steady dependency ratio and a large taxable base.  In the case of a large taxable base, all new government employees are proposed to switch to the national defined-contribution plan.

However, throughout the whole reform of defined-benefit pension plan, the social safety net for the workers with modest income and DI for people with disabilities would remain and be guaranteed under the principle of a fair social justice.  Due to a higher yield of cash generated by the new national trust fund portfolio, a means-testing rule that would govern the guaranteed pension would be relatively more generous than PAYG.

Secondly, this paper agrees with the Ball/Altman proposal on converting residual estate tax into a dedicated Social Security tax.  Rather than eliminating the estate tax in 2011, this paper suggests freezing the estate tax at the 2009 level and converting it into a dedicated Social Security tax.  The exclude amount would remain at the 2009 level, $3.5 million.  Consequently, it would reduce the total Social Security deficit of 1.89% to 1.38% of payrolls (Altman 2005). The Social Security deficit deduction is equivalent to raising payroll tax by 1% in the economy, or 0.5% for employees or employers.  This option would improve the 75-year actuarial balance by 0.3% points of GDP and would extend the trust fund exhaustion date by 17 years, to 2056 without a defined-benefit plan reform.

Thirdly, actuarial balance is last main goals.  However, in the current actuarial calculation, conservatism as a one of the main principles of actuarial science has not been followed well.

The broken conservatism starts with overstating inflation.  When workers retire and begin to collect benefits, those benefits are protected against inflation by adjusting them annually to the CPI, which overstates inflation.  A replacement of CPI called Chained CPI-U can be a more realistic measure of inflation because it takes into account both change of the basket of goods and price fluctuations.  The switch from the CPI-U measure to the chained-CPI-U would save 0.35% of taxable payroll (Altman 2005).

Additionally, an absence of a rational US GDP growth rate in actuarial equation causes an over-optimistic forecast over a real value of pensions.  In the long run, the economy of a developed industrial country grows at that rate of 2% each year.  Using a smaller expected rate of GDP growth would largely reduce the risk of overestimation in the future, as well as developing independence and transparency in actuarial calculations in Washington D.C.

In general, the sustainable financial solvency of Social Security could be achieved by a switch from defined-benefit pension plan to defined-contribution pension plan, a reform of residual estate tax and a more conservative actuarial calculation.   In this package of reform, a fair social justice would not be broken.   Although this paper provides a similar package of solutions as what other scholars have done since 1997, a sustainable Social Security reform can exclusively be achieved if both the Republican Party and Democratic Party come across their political spectrum and ideological dispute, and unite in support of a new Social Security system.

Source Cited:

Adiministration, Social Security. Social Security Budget. Budget Report, Washington D.C.: The White House, 2010.
Administration, Social Security. Disability Benefits. Social Security , 2008.
Altman, Nancy J. The Battle for Social Security. Hoboken: Wiley, 2005.
Krugman, Paul. "Social Security Lessons." The New York Times. August 15, 2005.
Malkiel, Burton. A Random Walk Down Wall Street. New York: Norton, 2007.
Office, Congressional Budget. Scoial Security Policy Options. Washington D.C.: The Congress of the United States, 2010

Quantitative Prediction of Our Behaviors

PhD. Bueno de Mesquita, one of the world's most prominent applied game theorists, predicted the fall of Honsi Mubarak through his computer model. For the past three decades, he has been honing a computer model that precisely foresaw several political events. Can such a program be developed into modeling predictions for consumer behaviors in a market economy in the near future?

Source: The Economist 

Preparing for a Worsening Global Recession

Market is not going to put up its patience forever while governments in Europe are running out bullets.

Source: BBC

Cultural Capitalism

"The worst slaveowners were those who were kind to their slaves." Hence, instead of running idiosyncratic charity, it is more important to reconstruct our society on a liberalism basis that poverty will be impossible.

Source: RSA

Fight of the Century: Keynes vs. Hayek Round Two

"Capitalism is about profit and loss. You bailout the losers there is no end to the cost... The world is a complex." - Well rapped.

Source: EconStories

Pay Pals - European Bailouts

Source: Daily Chart

A Bipolar Hunt for Energy

In the recent hunt for energy, businessmen from China and the United States, two oil-guzzlers, are running around world to lock in their foreign oil supplies. Since such a bipolar hunt for oil resources is often assumed by a strict zero-sum vision of the world's natural-resources market, most politicians in the United States unanimously regard Chinese hunger for oil as a threat to its own security. In the meanwhile, Chinese state diplomatic and domestic economic cooperation with Iran, Myanmar and Sudan has challenged the United States' diplomatic hegemony.

However, beyond all goods and evils, each country is depending on foreign oil production for her own domestic energy demand. Washington and Beijing share a common interest in securing open sea-lanes to ensure their cargo shipment. China typically picks up secondary deals or moves into markets from which the US is absent. And a general consensus is that it would be irresponsible for politicians in Beijing to curb its oil supply. Henceforth, great demand for oil from both countries not only creates a global energy competition, but also plants a natural ground for cooperation between the two countries. If two countries would simply consider themselves as consumers in global oil market, a cooperative common pool between the two, such as International Energy Agency with China joined, would combine and maximize their bargaining powers by creating a market monopsony in the global market, which may strategically protect both interests in maintaining oil supplies steady, stabilizing international oil prices instead of competing privileged relations with oil supply countries. Such practice would transform a bipolar hunt for oil resources into a non-zero-sum game.

In order to achieve such monopolistic bargaining power, it is necessary to have farsighted leaders on both sides of the Pacific to adapt to rapid changes in the global distribution of economic and political power, not leaders who let such shifts push them into an increasingly acrimonious confrontation.

Jasmine Revolution Clinging to China? No

On March 12, Wall Street Journal weekend published an article named "Is China Next?" written by Francis Fukuyama, an Olivier Nomellini Senior Fellow at the Freeman Spogli Institute for International Studies at Stanford University.

In the article, Mr. Fukuyama agreed on a theory argued by Samuel Huntington noted in his classic book - "Political Order in Changing Societies" - that increasing levels of economic and social development often leads to coups, revolutions and military takeovers. Mr. Fukuyama argued that the theory has been proved by in recent toppled regimes in Tunisia and Egypt.

However, in the case of China, the recent probability of a burst of a similar Jasmine Revolution is close to zero. Mr. Fukuyama derived such a conclusion from the following arguments.

1. The growing middle class are gaining dramatic economic improvements from economic growth in China.

2. Central government in Beijing has been focusing on job creation and altering its policies to reduce income disparities.

3. Compared to dictatorships in the Middle East, a self-forced leadership turnover every decade in Communist Party ensures political innovations in Beijing.

4. The Internet censorship in China moderates social radicalism.

5. People's Liberation Army in China traditionally stands strong in its cohesiveness and loyalty towards the central government.