Alan Greenspan's Savings' Hole Jude Wanniski February 23, 2005

Memo To: Members of Congress
From: Jude Wanniski
Re: Fixing Social Security

As you grapple with the complex economic issues surrounding the financial problems with Social Security and Medicare, each one of you should understand the dynamics of “national savings.” I say that after reading Federal Reserve Chairman Alan Greenspan’s testimony before the Senate and House banking committees last week. Again and again, members of the committee tried to grasp his argument that “national savings” must increase sharply – and soon, not decades from now – if the goods and services will be in sufficient abundance to provide for the needs of the work force and the retired population. Greenspan understands the problem better than anyone else in Washington, I think, but he is still missing a piece of the solution.

In his Senate testimony, here is how he best summed up his view, in support of the President’s proposed plan to privatize a portion of the current pay-as-you-go system even though privatization in and of itself will not put a dent in the financial problem. For that, national savings have to increase:

MR. GREENSPAN: Well, let me just say that in any move which we endeavor to create full funding, there is a huge transition cost because we have not built the stock of assets required, and that's the shortfall or the difference between the 1.5 trillion (dollars) and the 10 trillion (dollars) plus in funding assets. And actually, if you go further and you put Medicare in here, we're talking another $60 trillion. So the problem that we have is there is a huge transition cost to get us to a point where we're building the savings adequate to produce the assets. We're not doing that, and any scheme cannot get around the fact that there is a huge hole in the system and we have no choice but to find a way to fill it…

A bit later, Sen. Michael Crapo, [R ID] understood Greenspan to say that, at least in the first instance, privatization would not mean a net increase in savings:

SEN. CRAPO: So the employer's savings would be reduced, but the employee's savings would have gone up and there'd be net zero balance.

MR. GREENSPAN: Yes. In order to get savings, remember, you have to get consumption declining relative to income.

Technically, Greenspan is correct, but he does cause confusion by addressing the issue in static terms. The very heart of classical economics, which very few economists practice these days, is that the objective of sound economic policy is to increase the efficiency of the overall system, so that the nation’s real output of goods and services increases without increased toil. And because Production = Consumption + Savings, an increase in Production can mean an increase in consumption AND savings at the same time.

In the static Keynesian model, which Greenspan employs in addressing these issues, there is at any given time a fixed “pool of savings,” from which the economy draws to support the nation’s aggregate living standard. It’s almost impossible to solve the kinds of problems you are being addressing when you face a political “zero-sum” game. In this model, “savings” can only increase if someone is forced to save, by having the government tax him and invest the money for him in stocks or bonds. Or, by slashing government spending to balance its budget without drawing upon the savings of its own people or foreigners willing to hold our stocks and bonds.

If Greenspan were to make one small adjustment in his thinking, it would become clear to him and to you those simple changes in tax policy and monetary policy would increase the national “asset base” without forcing anyone to “save.” The fact is that everyone in the work force is capable to being more productive without working harder than they do now. It is part of the dynamics of the economy that as new entrants to the work force acquire new skills, they become more productive and will command higher wages and incomes. If their higher skills are matched by increases in the capital available to them, they can become even more productive at a greater pace. It does not take much education to teach a young man or woman who earns the minimum wage by flipping hamburgers to learn how to grill steaks and cook omelets, and if there is capital available for their employers to offer fine dining, the same hamburger flippers can quickly learn to make soufflés and Beef Wellingtons.

If we think of “capital” as the unused resources of the population – their time, energy and talent – it becomes much easier to see how reforms of the tax laws in combination with reforms of Social Security can be fostered without a painful, political approach to financial deficits. If the entire work force suddenly found that the financial markets would support a higher level of productivity because taxation of capital was reduced, that’s exactly what would happen. In his State of the Union Address, President Bush alluded to this concern when he noted that there are now three workers supporting one retiree and that by 2018 there would be only two workers to support a senior.

If you read Greenspan’s testimony carefully, you would see he knows the capital/labor ratio must increase by 50% between now and 2018, or there will not be enough goods and services to go ‘round to maintain today’s standard of living. Each of the two workers must have half again as much capital available to him or her as they do now, or there will be a generational war, as young and old slug it out for the diminishing pool of goods. If we could only see that our work force is now operating at only half of its potential, it even becomes clear that by getting close to full potential the system could support higher benefits to seniors to wish to retire years before their lives run out.

Most of you in Congress who are Democrats feel obliged to stick to the Keynesian economic model that has served you for several decades. This forces you to ignore the very concept of the capital/labor ratio, otherwise you would be logically led to conclude that the capital gains tax should be eliminated altogether. If any of you would ever ask Greenspan that question, he would say “by all means, do it immediately if you can, and don’t worry that it will increase the budget deficit because it will far more dramatically increase the nation’s productivity and its standard of living.”

Whatever you decide, though, be assured that the nation’s “savings rate” is of much less importance than its level of production. And don’t forget that all production is consumed within a calendar year or so; none of it is saved. Bread would go stale and new cars would pile up in inventories, unused and getting rusty.