Prescott on Rebuilding Social Security

It’s a shame that this Edward Prescott op-ed is behind the WSJ wall. Prescott (who won the economics Nobel this year)argues that mandatory investment accounts with limited investment options are necessary to solve the time inconsistency problem with savings.

Readers of this page will recall that I have made this proposal in a previous essay, but readers may also recall a letter that questioned an assumption I make about consumer behavior. In effect, the reader asked how, on the one hand, I consider people so irrational that they have to be forced to save, and, on the other hand, I consider people rational enough to manage their own retirement accounts.

But this question reveals a misunderstanding of the time inconsistency problem. The reason we need to have mandatory retirement accounts is not because people are irrational, but precisely because they are perfectly rational–they know exactly what they are doing. If, for example, somebody knows that they will be cared for in old age–even if they don’t save a nickel–then what is their incentive to save that nickel? Wouldn’t it be rational to spend that nickel instead.

Of course, a libertarian would prefer a system of neither mandatory investment nor wealth transfer. But if we’re going to get one or the other, I think the paternalism of mandatory investment is better on libertarian terms than expropriation and redistribution. Property rights are not unitary; they are a bundle. Mandatory investment restricts liberty over some sticks in the bundle, but the overall right to one’s earnings are preserved. In redistribution, one’s right is just straightforwardly violated–one loses the whole bundle. If we have the chance to implement a policy that involves a small violation of liberty but which will replace or prevent the implementation of a policy that would involve a larger violation of liberty, we should do it. Mandatory accounts help preseve an ethos of self-responsibility, which I think is crucial for a healthy society. And if the policy has overall superior economic consequences to the alternatives, as does mandatory investment, that is another strong reason to support it.

The rest of Prescott’s op-ed is full of plain good sense. He deflates worries about truck drivers runing themselves by “gambling” on the market, and Wall Street firms gouging the naive folk with gigantic fees. And he points out the ridiculousness of “Cassandra[s] screeching about evil policy makers and cranky politicians who are out to destroy Social Security.” As Prescott rightly notes, Social Security is simply bad policy. We have the opportunity to replace it with a better policy. So we should replace it.