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Welcome to the fifth edition of the Oxy Economics Newsletter! For those of you who participated last year, welcome back. For those of you who are new, we hope that you'll make the newsletter an annual habit. Where else can you hear about current events in the department, keep up to date with old classmates, and make new connections with economics majors from other eras?

The biggest news in the department last year was the retirement of Professor Halstead, after 27 years of teaching in the Economics Department. At our annual seniors awards ceremony, we included a segment honoring professor Halstead. The Department established the James F. Halstead MVP award, which each year will go to a student, nominated by her/his peers, who helps other students the most with their economics during the year. This year we had over thirty such nominations, a tribute to some of the changes in teaching approach and pedagogy that Professor Halstead helped institute while at Oxy. We all anticipated that Professor Halstead would be sorely missed, and as the semester has gotten underway, that has indeed turned into a reality.

The other big news in the department last year was the hiring of own Visiting Assistant Professor McIntyre to a tenure track position. This year we are looking to add two more tenure track faculty to the department.

There will be curriculum changes as well. After much discussion with our external reviewers, students, and each other, the department proposed that the Economics for Business & Management major be converted to an additional emphasis within the Economics major. This proposal was recently passed by the Curriculum Committee. The requirements for the major in Economics would be unchanged. The requirements for the additional ECBM emphasis would be as follows: 1) Students would meet the requirements for the Economics major; 2) in addition, students would take accounting, an internship, and a fourth 300-level class, Managerial Economics, or another 300-level course approved by their adviser. Any current Oxy student will still be able to major in ECBM if they so choose. The department will still be offering the new courses that were developed specifically for the ECBM major.

Once again, our students did us proud. For the third straight year, we graduated an unusually large and talented class, this year numbering seventy, count them, seventy senior economics and economics for business and management majors. Our department once again had more seniors graduate than any other department by a large margin, and we once again did quite well in terms of our share of academic honors, with fourteen students receiving honors in the department at graduation.

Well, that wraps up a new year, but we anticipate even more excitement in 2004-05. If you're in the area, please drop by and say hello; from our perspective, getting to visit with alums is about as good as teaching gets. 

If you can't get to the campus, please feel free to drop me a line at  <moore@oxy.edu> or give me a call at 323-259-2779. I'm always delighted to hear from our alums.

Robby Moore

A Brief Background

The Social Security system began collecting contributions from workers in 1937, and the first monthly retirement benefits were paid in 1940. Today, the system is financed by a 12.4 percent payroll tax on every worker's earnings up to $87,900. A participant typically starts receiving Social Security retirement benefits at his or her "normal retirement age," which ranges from 65 for those born in 1937 and earlier, to 67 for those born in 1960 and later. The benefit takes the form of an annuity - that is, retirees receive a fixed amount (indexed for inflation) each month for the rest of their lives. The Social Security system also includes a disability insurance program. My focus in this essay, however, is on the retirement program.

Two features of Social Security are worth pointing out. First, a worker's monthly retirement benefit is tied to his or her earnings history and marital status. The benefit formula is designed to be progressive: low earners receive a better rate of return on their contributions than high earners. This type of system - in which benefits are based on a formula that takes into account various worker characteristics - is known as a defined benefit system. An alternative type of system is a defined contribution system, in which each worker's contributions go into an individual account; upon retirement the worker gets whatever is in the account. Most private retirement plans - like 401(k)s - are defined contribution ones. Second, Social Security is a pay-as-you-go (PAYGO) system. This means that current workers' contributions are used to finance benefits paid to current retirees. The alternative to a PAYGO system is a funded system in which current workers' contributions are stored somewhere (either in individual accounts or in a centralized trust fund) and used to pay their benefits when they get old.

The "Crisis"

At the moment, the amount of revenue that Social Security takes in exceeds the amount paid out in benefits. This year, for example, the system will take in a around $150 billion more in revenue than it pays out in benefits. Whenever Social Security runs a surplus, the excess money accumulates in a trust fund. As a result of consistent surpluses in recent years, the value of this trust fund is currently around $1.6 trillion.³ If Social Security is currently running large surpluses, then what's the problem? The problem is that these trust fund surpluses are unlikely to last much longer. The Trustees of Social Security project that, by 2018, the system will start to take in less revenue than it pays out; this will necessitate drawing down on the trust fund. By 2042, the trust fund is projected to be exhausted.⁴ At this point, revenue from payroll taxes will be sufficient to cover only about ¾ of promised benefits.⁵

This anticipated funding shortfall stems from a change in demographics coupled with Social Security's PAYGO structure. In essence, PAYGO Social Security is a pyramid, or Ponzi, scheme in which those at the top of the pyramid (the initial investors) receive payments from the lower layers (the later investors). When the system started, those who were at or near retirement age began to collect payments from those who were working. This initial generation of retirees, like the founders of a Ponzi scheme, got a "free lunch" because they paid very little into the system, yet collected benefits. This is clearly reflected in the experience of Ida May Fuller, the very first person to receive a monthly retirement benefit. Fuller was a few years away from retirement when the system was created. In these last few years of her working life, she contributed $24.75 to the program. She began to collect retirement benefits in 1940. Fuller lived to be 100 and received a grand total of $22,888.92 over her retirement.⁶

Thus, the initial generation of retirees clearly did well. What about the next generation of retirees? The plan was for them to be supported by the next generation of workers. Because of population and wage growth, the contributions of each subsequent generation of workers were expected to be quite large relative to those of the previous generation; thus, each generation would receive a good rate of return on their contributions. In fact, given the prevailing demographic trends at the time, observers projected a real, safe rate of return of 4 percent.⁷ This rosy forecast led the proponents of PAYGO Social Security to argue that it was a unique sort of Ponzi scheme because it actually worked. As Nobel-laureate Paul Samuelson declared in 1967, "A growing nation is the greatest Ponzi game ever contrived."⁸

Of course, demographics have changed since the 1960s. In 1960, the dependency ratio (the ratio of those aged 65 and over to those aged 20-64) was .173. Since then, however, it has risen dramatically. Next year, it is projected to be .203, and by 2065, it is projected to rise to .409.⁹ Thus, the base of the pyramid is thinning out relative to the top. What are the underlying reasons for this change? To begin with, medical advances now allow people to live longer. In 1935, a 65-year-old could expect to live for an additional 12.5 years; today, that has risen to 17.5 years.¹⁰ Fertility rates have also fallen. Consistent with a shrinking pyramid base, workers have been getting lower rates of return on their contributions - lower than they could earn if they had instead invested their retirement savings in private financial assets.

These returns are likely to fall even more in the future. As the baby boomers retire and the dependency ratio rises even further, the funding shortfall predicted by the Social Security Trustees will occur. How bad is the problem? In a nutshell, we as a nation have promised ourselves $10.4 trillion more (in present value terms) in benefits than we expect to collect in taxes. To close this funding gap, policy makers will either have to raise taxes on workers or cut benefits for retirees. The Trustees estimate that an immediate 3.5 percentage point increase in the payroll tax, or a 22 percent cut in benefits, is required to do this.¹¹ Let me emphasize that there is no other way around this problem. Certainly, there are sneaky ways to carry out benefit cuts and tax increases. For example, an increase in the retirement age amounts to a benefit cut; an increase in government borrowing to pay promised benefits will require future tax increases or spending cuts; and transferring money from the rest of the government to Social Security will call for increases in non-Social Security taxes or cuts in non-Social Security spending. Thus, Kerry's promise not to cut benefits should immediately cause us to wonder what sacrifices he would have us make instead.

Restructuring the System?

While this "crisis" must certainly be dealt with, many observers have gone even further and questioned the merits of PAYGO financing in the first place. It is illegal and rightly so, they argue, for private employers to run PAYGO retirement plans - so why should the government be able to do it? Moving away from a PAYGO system would require building up a trust fund (or individual accounts) that would be invested in financial assets and then used to pay current workers' benefits when they retire. One of the main economic reasons to prefer a funded system to a PAYGO one is that a funded system can raise national savings (which is currently quite low). Workers' contributions in a PAYGO system are not saved; they are used to pay retirees' benefits. In a funded system, however, contributions are channeled, through financial markets, into investment projects will raise the rate of economic growth.¹²

There is, however, a problem with moving to a funded system: we are counting on current workers' contributions to pay for current retirees' benefits. If we instead channel these contributions into a trust fund or individual accounts, then who will pay the retirees' benefits? This is the problem that occurs when any Ponzi scheme is shut down: the last round of investors loses their investment. Another way to view this problem is that, if we are to raise national savings by funding Social Security, we have to make some extra sacrifices today in the form of tax increases and benefit cuts. This is a cost that politicians who support individual accounts, including Bush, tend to gloss over.

Despite the transition problem, I believe that the case for funding remains strong. But even if the decision is made to move to a funded system, another fundamental question remains: should the funds be accumulated in individual accounts ("privatization") or a centralized trust fund? Individual accounts entail switching to a defined contribution system, while a centralized trust fund allows the defined benefit system to be maintained.

Prominent economists have come down on both sides of this debate. Some, like Henry Aaron of the Brookings Institution, argue that a centralized trust fund is more desirable because it allows us to maintain the progressivity of the system - i.e., the feature that low earners get higher rates of return than high earners. It also allows workers to share the risks of bad labor market or investment outcomes, and it and keeps administrative costs low.

Others, like John Shoven of Stanford, argue that having a substantial individual accounts component (accompanied by a smaller defined benefit "safety net") is more desirable. In my view, the strongest arguments for individual accounts come from the realities of the political process. First of all, a centralized trust fund would require the government to become a major shareholder in private corporations. This raises numerous concerns. Would the government face political pressure, for example, to refuse to buy stock in companies that engage in outsourcing? How would the government use its influence within corporations? What happens if the government's political or social goals conflict with maximizing shareholder value? There is substantial evidence that state government pension funds, and pension funds in other countries, have fallen victim to such political pressures and conflicts of interest.¹³ Second, the government is less likely to raid individual accounts to finance other government spending or tax cuts. A number of studies - including one that John Shoven and I worked on this summer - have shown that the government's attempts to save money in its trust funds (including the Social Security trust fund) are offset by increased spending or reduced taxes elsewhere.¹⁴ In other words, the government treats surpluses in its trust funds not as savings, but as money that can be used to finance other programs or tax cuts. If the Social Security funds were treated as the private property of workers, this would be less likely to occur.

Of course, most advocates of individual accounts - myself included - would still want to preserve a defined benefit component (funded on a PAYGO basis) as a safety net for low earners. These so-called "two-tier" systems, I believe, offer the most reasonable option for reforming the Social Security system.

What are the chances of such reform being undertaken in the near future? Unfortunately, politicians hate to acknowledge budget constraints, especially in an election year. Thus, we are unlikely to hear realistic plans for covering Social Security's unfunded liability. Moreover, the short-term nature of politics discourages much serious discussion of an issue that does not really surface until 2018 (or 2042, depending on your perspective). When I teach Economics of the Public Sector at Oxy, I ask students to write a policy paper and participate in a class debate on Social Security reform. No matter what reforms are undertaken, I believe that young people - who are potentially stuck with an enormous liability - should play a significant role in shaping them.

* Sita Nataraj is Assistant Professor of Economics at Occidental College.

Notes:

    1. See http://www.georgewbush.com/SocialSecurity/Brief.aspx.

    2. Social Security Administration, “The Future of Social Security,” Publication No. 05-10055, ICN 462560, January 2004, available at http://www.ssa.gov/pubs/10055.html.

    3. Social Security Administration, “2004 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds,” March 23, 2004, available at http://www.ssa.gov/OACT/TR/TR04/.  See, in particular, table IV.A3.

    4. Social Security Administration, 2004 Trustees Report.  See, in particular, tables IV.B1 and IV.B3.

    5. Social Security Administration, “The Future of Social Security.”

    6. Social Security Administration, “A Brief History of Social Security,” available at http://www.ssa.gov/history/briefhistory3.html.

    7. John Shoven, “Social Insecurity,” Hoover Digest, 2000 no. 1, available at http://www.hooverdigest.org/001/shoven.html.

    8. Quoted in Sylvester Schieber and John Shoven, The Real Deal, New Haven: Yale University Press, 1999, p. 110.

    9. Social Security Administration, 2004 Trustees Report.  See, in particular, table V.A2.

    10. Social Security Administration, “The Future of Social Security.”

    11. Social Security Administration, 2004 Trustees Report.  See, in particular, section IV.B and table IV.B7.

    12. For a more complete analysis of this and other rationales for funding, see Barry Bosworth and Gary Burtless, “Privatizing Social Security: The Troubling Trade-offs,” Policy Brief no. 14, The Brookings Institution, March 1997, available at http://www.brook.edu/comm/policybriefs/pb14.htm.

    13. See Scheiber and Shoven 1999, pp. 347-351 for an elaboration of these points and a survey of the research on other governments pension funds.

    14. These studies include Kent Smetters 2003, “Is the Social Security Trust Fund Worth Anything?” unpublished mimeo, June 2003, available at http://irm.wharton.upenn.edu/WP-Security-Smetters.pdf; Barry Bosworth and Gary  Burtless, “Pension Reform and Saving,” unpublished mimeo, January 2004, available at http://www.brook.edu/views/papers/bosworth/20030129.pdf; and Sita Nataraj and John Shoven, “Has the Unified Budget Undermined the Federal Government Trust Funds?” paper prepared for Social Security Administration and Michigan Retirement Research Consortium conference, National Press Club, August 12-13, 2004.

Last year was Jim Halstead's final year at Occidental College; he retired in May.  He spent his last year teaching two of his favorite courses, Principles of Economics I and Environmental Economics and Policy. The Department saw Jim off into retirement in truly grand style, and he was extremely pleased to end his Oxy career in such a fulfilling manner. Since May, Jim has begun to learn the guitar, to paint his house, to plan a retirement and 30th wedding anniversary celebratory trip to England and Ireland during the month of September, and to learn the ins and outs of his new computer system which was made available by a generous gift from his departmental friends and colleagues. In the longer run, he plans to continue the guitar, to do some volunteer work in Pasadena's Adult Literacy Program and to submit his application to become a bartender at Crown City Brewery. This was another slow year for brewpub touring mostly because Jim's unvisited brewpubs are now slung far and wide across the country, but Jim's total brewpub visitations continues to rise, now approaching 450 (Ireland and England should add to this). Most late Friday afternoons and early Friday evenings, Jim can be found sitting in the "post" position at Crown City Brewery in Pasadena; his promise to buy you a beer if you stop by to see him at the Crown remains in place. Jim would like to take this opportunity to say that he believes teaching at Occidental was a distinct privilege, and to thank his many students who, over his 27 year tenure, made his work pleasant, interesting and challenging.

Mary Hirschfeld remains on leave, studying theology at the University of Notre Dame.

John Karayan, who is rumored to have gotten his nickname "Doc" due to his likeness to a Disney cartoon character, is looking forward to another great year. This past one was exciting, with a host of scandals spicing up accounting and financial analysis (the topic of ECON 233, which he teaches). It also made even more interesting the expert witnessing on taxation and accounting which Doc occasionally does in complex Federal business litigation. Along with presenting papers (e.g., Implementing the Model Tax Curriculum with the Strategic Tax Planning Perspective) and publishing articles (e.g., a longitudinal study assessing changes in an introductory core course), he published a treatise last year on State and Local Tax Planning which has been adopted by several Law Schools and Masters in Taxation Programs. Doc's next book -- on Stock Market Analysis -- is due out momentarily. More importantly, his son got through his second year as a chemistry major at Duke relatively intact, his daughter is now a frosh at Washington University in St. Louis majoring in Classics, and he & his bride are "empty nesters" for the first time in over 20 years.

Mary Lopez is a new faculty member who received her Ph.D. from the University of Notre Dame in 2003. This fall she is teaching Principles of Economics II and Economics of Immigration. In the spring she will teach Principles of Economics II and Economics of Race and Gender. Her dissertation focuses on the impact high-skill immigrants have on the U.S. economy.

Jerry McIntyre starts his fourth year at Oxy delighted to be on tenure-track. He had a blast his past year and is looking forward to another great year. After commuting from Santa Monica during the school year, he wandered more widely this summer visiting Santa Cruz, San Francisco, New York, and Washington D.C. In addition, he continued his research on economic growth, macro- and international economics. He looks forward to seeing everyone in late August and is psyched and ready to start the semester. He extends an open invitation to all to drop by his office for an espresso and some econ whenever they are free.

Robby Moore served as Chair of the Department for the Spring semester and will be continued in this capacity for three years. Along with recently retired Professor Halstead, he will be presenting a poster session at the AEA meetings in Philadelphia on "Predicting the Effects of Macroeconomic Shocks and the Self-Correction Mechanism: A 'Hands-On,' Collaborative Approach for the Principles Course". He also is serving as the new director for the Center for Teaching Excellence.

Sita Nataraj finished her second year of teaching at Oxy. She taught 102, 250, 272, and 308. She also supervised two honors theses, one on the economics of smoking, and another on immigration policy. She spent a good portion of her summer at Stanford writing another paper on Social Security with John Shoven ("Has the Unified Budget Undermined the Trust Funds?"). She made her TV debut on C-SPAN when her co-author presented this paper at a conference in Washington, DC. In addition to the Stanford and Washington trips, she also traveled to Vancouver, Bloomington, Las Vegas, and Sofia (Bulgaria). After all that travel, she is glad to be home and looking forward to the start of the school year. She is especially excited about her new Game Theory course in the fall.

Giorgio Secondi taught Econ 101 again in the fall, experimenting this year with an "all-Frosh" section, which went very well. He also taught economic development and went back to teaching intermediate macroeconomic theory. He continued as coordinator of the department's honors program. This year we had a record eleven students completing honors theses on such topics as executive compensation, the economics of immigration, and policies on cocaine and heroin use. Giorgio also started a new project to study how international students learn economics. He will present the results of this study at a conference at Grand Teton National Park (Wyoming) in September. During the summer he decided to do something different and taught economics in a program for high school kids at Phillips Exeter Academy, in New Hampshire. This was his first time teaching high school students, and he found it challenging but rewarding. Being able to do some rowing in New England also helped make his time on the East Coast a lot of fun.

Carolyn Sissoko is returning to teach a second year at Oxy. She spent the summer reworking a paper on Venetian banking and preparing three new courses: Econ 317, a survey of American economic history with an extended look at the consequences of slavery and at the great depression, Econ 495, a senior seminar that takes a historical approach to study the macroeconomic role of financial institions and Econ 101. She is looking forward to seeing everyone again at the start of the semester.

Woody Studenmund continues to love teaching his econometrics and managerial economics courses, but he has scaled back some on his administrative work. In particular, he stepped down as department chair in January after almost four years in the role. He couldn't go "cold turkey," however, so he kept involved by coordinating and editing the department's self-study report (over 200 pages!) as a part of our program review process. In addition, he's now about half finished with the revison of the 5th edition of his book, "Using Econometrics," and he hopes to have the published text on the market by the summer. He encourages all alums to visit the campus in 2005 to see the department's new offices on the second floor of Fowler Hall.

Mike Tamada continued as the Director of Institutional Research. His projects included working with Dean Chan on a faculty database and helping with assessment of the success of Oxy's diversity efforts.  He also taught the economics of immigration in MSI this summer.  He advises the men's and women's Ultimate Frisbee Clubs and annually travels to Potlatch, a large coed Ultimate tournament in Seattle, to play with the Oxy reunion team. This summer he hiked up Mt. Whitney and he is planning a hiking trip to Japan in the fall.

Jim Whitney was on sabbatical in Fall 2003 and used the opportunity to return to his old research stomping ground--the economics of professional team sports. His resulting paper, forthcoming in Economic Inquiry, demonstrated a point that might seem obvious to sports fans but addressed a long-running controversy in the economics profession itself: big city teams do indeed win too much. Jim returned in Spring 2004 to teach a new course, "Law and Economics." Then a new prep for the Fall: a frosh writing seminar on the global economy. Meanwhile, Jim and Linda's daughter, Camille, left town for her junior year abroad in Argentina.