Sunday, April 24, 2005

The Biggest Reason to Protect Social Security

George Orwell once said: "We have now sunk to a depth at which re-statement of the obvious is the first duty of intelligent men." In our continuing series on Social Security, I decided to skip to the last myth to be busted:

Myth #6: Social Security is a drag on the economy. (Reality: Social Security has been a mighty engine for U.S. economic growth in several different ways.)

This is because in all of the excellent mobilization going on out there on telling the truth about Social Security, few are talking about perhaps the most fundamental reason of all not to tamper with the program. Fact is, Social Security is a critical piece of our society's economic infrastructure put into place to make the boom and bust business cycle smoother and more predictable. This in turn makes our economy safer, more productive and the most secure place on the planet for someone to do business.

De-emphasizing Social Security and the rest of the social safety net may have a stunning and more than a little frightening effect on the entire macro economy. To see it, let's do what Orwell suggests and look at restating the obvious. In this case we remind ourselves why the Social Security system was enacted in the first place.

When President Franklin Roosevelt signed the Social Security Act in 1935, he explained to the American people exactly what the bill was designed to do:

"It is a structure intended to lessen the force of possible future depressions. It will act as a protection to future Administrations against the necessity of going deeply into debt to furnish relief to the needy. The law will flatten out the peaks and valleys of deflation and of inflation. It is, in short, a law that will take care of human needs and at the same time provide for the United States an economic structure of vastly greater soundness." (Statement on Signing the Social Security Act August 14, 1935, Franklin Roosevelt, accessed at the FDR Library)

So Social Security is more than just a social program but also an integral part of managing the United States macro economy. The concept is pure Keynesian economics at it's best. If you ensure that a higher proportion of the population has buying power regardless of where you are in the boom or bust business cycle, you will lessen the severity of the bust, without having much of an effect on the boom.

It's just common sense. Take two local merchants. One merchant is located in a place where only 5% of the town can afford his products when times are bad. The other merchant lives in a place where 30% of the town can afford his products when times are bad. Which merchant is worse off? Which businessman can afford to hire more people, pay more taxes and contribute more to his community, helping to jump start a bad economy that much quicker?

A strong guaranteed Social Security and the rest of the social safety net ensured that no matter what, more people could afford to participate in the economy than if those programs weren't there. Then, as those dollars recycle through the economy changing hands at a fast pace, a 'multiplier effect' takes over and jump starts the economy quicker, lessening the impact of bad times and lengthening the life of good times.

Has it worked? You bet. Due to the stabilizing effects that President Roosevelt described, the severity of the ups and downs of the business cycle substantially lessened after Social Security was put in place. The United States was buffeted by extreme booms and busts throughout the 19th century up through the Great Depression, as shown on this chart.

While you can visually see how the jagged lines smoothed out especially after World War II, the business cycle smoothed out on a statistical basis as well. Before Social Security was enacted, the standard deviation of annual economic growth stood at 0.59 and after Social Security was enacted the standard deviation dropped to 0.44, indicating lower volatility. Taking the upheaval of World War II out of the equation drops post war standard deviation of annual growth to 0.24. This means that economic growth became more predictable and the business cycle of boom and bust became less painful for the society, just as Roosevelt had predicted. At the same time, the economy grew at a faster pace. In the seven decades before Social Security, average annual GDP growth stood at 3.4%. After Social Security was enacted, average annual growth rose to 3.86%. While that seems a small difference, it represents additional trillions in our economy today than otherwise might have been. (Data derived from L. Johnston and S.H. Williamson, "The Annual Real and Nominal GDP for the United States, 1789 Present." Accessed at Economic History Services, March 2004,

So what happens when the "economic structure of vastly greater soundness" is tampered with or eliminated? Especially if those doing the tampering show little ability to implement economic policies that perform as expected? Well, it's not much of a stretch to imagine that business cycles, both up and down, will become more pronounced, more unpredictable and harder to control. It's also not a stretch to imagine that overall economic growth might slow back down to pre-New Deal levels.

Don't let them destroy Social Security. We have only one macro economy to lose.