In Which We Look Forward To The Brad Delong v. Paul Krugman Cage Fight

13 january 2013

Paul Krugman’s column today concentrates on the thought that raising the eligibility ages for Social Security and Medicare won’t have much effect on Federal finances and even if they did they would be unfair anyway. So, basically, Yah Boo! and make the rich pay up.

I may have missed some of the subtlety of his argument there. However, this does raise the interesting possibility of a cage fight (err, for respected economists “cagefight” means the occasional blog post in which one begs the other to “consider that you might be mistaken, sir” but it’s fought with no less ferocity for all that) between Brad Delong and Professor Krugman. For all that they usually sing from the same hymn sheet (and have done at least one research paper together) their two views here are diametrically opposed:

First of all, you need to understand that while life expectancy at birth has gone up a lot, that’s not relevant to this issue; what matters is life expectancy for those at or near retirement age. When, to take one example, Alan Simpson — the co-chairman of President Obama’s deficit commission — declared that Social Security was “never intended as a retirement program” because life expectancy when it was founded was only 63, he was displaying his ignorance. Even in 1940, Americans who made it to age 65 generally had many years left.

Now, life expectancy at age 65 has risen, too. But the rise has been very uneven since the 1970s, with only the relatively affluent and well-educated seeing large gains. Bear in mind, too, that the full retirement age has already gone up to 66 and is scheduled to rise to 67 under current law.

Delong has long been making the opposite argument: well enough that he’s managed to convince me of the righteousness of his analysis.

Just as an aside here, this isn’t about the specific American political situation presently. This applies to all such state provision for old age and has done so from the day that Bismark brought in the first such modern system. This is a general economic point about every country’s government run pensions system.

Delong starts out by pointing out that social security (or Bismark’s system, or Lloyd George’s old age pension in the UK and so on) is not in fact a retirement program nor a retirement system. It is, instead, a form of social insurance. Insurance against the possibility of outliving your savings. The conclusion from this starting assumption is therefore that the eligibility age should be the median age of death of the specific age cohort. Although, as that is something it’s only possible to calculate in hindsight, of the previous age cohort.

The analysis runs like this: we’ve all got a pretty good idea of how long we’re likely to live. No, of course not, we don’t know which of us will be stricken with cancer when young, who exactly will live to 100 and so on. But as a general idea of how long the average person will live, yes, we do have a good idea. We can thus say that there’s a rational level of savings for anyone to make to take care of their hoped for retirement and old age. It would be extremely irrational for us all to save as if we’re all going to live to 100. There would be vast amounts of pleasure, goods and activities that we would be giving up earlier in life to prepare for something really still quite unlikely: that cake with the 100 candles. But similarly, it would be irrational not to save anything at all, to assume that there would be no golden years at all.

The rational amount we should therefore put aside during our working lives is the amount to pay for our likely number of years in retirement. And we do know that this number, our expected lifespan, has been rising over the decades. Fortunately, so have our incomes so saving from our greater incomes for those more years isn’t too difficult.

However, here we come to the great problem with averages. Our expected lifespan, thus our expected length of retirement, is an average. Some will die before this age: sorry, all that saving’s wasted. Should have had more beer and cigars when young. But, well, such things happen: no one ever said the universe would do everything we wanted. However, we’ve this other problem: the other half of the population will live longer than this average. And if everyone’s been saving the right amount for the average lifespan then this second group are going to be  just right out of luck because they’re going to enjoy that longer lifespan on precisely zero money.

Yes, yes, of course there are ways of dealing with this, conversion of savings to annuities being one way. But the basic point above still stands. It’s rational to save for one’s extended lifespan, irrational to save more than that on the off chance that we’ll live longer. It’s at this point that, in the Delong analysis, social security comes in.

Social security is social insurance against outliving your savings. It is not a retirement program at all: it’s a program to deal with the uncertainty of how long our retirement will be.

At which point it becomes obvious that the eligibility age should rise with increasing lifespans. For as the young of today see the increased lifespans of today’s elderly they will be (perhaps should be) saving more in order to provide for that longer retirement that they know is rationally likely. But there’s still that risk of outliving the rational amount of savings: thus social insurance against it. Delong has thus recommended that the eligibility age for social security should rise along with lifespans. As is indeed happening in countries around the world as lifespans lengthen.

As I say, this is Brad Delong’s analysis (and if I’ve got it wrong in anything more than detail or rhetorical flourish, my apologies to him) and it’s one that has convinced me. But this then leaves me at least with an interesting prospect. Delong usually agrees with Krugman. Indeed, has said repeatedly that Krugman is always right. Yet here Krugman is insisting that Delong’s long held and often expressed analysis is wrong. Which leaves me just reaching for the popcorn and waiting for the cage fight exchange of blog posts.