Re: Franco Modigliani [and his proposals to save Social Security -- CITS

[from a discussion on "federal-debts@topica.com" -- a list that
was previously, "concordcoalition@yahoogroups.com," where
Mr. Hart raised the recent writings of Modigliani, an
economist who Samuelson called the "greatest economist in
the world."  Prior exchanges appear below.]

Dear Walter,

Over time, I have sensed that you have appreciated my
newsletters, and, you constantly bring a steady
consideration of the issues.  This is thoughtful, and
appreciated.

In reply to your comments, we know that the transition
Modigliani describes (your cited URLs below) involves a hugh
sum of money to  change Social Security from pay-as-you-go,
to some jointly invested "pot of money."

As I say this, I might, in contrast, suggest an
incremental approach where, say, we move funds to
the "central pot" at the rate of 10% every ten years.

But while this aids in the transition and "double
taxation" involving the "transition era workers" it still
does not solve the problem of long wave fluctuations in the
stock market.

In that Modigliani passed at age 85, this year, let's
think about how old he was in 1925?

That is 78 years ago, so he was age 7.

At the crash, he was age 11 and he fled from Italy to the US
in 1939, so, his experience of the 30's is from an Italian
perspective.

I look at these dates because we know, as a fact, that
young experiences do shape a person.

I, in contrast, born in 1946, have absolutely no direct
experience with a major crash -- except as was conveyed
to me via two parents who struggled through the Great
Depression.

That second-hand knowledge is not insignificant.

I've read that children of "that age" tend to two
responses.  There are those, such as I, who were "taught
the lesson" and practise a level of frugality that, in
this era, actually looks quite odd.  (I, for example,
watched my father hang paper towels out to dry, if they
were not very soiled.)

And, there are the children who looked at the impoverished
level of their parents, and declared that they would
never live such a financially constrained life.

My sense?  For every person such as I, there are 20 who
are determined to live the "high life."

Are such attitudes critical in the flow of future events?

Absolutely.

And, of these, those who own homes, are mostly playing
a game of musical chairs.  As long as their house
prices keep rising, they will feel the "wealth effect"
and they will borrow, both to further build onto their
houses, or extract the equity for other acquisitions.

And, as long as the house market rises, there is little
danger.  The debt-financed consumption simply continues.

When analysts look at the result, they see a GDP growth,
and, that is the mantra of higher stock prices.  That
the GDP growth is mostly achieved via debt, simply seems
to mean nothing to the financial community.  They don't
call it debt, they call it credit.

***

Returning to Modigliani, his prescription, one way or
another, demands a "healthy economy."  And, it does
not compensate for 10 years of economic depression.

I have previously published -- over 100 years, average
inflation - 4%, average return on low risk instruments - 5%,
average return on stocks, 8%.

So.  Holding money safely, one gets (a real) 1% per annum.  One
analyst said this is close to taking a person's life
span (100) and the reciprocal == 1%

Stocks demand a 3% "risk premium."  Why?  For every stock
that remains "listed" -- there are those of companies that
fail, and become "delisted."  So, the 3% premium is
necessary to draw investors into the market -- some of
whom will eventually hold worthless stock.  (mutual funds
are a response to this dilemma, spreading the risk)

***

So.  In that 100 years is much longer than the Kondratieff
cycle, I would have no objections to having my retirement
paid out of a trust that averaged out the fluctuations
over 100 years.

But, is Modigliani promising this degree of averaging when
he prescribes placing a "central pot of money in the markets?"

Absolutely not.  A whole bunch of retirees could arrive
at precisely the moment that stocks plummet and fixed
instruments pay next to nothing.

Can retirees wait out, say, a ten year period of this
kind?

I don't think so.  While some have buttressed their S.S.
with Keoghs, their Keoghs will exhibit the very same
behavior.

The result?  Only those who are still working (in the '30s,
this was 75% of the labor force) have the ability to
supply the cash flow to retirees via their S.S. payments.

In summary, I believe that all booms are dangerous to all
plans for the future.  They are dangerous to Social Security
payments and they are dangerous to all others related to
their jobs, individual investments, and tranquility.
(Kindleberger reached the same conclusion in his book of
1979)  And Kindleberger and Modigliani both passed away
in the last year.  We are losing our "smart ones."

Regards,

Curtiss

Walter Hart wrote:
>
> Dear Curtiss
>
> I am a bit of a plodder whenever anyone throws math into the equation,
> which I know is a terrible admission to make. I'm actually still reading=
> 
> through Modigliani's working paper at
> http://web.mit.edu/francom/ssecurity/
>
> But Modigliani at least appeared to claim that the transition cost to a
> fully pre-funded system would not impose a doubling of the burden on the=
> 
> transition generations. See the following excerpt:
>
> "This difference is also shown by the curve labeled =93transition cost=94 i=
> n
> the lower left-hand corner.  It is seen that the cost starts at 2% and
> stopped by year 15.  This cost of transition from a permanent 18.75% to
> 3.1% per year contribution appears surprisingly small, with our
> approach, less than 2% of payrolls per year, on the average, for some 15=
> 
> years.  This is in sharp contrast with the common perception that the
> transition cohorts have to pay, through their life, a double
> contribution: one to the old SS and one to the new funded system."
>
> "The next question is: how might that cost be allocated?  There are many=
> 
> ways to spread the cost between different groups.  For instance, one
> could place the burden on the current workers by increasing their
> contribution rate, to the level indicated by the =93required contribution=
> =94
> curve, or on the current retirees by lowering pensions temporarily.
> Either action or any combination of the two would reduce consumption and=
> 
> increase saving.  Alternatively, the government could absorb the
> transition cost, and the employees=92 contributions would remain constant=
> 
> until the transition cost ceases, and then declines thereafter as shown
> by column (3).  The government contribution, in turn, could be financed
> by increased public saving through higher taxes or lower government
> consumption, or finally by borrowing and increasing government debt,
> with the burden falling on future generations.  It must be understood
> however that the latter method would be counterproductive, for the
> increase in debt would offset the new saving of the system, thus
> negating one of the important benefits of funding, namely that of
> increasing national saving and capital."
>
> My interest in the shift to a pre-funded system arises from the
> principle that "you can't get something from nothing" and from the idea
> that the consequence of trying to do so is inequity. That said, Bill
> Larsen, who used to participate in the Concord Coalition list and who is=
> 
> running for Congress in Indiana on a "Repeal Social Security" platform,
> has his own mathematical complaints about Modigliani's proposal.  See
> http://forums.nytimes.com/webin/WebX?8@107.u9Ryazl126c.232290@.f264b53
> at the NY Times forum on Social Security #7816).
>
> Best regards,
>
> Walter
>
> W. Curtiss Priest wrote:
> >
> > Walter Hart wrote:
> > >
> > > Is anyone familiar
> >
> > Yes, I held an office at MIT within sight of his office.
> >
> > Oddly, Samuelson and Kindleberger gained far more visibility
> > regarding the national economy.  I gather from the obituary
> > that Modigliani was known more as a teacher's teacher.  If
> > someone gets a Nobel prize in 1985, the contribution preceeds
> > that by another 20 years.  And, frankly, the idea that
> > he "invented" valuing stocks based on their returns is a
> > tad unbelievable.  Roger Ward Babson knew this full well
> > in his writings during the '20s.
> >
> > > http://www.socialsecurity.org/pubs/articles/art-biggs020425.html
> >
> > As Mr. Johnson knows, I cringe when I see someone at the
> > Cato Institute speaking mightily of Modigliani's SS position.
> >
> > Whether Mr. Johnson agrees, or not, the Cato Institute is
> > about as right wing as they get.  So they back anything
> > that pumps more money into "today's market."
> >
> > Modigliani promises two things:
> >
> >       1.  That by having a "single pot" -- the risk to
> >               the retiree is less than if each retiree
> >               had his/her own pot, subject to whatever
> >               freakish variations
> >
> >       2.  That to go from the pay-as-you-go plan to an
> >               invested plan means that some generation
> >               has to pay twice
> >
> > Modigliani is betting that the assets of the "single pot"
> > will be larger than a possible smaller workforce, in the
> > future.
> >
> > This is quite the bet!  We certainly know we have a bulge
> > of retirees coming up in the next decade.
> >
> > And, it would certainly make sense to have that bulge
> > finance themselves, than to have a smaller, trailing
> > population trying to support all of those S.S. checks to
> > the larger bulge.
> >
> > However, there are people like myself who witness this
> > "bulge" not only to not be contributing to the single
> > pot for the future, but, "mortgaging the farm" in so many
> > extreme ways, that they, in their excess, threaten the
> > very economic security that Modigliani needs for the pot
> > not to crumble.
> >
> > For this current bulge to really create the pot and pay
> > S.S. for the current retirees would require a measure of
> > financial restraint that we simply do not see.
> >
> > I would think that large fences and very powerful cattle
> > prods would be required to make his proposal work.
> >
> > So, 'on the face of it' -- it looks grand -- but -- how
> > and would it survive?
> >
> > The opinion of others is welcome.
> >
> > Regards,
> >
> > Curtiss
> > --

Walter Hart's original message:

Subject:    Franco Modigliani
    Date:    Wed, 8 Oct 2003 20:10:09 +0000
    From:    Walter Hart <walterhart@juno.com> Reply-To:   
federal-debts@topica.com
      To:    federal-debts@topica.com

Is anyone familiar with the work of Franco Modigliani, the nobel
laureate economist?  I hadn't heard of his work before, but
essentially his proposal for reform of Social Security is based on
full pre-funding through use of a collective investment account.

In the Boston Globe obituary, "Franco Modigliani, 85, MIT teacher,
Nobel laureate in economics" By Louise Story and Laura Levis, Globe
Correspondents (Boston Globe 9/26/2003), it states:

"In his later years, [Modigliani] took public stands on economic
policy issues, especially Social Security policy. "He has the perfect
Social Security program, if only the fools out there would listen to
him," Samuelson said in a 2002 Globe interview.

http://www.boston.com/news/globe/obituaries/articles/2003/09/26/franco
_modigliani _85_mit_teacher_nobel_laureate_in_economics/

Other links regarding his work on Social Security include:

http://web.mit.edu/francom/ssecurity/

http://mit-smr.com/past/2003/smr44213.html

http://www.socialsecurity.org/pubs/articles/art-biggs020425.html

Best regards,

Walter Hart


-- 


           W. Curtiss Priest, Director, CITS
   Research Affiliate, Comparative Media Studies, MIT
      Center for Information, Technology & Society
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