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, http://www.eh.net/hmit/gdp/)

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.

5 comments:

Corey said...

You say that FDR established SS as a means to, among other things, improve the rate of growth of the economy and dampen its fluctuations. You claim that his program succeeded--and contines to succeed-- because the AVG annual growth and SD around that average have been higher and lower, respectively, since SS was enacted. QED.

It is just as likely that the invention of the Frisbee in 1950 is REALLY what caused the improvement in the macroeconomy. Your graph 'proves' it as much as it proves your contention that SS was the cause. Or maybe it was the Roswell incident in 1947. Or maybe the discovery of the Dead Sea Scrolls! All kinds of things happened in the late forties.

I'm not saying, by the way, that it *wasn't* SS that produced the effects you claim. I would simply suggest that you have amassed all of one data point in support of your hypothesis. But this is the fundamental problem with macroeconomics--there are precious few systems that are similar enough to pass as an ensemble for the purposes of analysis.

It's fine if you want to *believe* that SS is a good thing for the economy, but until you find additional positive or negative examples to support your hypothesis, you're taking it on faith. Dressing your claims up in the language of statistics doesn't give them validity.

Richard said...

Corey, you had said: "You say that FDR established SS as a means to, among other things, improve the rate of growth of the economy and dampen its fluctuations."

No, I didn't say that. FDR said that. I quoted him.

"It is just as likely that the invention of the Frisbee in 1950 is REALLY what caused the improvement in the macroeconomy."

This kind of argument might be valid IF (1) there was a demonstrable correlation between frisbee sales and economic growth, which there is not; and (2) there wasn't a huge body of academic, theoretical and empirical evidence called Keynesian economics that informed FDR's prediction.

You then said: "I would simply suggest that you have amassed all of one data point in support of your hypothesis."

In addition to the chart, I also pointed to links to acquaint readers with Keynesian economics, it's history, it's tenets and it's theory. Beyond that, other blog posts I've posted have gone into great detail on how increased social spending and Democratic Party policies have resulted in fact with higher economic growth than Republican policies. So it's just not one dataset taken out of context we're dealing with here.

What we see here is one icon of one ideology, the Democratic-Keynesian FDR putting in place a bold fiscal program (SS and the New Deal) and saying at the outset what the economic outcome will be. And, that economic outcome demonstrably came to pass.

In 1981, an icon of another ideology, the Republican Supply-Side Ronald Reagan, put forth his bold fiscal program (Reaganomics) and saying at the outset what the economic outcome would be. That outcome was increased economic growth over the Carter years and a balanced budget. Neither came to pass. Growth went down from the Carter years and deficit skyrocketed.

To put it another way, SS and the New Deal were an experiment in the validity of the Keynesian hypothesis. If we enact this program, we should see overall increased growth and a smoothing of the business cycle over long periods of time, they said. That's what happened. The hypothesis was proven.

Later, Supply Siders wanted to disprove Keynesian economics and do their own experiment with a supply side hypothesis. They tried it. Their hypothesis failed to happen. It's really that cut and dry Corey.


Kind regards,
Richard

Corey said...

You said: "This kind of argument might be valid IF (1) there was a demonstrable correlation between frisbee sales and economic growth, which there is not..."

You didn't refute my Frisbee argument; you substituted a different argument, one I didn't make. You suggested that IF there were a correlation between Frisbee sales etc...but I stated that it was the mere INVENTION of the Frisbee that caused the change in the stationarity of the economic growth distributions, not sales or anything else. And it was meant as a joke, a rhetorical device, and not really intended to elicit a response.

You said: "In addition to the chart, I also pointed to links to acquaint readers with Keynesian economics, it's [sic] history, it's [sic] tenets and it's [sic] theory. Beyond that, other blog posts I've posted have gone into great detail on how increased social spending and Democratic Party policies have resulted in fact with higher economic growth than Republican policies. So it's just not one dataset taken out of context we're dealing with here...What we see here is one icon of one ideology, the Democratic-Keynesian FDR putting in place a bold fiscal program (SS and the New Deal) and saying at the outset what the economic outcome will be. And, that economic outcome demonstrably came to pass."

Wrapping a theory and a context and a prediction around one data point doesn't produce more data points. I'll acknowledge that your one data point supports your theory, but you'll have to amass many, many more points in order to convince me that the effects you cite (and which I stipulate) follow from your theory.

If you want to bolster your thesis, you need to explain why a whole host of other factors (advancing technology, the rebuilding of Europe and realigning of global interests following WWII, and so on) plays NO role in your theory explaining economic performance subsequent to FDR. Further, you need to show similar graphs for other countries. If you can show me that, say, four times out of five a country that adopts Keynesian practices experiences a sustained reduction in volatility coupled with higher growth, then maybe I'll think about drinking the Kool Aid.

In an earlier post (on my site), you said: "...(2) policies that act to put more cash or control in the hands of less affluent classes grow the economy more than policies that put more cash or control in the hands of affluent people. This is because less affluent people will spend a higher proportion of that cash faster than more affluent people in types of spending that in turn grow the economy more than other types of expenditures. (More of a dollar spent on a loaf of bread will recycle in the domestic economy versus a dollar spent on French wine or invested in a Eurofund.)...
(5) This clear record that shows that social and domestic spending grows economies better than supply side tax cuts is empirical proof that supply side economists are in error and the currently out of favor Keynesian wing of economics should be dusted off and promoted..."

The U.S. tossed aside Keynes in the early 1980's, right? The Europeans have largely retained Keynesian economics. They spend much more on social programs for the "less affulent" and tax the hell out of the upper classes. Doesn't your theory then imply that the European economies should have outpaced that of the U.S.
for the past twenty years or so? And wouldn't saavy investors have seen this coming and bid up the CAC and DAX?

You don't prove a hypothesis with one experiment. You can't regress to a line with one data point. You're obviously bright, Johns Hopkins and all. It does not become you to insist that anything in macroeconomics is "really that cut and dry".

Richard said...
This comment has been removed by a blog administrator.
Richard said...

(I deleted my previous post because it was in desparate need of spell checking. This post is probably equally in need of grammar checking, but I ran out of time.)

In a message dated 6/20/05 7:53:15 PM Eastern Daylight Time, Corey writes:

"Wrapping a theory and a context and a prediction around one data point doesn't produce more data points. I'll acknowledge that your one data point supports your theory, but you'll have to amass many, many more points in order to convince me that the effects you cite (and which I stipulate) follow from your theory."

As I said before, I'm presenting lots more than just one data point. Start with 150 years worth of American economic history. Then browse through my blog and see other datapoints, like Keynesian Democrats growing the economy and creating jobs far more than their trickle down/supply side Republican counterparts through time since WWII. So we not only see (1) the big picture when economic philosophy and implementation changes in a big way a la the New Deal/Social Security, as well as (2) the difference in outcomes caused by smaller adjustments toward and away from Keynesian principles represented by different administrations taking control.

Then you said: "If you want to bolster your thesis, you need to explain why a whole host of other factors (advancing technology, the rebuilding of Europe and realigning of global interests following WWII, and so on) plays NO role in your theory explaining economic performance subsequent to FDR. "

Straw man. You can't prove a double negative. I also can't prove that skirt hem lengths or Super Bowl winners aren't the controlling factors either. A whole subculture of weirdos have sprung up pushing those theories.

Then you said: "Further, you need to show similar graphs for other countries. If you can show me that, say, four times out of five a country that adopts Keynesian practices experiences a sustained reduction in volatility coupled with higher growth, then maybe I'll think about drinking the Kool Aid."
>>snip<<
The U.S. tossed aside Keynes in the early 1980's, right? The Europeans have largely retained Keynesian economics. They spend much more on social programs for the "less affulent" and tax the hell out of the upper classes. Doesn't your theory then imply that the European economies should have outpaced that of the U.S.
for the past twenty years or so? And wouldn't saavy investors have seen this coming and bid up the CAC and DAX?"

The latter point isn't really true. Most European countries have gone through the same ideological seesaw as we have from factions favoring redistribution of wealth towards the rich as well as the other way. For every Mitterand there's a Thatcher. What you suggest is a good idea though. I don't have enough time or expertise to dope out the GDPs and political dynamics of each European country but here's a start:

I looked at the UK. Googling got me to the OECD site which gives annual GDPs for member countries going back to 1980. Here's the site:
http://www.oecd.org/document/43/0,2340,en_2649_37451_1934699_1_1_1_37451,00.html

Exporting the data for the UK into my spreadsheet and applying AVE and STD formulas to the 24 year sample (1980-2004) you can get the volatility and average growth for the regimes that the UK has had in that time. The Thatcherite Tories held sway from 1979-early 1997. Tony Blair's Labour Party took over then until now. These two parties are good contrasts, with many of the same supply side economists advising Thatcher as had advised Reagan. Blair's middle of the road Labour stance is very close to pro-Keynesian capitalism found in the US Democratic Party. During the Tory years, annual GDP growth averaged 2.36%. During the Labour years it averaged 2.81%. (The numbers are Tory - 2.39%; Labour - 2.74% if you give 1/2 of 1997 to each.) Std deviation for the Tory years is .019. For Labour it drops by 2/3rds to .006.

So here again when the Keynesian take over the national economy in the UK, economic growth rises by about .4-.5% per year and the volatility of the business cycle drops substantially. Now with the OECD data I could do the same with most developed countries on the list IF I knew enough about each country's political history to be able to compare apples to apples. I do not believe that it's fruitful to take the current political orientation of country X and compare it to country Y because each country has unique circumstances. For example is it fair to compare Norway's results with say Italy's when the former discovered oil off their shores while the Italians didn't? I don't think so.

Then you said: "You don't prove a hypothesis with one experiment. You can't regress to a line with one data point. You're obviously bright, Johns Hopkins and all. It does not become you to insist that anything in macroeconomics is "really that cut and dry". "

I've noticed that when trying to convince people of the correctness of their program, politicians will be quite cut and dry on their predictions. Only when those predictions fall flat on their face do people suddenly recall all of the complexities of the real world that prevent them from concluding anything about anything. So far that's a rhetorical problem that the Republicans and supply siders face, but the Keynesian Democrats don't, for the actual experience supports the latter, obviating the need to make excuses.

Kind Regards,
Richard