COMMERCE BANK ECONOMIC REVIEW - March 2005

The Battle Over Social Security Heats Up

By Joel L. Naroff, Ph.D.

Government data are sometimes like the weather. If you don’t like them, wait a while and they will change. We were reminded of that during February. It turns out the economy really did quite well at the end of last year. 

The Commerce Department discovered a whole lot of growth they hadn’t seen previously. The economy actually expanded at a quite solid 3.8% pace in the last quarter of 2004, not the initial estimate of a more moderate 3.1% rate. It’s not unusual for the data to be revised, but this increase was a touch more than normal. Regardless, we did carry a lot of momentum into 2005.

But that was then and we need to ask the basic question: What will the economy bring us going forward? Unfortunately, we didn’t get a clear answer. 

Job growth was quite strong in February as firms added 262,000 new positions. This was the first really solid gain in four months. Still, there were some factors in the report that point to somewhat more modest increases going forward. And importantly, wage growth was flat and that points to limited income gains. Because the positive effects of tax cuts and debt refinancings are fading, we need solid increases in wages and salaries to keep household spending going. 

In addition, the jump in the unemployment rate to 5.4% from 5.2% in January cannot make people overly happy. Consumer confidence dipped during the month and motor vehicle sales were not that great. 

The real story during February was Social Security, as Federal Reserve Chairman Alan Greenspan weighed in on the subject. He likes the idea of privatization of accounts. But as usual, the devil is in the details and there are a lot of problems with the specifics. 

First of all, privatization by itself simply does not insure the solvency of the system. To do that, there will still have to be cuts in benefits, an increase in the retirement age and/or an increase in taxes. So the whole idea that privatization would solve the Social Security problem was thrown into question.

The Fed Chairman also was concerned that the transition costs, which could run between $1 trillion and $2 trillion over ten years, could cause problems in the bond markets leading to rising interest rates. He suggested that any plan be implemented very slowly.

So, why does the Fed Chairman like the idea of privatizing a part of Social Security? His argument seems to boil down to this: Under the President’s plan, individuals would control some of the funds, not the government. 

In the past, the Social Security surpluses have been used to lower the budget deficit. In essence, Washington has spent the retirement funds. But the privatized money could not become pork and that would force some fiscal responsibility on the President and Congress. In short, privatization is good because it might stop our politicians from spending money.

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, “America’s Most Convenient Bank,” is a leading retailer of financial services with 300 convenient stores in New Jersey, New York, Pennsylvania and Delaware. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.