Wealth – a mass of things of value for which someone would be willing to trade or work for – is created through work. It is also created through the extraction of natural resources. If work is used to provide services (hair cuts, lawn mowing) or things that are used or destroyed (rock concerts, food), then the net wealth of society is fixed. If you have a magic coin and I give you a haircut for that magic coin, after the haircut I now have the magic coin and in two weeks you no longer have a haircut, so the wealth of the world is still one magic coin. I could also just club you over the head and take the magic coin without giving you the haircut and the net effect would be the same, although you would be less happy (just like with Social Security taxes).
Let’s say that instead of giving you a wasting asset like a haircut, I dig up some ore and create a knife and trade it for your magic coin. As long as you take care of it, the knife will last indefinitely. This time instead of the fruit of my labor decaying away, I have created wealth. The wealth of the world is now doubled and worth two magic coins – one in the form of a knife, and one in the form of a magic coin.
Social Security in its present form, from a cash-flow perspective, is like me clubbing you over the head and taking your magic coin. When you do work and I take it from you without providing anything of value in return (other than perhaps some nice stories about the good ol’ days), the amount of wealth in the world is decreased when I use up the result of your work (for example, the food you grew). When you are ready to retire, if there is someone who is willing to allow you to take the result of his labor without immediate compensation, then you will be fed. This can continue indefinitely so long as there are enough people still working, although there is only a certain amount that can be taken from the still working before they will stop working. This means that you may get just enough, or almost enough, but you won’t get a huge excess. After all, the next guy needs to eat too.
The problem comes when you have a large bump in the population – the Baby Boom. If you were to have those Boomers, while working, pay enough to pay for themselves and those currently retired, and you were to store the excess taken somehow until the large bump in the population retires, those coming after them would only need to provide as much as the generations before them provided since the additional revenue needed would be there in storage.
But the wealth, while taken, was not stored because Social Security is a pay-as-you-go system. Extra revenue beyond what is needed to pay for current retirees was spent on other things – nuclear missiles, EPA studies, White House Dinners, trailers for hurricane victims, schools in Iraq, etc…. This means that as the Boomers are starting to retire, the amount of wealth being taken from those after them (Gen X) is not enough to provide the same level of benefits unless the amount being taken is increased. This means that either the Boomers will see their benefits cut or the Gen Xers will need to provide far more than they get. It probably will mean a little of each. This is where we currently are.
But let’s say now that instead of me clubbing you over the head and taking your magic coin, I use my wealth to create things of value – say a knife or a table – and then store them until I retire. Things that I can give you for your magic coin which you will gladly accept because they are useful and therefore valuable. As I am selling my tables and knives to you for your magic coins, even though I use the magic coins up to sustain me, you still have the knives and tables which you can trade for magic coins from someone else when you are ready to retire. No one needs to get clubbed over the head.
Now, instead of saving up tables or knives, let’s say that I trade my labor for interests in corporations. These things don’t only hold their value – they grow in value. As the corporation starts to generate more revenue, by providing something that other people are willing to do work or trade something they have of value to obtain, the corporation becomes more valuable. The amount of wealth in the world is increased. When I sell my shares of stock, I am not draining anything from those still working – I am trading something for something. I am not just banking the wealth created by my labor – I am growing it.
And no, contrary to the myth currently being presented, it is not true that those who have invested in the stock market have only done about as well as the “investment” in Social Security or done worse. They have done better – far better. The return on stocks over the last 50 years has been over 10%, even with the 2000 and 2008 crashes. The return on Social Security has been about 1%. This is the difference between getting $10,000 per month in retirement and $10,000 per year. (A more thorough analysis will come in a future post to show the difference.)
So, if we keep doing as we’re doing – clubbing the next generation over the head and stealing their magic coins, the ability to feed the current generation will always be dependent on the work of the next generation. If too much of that work is expended for other purposes – for example for paying for wars or interest on debt – there will not be enough available to feed current retirees or the next generation will effectively become slaves with nothing to show for their labor. If retirees instead have saved their work over their lifetimes for themselves, in things that have value, there will be no such dependency and both generations can enjoy the fruits of their own labor.