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Transcription of interview with Peter Diamond on January 13, 2014.
Douglas Goldstein, CFPÆ, Financial Planner & Investment Advisor
Peter Diamond is from MIT and heís been there since 1966.
He was also one of the three economists who won the 2010 Nobel Prize in economics on unemployment.
Douglas Goldstein, financial planner & investment advisor, interviewed Diamond on Arutz Sheva
Radio.
Douglas Goldstein: One of the topics youíve spoken about is the question of social security.
A lot of my clients who live here in Israel live on their social security and the question
they worry about is it stable and the issue that they are really concerned about is this
whole topic of windfall elimination provision which basically says that if they letís say
lived in America for a few decades pain into the system and expected to get a certain amount
then they move to Israel and are able to get an Israeli pension, they may actually have
their social security cut.
Is that fair?
Peter Diamond: Letís start with the basic question of social security that you started
with, is it sustainable and whatís the future look like?
The projections of the actuary and the congressional budget office say about 20 years from now
the trust fund will hit zero.
Under the law that governs social security, social security is not allowed to borrow.
If the law hasnít changed then benefits for everybody will be cut so that the expenditures
match the payroll tax revenue which will continue rolling in when people think thereíll be
nothing for them, they are forgetting the payroll tax revenue was there.
The current projection is in 20 years, everybody gets about a 25% benefit cut and that would
be a crisis, crisis for lots of families, crisis for the economy and obviously thatís
not going to happen.
Normal political process, the US and elsewhere is to not do anything about it until we get
close to it.
Thatís terrible policy.
Itís particularly terrible policy in the current context.
Itís terrible policy because the sooner one starts addressing a problem like that, the
more you can face it slowly, the more you can spread it more fairly across different
generations.
Also the less the political pressures of people trying to defend what they have, something
thatís not going to kick in for 10 years or 15 years, just leave the political process
more sculpt without the self defense pressures.
I think right now would be a great time political divide apart for starting to face in.
It would also fit with our current problem.
In my view, the US has an unemployment crisis and a debt problem.
A crisis thatís something you really need to address right away because the costs are
large and keep [mounting].
A problem is something probably better to address sooner rather than later but it doesnít
have to be addressed right away and social security fits in this beautifully because
everyone always facing things slowly and so you donít make the unemployment problem works
today by doing it, but by doing that you have a big impact on the projected debt problems
down the road.
Douglas Goldstein: Youíre just making a connection between solving social security slowly today
and the connection I would have with unemployment now?
Peter Diamond: The problem weíre having in the US is fiscal austerity which is hurting
on unemployment today and even worse in something like the sequester thatís being done in a
stupid mean way.
Cutting across the board, cutting good programs and bad programs, itís deliberately stupid.
It was chosen to be bad policy in the expectation that it would lead to new reforms, it hasnít.
The idea that you sabotage the functioning of the government in the hope that it would
lead to a better political outcome, itís just a terrible
way to be going forward.
Douglas Goldstein: Dealing with unemployment is something that politicians have to deal
with right now before the next election whereas dealing with 20 years down the line, they
will probably be long gone by then.
Why would you expect them to really think that for an advance?
Peter Diamond: I never for effect suggest that this has any real possibility.
Itís exactly what youíve said and it puts the fault exactly where it belongs on the
voters.
Voters donít tend to say ìThatís a real problem coming.
Itís going to affect me and my children but Iím not going to hold it against the politician
if he does nothing about it,î thatís the fault of the voters.
Itís an issue around social security.
Itís an issue around global warming and the fault is with the voters.
We need voters to hold politicianís feet to the [fire] more than we do.
Douglas Goldstein: I work in the United States for about 10 years.
I put in my 10 years into social security, I paid taxes with the expectation that I would
ultimately receive a pension albeit a small one then I started reading more closely my
social security statement and it said if you receive a foreign pension as well as other
possibilities then you will not get the full social security payment that it says in the
statement and then I run to their calculator and I discovered that I was going to end up
getting about half of what I thought I should get based on the amount that I put in.
Is this a normal thing for a government to do?
Peter Diamond: Itís a totally appropriate thing given the structure of social security
which is very unusual across countries.
Iíve looked at systems in many countries.
Most systems are linear that is what you get back relative to what you earn and pay taxes
on, itís a linear function, same proportion across the board.
Social security is not like that.
It has the progressive benefit formula.
It gives 90% of your average earnings for very low earners and then thereís a second
[throw] of low level and the third where it gets down to 15%.
So the formula is progressive with the goal of giving a larger replacement rate to people
who have had lifelong low earnings and if youíve had lifelong low earnings, you need
for replacement.
Itís plausibly going to be much larger after you retire than somebody who has had high
earnings his whole life.
The formula is directed more of benefit to people who are needy.
If for example, youíre a Massachusetts civil servant and youíre not in social security
while youíre a civil servant but you are in social security for 10 years so you get
a benefit based on your lifetime average was a whole bunch of zeroes, you look very poor
but youíre not.
Youíre going to receive a pension from the commonwealth of Massachusetts and you have
all your earnings all for your lifetime,
Douglas Goldstein: Isnít that pension based on what the number of years you put in as
a civil servant and then you get that piece and then the piece you put in as a person
paying it to social security would get that piece?
Peter Diamond: The piece youíre getting from the federal government now from the commonwealth
of Massachusetts is based on whether over your lifetime you have been poor or not.
If you havenít been poor then you donít get the extra amount targeted on people who
are poor and if you go abroad and have high earnings abroad, then on a lifetime basis
you are not accurately depicted as somebody who had 10 years of earnings and then a whole
bunch of zeroes, never able to earn another penny and to accumulate a pension based on
all those zeroes.
The formula is set up to accomplish a social goal and you are not part of that social goal.
So you should be treated by the system the same way somebody with similar lifetime opportunities
and achievements should be treated.
The WEP doesnít do a great job of doing that but we absolutely need something like that
or basically you are reaping off your ability to accurately measure your need.
Douglas Goldstein: Itís more like a Ponzi scheme because youíre putting in hoping that
thereís always going to be someone behind you to put in more when you retire.
Peter Diamond: Itís not like a Ponzi scheme.
Any contrary that has national debt, is that a Ponzi scheme because it will be future tax
payers that will be on the hook for the national debt?
Is the national debt was used for investments and the country use richer as a result, is
it a Ponzi scheme?
Of course not.
Douglas Goldstein: Isnít a pension like an investment, investing in your future?
Peter Diamond: First of all, there are investments that are like an IRA where youíre buying
assets and youíre hoping it will work a lot when you retire and then you can live off
it or you can be in a public program where just as your future wages depend on what the
government does around public investments and the climate for private investments, you
are part of the society that is looking after poor people and it is part of the overall
physical stance.
The point of a Ponzi scheme the way it was started, the way itís named after Ponzi is
itís deliberately cheating people to run off with the profit by the creator by paying
out grossly unsustainable amounts to attract more investments.
Thatís not what was going on in any pension schemes.
Yes some of them are badly designed, some of them havenít go built in [inaudible 0:13:11],
the kinds of rules that will automatically give its sustainability but what youíve got
is the forecast of a political process just as youíve got the forecast of political process
if you buy a treasury bond.
Itís a
program to help everybody because a lot of people up and down the income distribution
donít save enough.
It really has two goals.
One is normally labeled consumption smoothing and to help people do that.
It comes as a real annuity.
You want to buy a real annuity in the market, what kind of prices youíre going to pay for
that?
It comes as a real annuity.
It is part of a package up and down the income distribution but it has a second goal which
is relieved in poverty among the elderly.
So we have two different goals here: consumption smoothing over your lifetime when you may
or may not have saved well, even if you saved enough, you may have invested well, even if
you invested well, you may have been quavered by the financial crisis and also to do more
for people who have been lifetime poor.
Doing both of those in a single program leads to a complexity that leads to lots of people
not understanding whatís going on.
Douglas Goldstein: How can people follow the work that youíre doing
now?
Peter Diamond: At the MIT economics department website, there is a page for each member of
the faculty and on that page, I post articles as I write them both the technical ones for
the economics community and a variety of other pieces that I think maybe of interest.
Douglas Goldstein, CFPÆ, is the director of Profile Investment Services and the host
of the Goldstein on Gelt radio show (Monday nights at 7:00 PM on www.israelnationalradio.com.
He is a licensed financial professional both in the U.S. and Israel.
Securities offered through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, NFA,
SIFMA.
Accounts carried by National Financial Services LLC.
Member NYSE/SIPC, a Fidelity Investments company.
His book Building Wealth in Israel is available in bookstores, on the web, or can be ordered
at: www.profile-financial.com (02) 624-2788 or (03) 524-0942.
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