- The Washington Times - Wednesday, March 8, 2000

As part of his proposed budget for fiscal year 2001, the President Clinton again requested that a portion of the annual Social Security surplus be invested in the private sector. The good news is that this shows the White House understands the current system is unsustainable and realizes that investing in stocks, bonds, and other income-producing assets is the best way of ensuring future retirement security.

The bad news, unfortunately, is that the administration wants politicians to have control over how the money is invested. This is a truly awful idea, and any member of Congress who is tempted to approve this radical proposal should read a report published in January by the World Bank. Titled "Managing Public Pension Reserves," this study demonstrates that government-controlled investment of Social Security funds would be a recipe for disaster.

Simply stated, the international evidence shows that government-managed pension systems do a poor job of building wealth and retirement security for workers. The reason: Bureaucratic incompetence and political interference prevent funds from being invested prudently. As a result, most of these systems actually lose money. And the small handful that show positive returns perform very poorly when compared with the privatized systems that are earning impressive returns using private-sector fund managers.

This World Bank research has important implications for the United States because there is a growing consensus that Social Security cannot be sustained in its current form. The program has a gigantic $20 trillion long-term deficit, and the red ink will begin to flow shortly after the baby boom generation begins to retire. The problem is simple demographics. There are too few people entering the work force and too many people about to retire.

This looming crisis can be addressed in two ways. First, policy-makers can simply wait until 2014 when Social Security is projected to go in the red and then impose big tax increases and/or benefit reductions. Needless to say, this is not a very attractive option, and it explains why there is so much dissatisfaction with the "pay as you go" approach.

The other alternative is to set aside money now, investing the funds so that there will be a substantial nest egg that can be used to help finance future retirement needs. In the language of pension experts, this means future obligations would be at least partially "funded."

The president, not surprisingly, is trying to do both. Part of his supposed Social Security reform plan is a charade, consisting of a proposal to add more IOUs to the trust fund. At best, this deceptive form of financing will simply give future politicians an excuse to impose higher taxes on future workers.

Yet the president also proposes to add a "funded" component to the Social Security program. Unfortunately, as mentioned above, he wants to do the right thing in the wrong way. Mr. Clinton's plan to have the government invest is bad for two reasons.

First, the World Bank evidence shows politicians and bureaucrats are not good investors. The administration argues that the United States would be different and that safeguards would be put in place to ensure that all funds were invested for economic rather than political reasons. Such assurances ring hollow, though, when one considers that the president already is on record in favor of forcing private pension funds to make "economically targeted" investments.

Supporters of the White House plan also assert that the international evidence is misleading. More specifically, they argue that the superiority of private management is overstated since it compares the returns with government-controlled funds in less-developed nations like Uganda and Venezuela with the returns to privately managed funds in advanced nations like Australia and Switzerland.

Yet the World Bank study adjusts for this factor. According to the report, "[P]rivate management produces returns that are about 430 basis points higher than publicly-managed schemes after taking into account differences in the governance index." Translated into simpler terms, this means that government-controlled funds will produce very low returns even in advanced nations where there is no corruption and the politicians are genuinely trying to act in the best interest of workers.

The other problem with the Clinton plan is that all the benefits would go to the government. In other words, even if the plan somehow worked perfectly and politicians displayed amazing financial acumen, workers would not see their promised benefits climb by even one penny. And since Social Security provides very low benefits when compared with the record amount of taxes that workers pay into the system, this is an especially egregious feature of the proposal.

The only reform that will both address Social Security's immense financial crisis and give workers more retirement income is privatization. Create a "funded" system, but let workers have personal accounts so that they can reap the benefits of compound interest. Nearly two dozen nations have moved in this direction, and the results have been universally positive. American workers deserve the same opportunity.

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