THE BLOG

Risky Business

01/25/2013 05:03 pm ET | Updated Mar 27, 2013

It wasn't surprising that, in his second inaugural address, President Obama asserted his continuing support of Medicare, Medicaid, and Social Security. What was unusual and remarkably insightful was his reference to the role these programs play in underpinning our prosperity. As Obama put it, "they free us to take the risks that make this country great." It's common to cite these programs as cushioning the burdens of old age and providing access to otherwise unaffordable health care. But how often do we think of them as protecting our backs in an uncertain, risky, and rapidly changing global economy? How often do we think about the safety net as proving some assurance that risk-taking of the kind represented, say, by starting a new business or going back to school to change careers doesn't have to mean that we have increased our risk of winding up in abject poverty or ruined by the cost of an illness?

In fact, Americans and America already face more economic risk than was the case a generation ago. After World War II, for example, the United States produced 60 percent of the world's output and owned 60 percent of the world's gold supply. It had small import needs. It was a creditor nation with apparent immunity from the troubles of other nations. First-year students of economics were taught that they could virtually ignore trade, since its impact, relative to the rest of the economy, was too small to matter. In this environment, the nation's ability to support its older citizens, including retirees, was not in doubt.

Well, we've come a long way.

Today, international market forces affect the price of just about everything that we consume. American jobs have been under pressure from foreign competition for decades. And American workers increasingly face more exposure to the risks of the market. To cite one example, defined benefit retirement programs have just about been replaced by defined contribution schemes -- where pension plans still exist at all. The difference: in the former, the employer bears the market risk; in the latter, the risk is borne by the worker. Some have argued that this risk can be totally mitigated by, for example, simply investing in market index mutual funds. But in practice, that turns out to be more difficult than it sounds.

First of all, the obvious: markets go up and down, sometimes dramatically, and it's just plain difficult to match these moves. People enter and leave the markets at different times, depending on when they retire or add contributions to pension funds, and the funds themselves also have different transaction costs and administrative fees. Apart from these limitations, there is the problem caused by reaching retirement age when the market is in a prolonged slump. Even in the very successful 20th-century stock market, for example, there were three periods of twenty years where returns were zero or negative.

Given these risks and uncertainties, it's hard to see how the introduction of additional risk can make people feel more secure. Yet, that is exactly what is proposed by the advocates of replacing Social Security and Medicare with private accounts and health "savings plans." In their view, people are all supposed to do so well that we all wind up with nice nest eggs, far exceeding the modest support provided by Social Security. At this point, it's worth mentioning that work done by Dean Baker and others have long shown that, even in the best of times, growth projections, widely agreed upon in the economic community, make such stock performance almost impossible. (See, for example, Baker, "Saving Social Security With Stocks," Twentieth Century Fund, 1997.) Stocks are already priced high relative to earnings. It is unlikely that they will be unable to sustain a high ratio of price to earnings indefinitely, let alone increase dramatically as projected under most privatization scenarios. Baker showed that to sustain such increases, given reasonable assumptions about GDP, all other sectors would see their share of the economic pie reduced. Indeed, under some scenarios, wages would have to become zero or negative, since the perpetually galloping stock market returns would capture so much of national income. In other words, the notion that we can all get rich is a pipe dream.

This is very different from saying it wouldn't be better for all of us to save more. But, obviously, that is hollow advice for workers who are just getting along from paycheck to paycheck. Make no mistake: we are in somewhat of a fix. With a greater proportion of the population in retirement in years to come, there is sure to be a wrestling match about how to allocate more of our GDP to the elderly. But without Social Security and Medicare, the definition of acceptable risk taking would have to be altered.

As the president said, reinforcing rather than reducing Social Security and Medicare provides a least a minimum level of comfort about one's old age. Without that assurance, Americans would find that their risk had increased and that they had less ability to hedge against an uncertain future.