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   The New York Times
------------------------------------------------------------------------


         February 1, 2005

*OP-ED COLUMNIST*


   Many Unhappy Returns

*By PAUL KRUGMAN 
<http://www.nytimes.com/top/opinion/editorialsandoped/oped/columnists/paulkrugman/index.html?inline=nyt-per> 
*

The fight over Social Security is, above all, about what kind of society 
we want to have. But it's also about numbers. And the numbers the 
privatizers use just don't add up.

Let me inflict some of those numbers on you. Sorry, but this is important.

Schemes for Social Security privatization, like the one described in the 
2004 Economic Report of the President, invariably assume that investing 
in stocks will yield a high annual rate of return, 6.5 or 7 percent 
after inflation, for at least the next 75 years. Without that 
assumption, these schemes can't deliver on their promises. Yet a rate of 
return that high is mathematically impossible unless the economy grows 
much faster than anyone is now expecting.

To explain why, I need to talk about stock returns. The yield on a stock 
comes from two components: cash that the company pays out in the form of 
dividends and stock buybacks, and capital gains. Right now, if dividends 
and buybacks were the whole story, the rate of return on stocks would be 
only 3 percent.

To get a 6.5 percent rate of return, you need capital gains: if 
dividends yield 3 percent, stock prices have to rise 3.5 percent per 
year after inflation. That doesn't sound too unreasonable if you're 
thinking only a few years ahead.

But privatizers need that high rate of return for 75 years or more. And 
the economic assumptions underlying most projections for Social Security 
make that impossible.

The Social Security projections that say the trust fund will be 
exhausted by 2042 assume that economic growth will slow as baby boomers 
leave the work force. The actuaries predict that economic growth, which 
averaged 3.4 percent per year over the last 75 years, will average only 
1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to get 
that 6.5 percent rate of return, stock prices would have to keep rising 
faster than profits, decade after decade.

The price-earnings ratio - the value of a company's stock, divided by 
its profits - is widely used to assess whether a stock is overvalued or 
undervalued. Historically, that ratio averaged about 14. Today it's 
about 20. Where would it have to go to yield a 6.5 percent rate of return?

I asked Dean Baker, of the Center for Economic and Policy Research, to 
help me out with that calculation (there are some technical details I 
won't get into). Here's what we found: by 2050, the price-earnings ratio 
would have to rise to about 70. By 2060, it would have to be more than 100.

In other words, to believe in a privatization-friendly rate of return, 
you have to believe that half a century from now, the average stock will 
be priced like technology stocks at the height of the Internet bubble - 
and that stock prices will nonetheless keep on rising.

Social Security privatizers usually defend their bullishness by saying 
that stock investors earned high returns in the past. But stocks are 
much more expensive than they used to be, relative to corporate profits; 
that means lower dividends per dollar of share value. And economic 
growth is expected to be slower.

Which brings us to the privatizers' Catch-22.

They can rescue their happy vision for stock returns by claiming that 
the Social Security actuaries are vastly underestimating future economic 
growth. But in that case, we don't need to worry about Social Security's 
future: if the economy grows fast enough to generate a rate of return 
that makes privatization work, it will also yield a bonanza of payroll 
tax revenue that will keep the current system sound for generations to come.

Alternatively, privatizers can unhappily admit that future stock returns 
will be much lower than they have been claiming. But without those high 
returns, the arithmetic of their schemes collapses.

It really is that stark: any growth projection that would permit the 
stock returns the privatizers need to make their schemes work would put 
Social Security solidly in the black.

And I suspect that at least some privatizers know that. Mr. Baker has 
devised a test he calls "no economist left behind": he challenges 
economists to make a projection of economic growth, dividends and 
capital gains that will yield a 6.5 percent rate of return over 75 
years. Not one economist who supports privatization has been willing to 
take the test.

But the offer still stands. Ladies and gentlemen, would you care to 
explain your position?


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