Smoke and Mirrors, Part 2

SMOKE AND MIRRORS, PART 2….In my previous post I mentioned in passing that it’s hard to come up with future projections in which (a) economic growth is bad enough that Social Security goes bust in 2042 but (b) economic growth is good enough that private accounts have investment returns of 7% annually ? and thus are lucrative enough to save Social Security. This point is worth expanding on a bit.

Every year the Social Security trustees produce a 75-year financial estimate. To do this, they make estimates of population growth, life expectancy, economic performance, and so forth, and then add them all up into an overall estimate of long-term solvency. In fact, they make three estimates (see chart on right), and the one you hear about in the news is the middle one, or “intermediate projection.” In that projection, Social Security starts running a deficit in 2042. The key assumptions in the intermediate projection from 2015 forward are the following:

  • Labor force growth: 0.2% per year.

  • Productivity growth: 1.6% per year.

  • Average hours worked: no change.

Which leads to the following overall estimate:

  • GDP growth: 1.8% per year.

This growth is lower than we’re used to, but that’s because GDP growth = population growth + productivity growth. Since population growth is slowing down, so will GDP growth.

Still, what if you assume that things will be a little more robust than this? If you project GDP growth of around 2.6% per year, you end up with Estimate I, and in that scenario Social Security never runs out of money. In fact, if you project GDP growth just a few tenths higher than 1.8%, Social Security stays solvent for the next century.

In other words, if GDP growth averages, say, 2.2% over the next 75 years, Social Security is in fine shape and we don’t have to do anything. We only need to “fix” it with private accounts if GDP growth is less than that.

So here’s the puzzler: for private accounts to be worthwhile, they need to have long-term annual returns of at least 5%, and 6-7% is the number most advocates use. But are there any plausible scenarios in which long-term real GDP growth is less than 2% but long-term real returns (capital gains plus dividends) on stock portfolios are well over 5%?

Privatization enthusiasts are encouraged to leave their answers in comments.