NYTimes.com > Opinion

Buying Into FailureBy PAUL KRUGMAN
(also available on pkarchive.org)

Published: December 17, 2004

As the Bush administration tries to persuade America to convert Social
Security into a giant 401(k), we can learn a lot from other countries
that have already gone down that road.

Information about other countries' experience with privatization isn't
hard to find. For example, the Century Foundation, at www.tcf.org, 
provides a wide range of links.

Yet, aside from giving the Cato Institute and other organizations
promoting Social Security privatization the space to present upbeat tales
from Chile, the U.S. news media have provided their readers and viewers
with little information about international experience. In particular,
the public hasn't been let in on two open secrets:

Privatization dissipates a large fraction of workers' contributions on
fees to investment companies.

It leaves many retirees in poverty.

Decades of conservative marketing have convinced Americans that government
programs always create bloated bureaucracies, while the private sector is
always lean and efficient. But when it comes to retirement security, the
opposite is true. More than 99 percent of Social Security's revenues go
toward benefits, and less than 1 percent for overhead. In Chile's system,
management fees are around 20 times as high. And that's a typical number
for privatized systems.

These fees cut sharply into the returns individuals can expect on
their accounts. In Britain, which has had a privatized system since the
days of Margaret Thatcher, alarm over the large fees charged by some
investment companies eventually led government regulators to impose a
"charge cap." Even so, fees continue to take a large bite out of British
retirement savings.

A reasonable prediction for the real rate of return on personal
accounts in the U.S. is 4 percent or less. If we introduce a system with
British-level management fees, net returns to workers will be reduced by
more than a quarter. Add in deep cuts in guaranteed benefits and a big
increase in risk, and we're looking at a "reform" that hurts everyone
except the investment industry.

Advocates insist that a privatized U.S. system can keep expenses much
lower. It's true that costs will be low if investments are restricted
to low-overhead index funds - that is, if government officials, not
individuals, make the investment decisions. But if that's how the system
works, the suggestions that workers will have control over their own money
- two years ago, Cato renamed its Project on Social Security Privatization
by replacing "privatization" with "choice" - are false advertising.

And if there are rules restricting workers to low-expense investments,
investment industry lobbyists will try to get those rules overturned.

For the record, I don't think giving financial corporations a
huge windfall is the main motive for privatization; it's mostly an
ideological thing. But that windfall is a major reason Wall Street wants
privatization, and everyone else should be very suspicious.

Then there's the issue of poverty among the elderly.

Privatizers who laud the Chilean system never mention that it has
yet to deliver on its promise to reduce government spending. More
than 20 years after the system was created, the government is still
pouring in money. Why? Because, as a Federal Reserve study puts it,
the Chilean government must "provide subsidies for workers failing to
accumulate enough capital to provide a minimum pension." In other words,
privatization would have condemned many retirees to dire poverty, and
the government stepped back in to save them.

The same thing is happening in Britain. Its Pensions Commission warns that
those who think Mrs. Thatcher's privatization solved the pension problem
are living in a "fool's paradise." A lot of additional government spending
will be required to avoid the return of widespread poverty among the
elderly - a problem that Britain, like the U.S., thought it had solved.

Britain's experience is directly relevant to the Bush administration's
plans. If current hints are an indication, the final plan will probably
claim to save money in the future by reducing guaranteed Social Security
benefits. These savings will be an illusion: 20 years from now, an
American version of Britain's commission will warn that big additional
government spending is needed to avert a looming surge in poverty among
retirees.

So the Bush administration wants to scrap a retirement system that works,
and can be made financially sound for generations to come with modest
reforms. Instead, it wants to buy into failure, emulating systems that,
when tried elsewhere, have neither saved money nor protected the elderly
from poverty.

E-mail: krugman@nytimes.com