February 6, 2005

#175: Even when he makes a valid point, no one notices


It’s a testament to how much radioactivity Paul Krugman has picked up over the years from his excessive partisanship and nastiness that even when he makes a valid point, no one notices. His admirers assume he can do no wrong, and his critics consider him a political hack. We’ve always prided ourselves as acknowledging the few times (very few!) when Krugman has it right. Now is time to do so again. In Many Happy Returns (02/01/05) he makes a point so potentially devastating to the Bush Social Security reform initiative that we doubt it could survive if this point were exploited effectively.

Here’s the deal. All economic projections beyond a few years are very sensitive to assumptions about economic growth rates, i.e., the growth rate of the GDP. In many cases these assumptions are buried in footnotes, but they are always there if you look hard enough. In the case of the Social Security Administration, their projections of two crucial dates (2018 when the trust fund begins running a deficit and 2042 when the trust is depleted) are based on an assumed annual GDP growth rate of 1.8%. The SSA claims that rate is based on historical experience but, in fact, they used only the period from 1966 to 2000 to make the calculation. This period includes the episode from the late 60s to the mid 90s when productivity in the US “fell off a cliff.” Economists are still debating exactly why this happened but whatever the reason it is definitely over now. Growth in 2004 will be near 4% and since 1995 it has averaged about 3% including the 2001/2002 recession. The low growth episode of the 70s and 80s should be considered a historical aberration and not a basis for projections of the future.

Now what Krugman and the Democrats should be doing is jumping up and down and demanding that the SS Administration rerun their projections using what most economists would consider a reasonable growth rate. If this were done we have no doubt that for rates over 3% the current “problem” dates of 2018 and 2042 dates would be pushed out further by at least 20 or 30 years. Some doctrinaire Krugman critics have tried to argue that since future SS benefits are tied to wage indexes higher economic growth rates would have little effect, i.e., higher growth rates would mean higher wages and therefore higher benefits. Sorry guys! Nice try, but it won’t work. The wage indexing affects only the marginal cohorts, i.e., those who retire each year. Recipients already retired receive only a CPI boost. This means that wage indexing phases in slowly and the impact is pretty far out.

Make no mistake. If the SS Administration used a more reasonable growth rate, the SS “problem” would be much reduced if not eliminated. Economic growth works wonders.

So why don’t Krugman and the Democrats ride this horse to victory? We’re guessing but it’s probably because acknowledging the higher growth rate would mean acknowledging a great Bush economy. This may explain why Krugman simply accepted the lower growth rate and spent most of his column in an overly complicated attempt to show why such a low growth rate is inconsistent with the administration’s stock market returns assumptions.

He’s right about that too, by the way. The administration shouldn’t get away with using a low growth rate assumption to trash the SS outlook and then use a higher rate to tout a SS reform initiative.

[The Truth Squad is a group of economists who have long marveled at the writings of Paul Krugman. The Squad Reports are synopses of their discussions. ] Posted by John Weidner at February 6, 2005 8:52 PM
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