It turned out the privatizers were not up to the challenge. If they picked a high number for real stock returns (say 5.0 percent), they would soon have price-to-earnings ratios well over a hundred to one. No economist wanted to be associated with this prediction.
The alternative was to assume a high dividend yield. This quickly had companies paying out more than all of their profits in dividends or share buybacks. This meant they wouldn't even be able to invest enough to maintain their capital stock, also an unlikely scenario.
The moral of the story is that there is no free lunch in financial markets. That was true back in 2005 and is probably even truer today. Price-to-earnings ratios are even higher than in 2005, and profits are an unusually large share of national income, meaning that they are likely to grow at a slower pace than the economy as a whole in future years. With real estate also at unusually high prices, it is virtually guaranteed that returns to all forms of financial capital will be considerably lower in future years than in the past.
In this story, the best way to generate wealth for future retirees is to minimize the money that is wasted in fees for the financial industry. This is the route being followed by the states of Illinois, California, and Oregon, all of which have passed legislation that allows workers in the private sector to invest with their public employee retirement funds. Several other states are close behind in this process.
While these plans keep a strict separation of the funds, they allow workers throughout the state to invest their money by taking advantage of the structure already in place for public employees. The savings on administrative expenses compared to existing IRAs or 401(k)s can easily be on the order of 1.0-2.0 percentage points annually. This difference could translate into almost $30,000 in additional savings for someone putting aside $2,000 a year for 30 years, a difference of close to 30 percent.
In short, insofar as we want to supplement the income provided by Social Security, we should look to the program as a model. Keep it simple and keep the costs low. If people want to speculate in financial markets they are welcome to do so, but retirement policy means simple and cheap, and if that reduces profits for the financial industry, that's good too.
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