(as some studies suggest), but that a shift to individual accounts would not raise national saving.
The fundamental point is that broad prefunding and privatization are distinct concepts, and conflating them confuses rather than informs the debate. It is also important to keep the concepts of narrow and broad prefunding distinct; they are too
often confused. The fundamental issue involved in broad prefunding is, given the
inherited level of implicit and explicit debt, the optimal policy of paying it off. This
optimization problem does not depend on how or why the debt was acquired, and it is not
affected by the introduction of narrowly prefunded individual accounts.
The conclusion is that the tradeoffs involved in how to prefund -- for example,
through a public or private approach -- are distinct from the tradeoffs involved in whether
to prefund. Indeed, Heller (1998) and Modigliani, Ceprini, and Muralidhar (1999)
argue that a prefunded, public, defined benefit system may be preferable to a prefunded,
private, defined contribution system. Automatically linking privatization and broad
prefunding, rather than examining each choice separately, fails to reflect the full range of
policy options.
Myth #2: Rates of return are higher under individual accounts
A second myth is that rates of return would be higher under individual accounts
than under a pay-as-you-go system. For example, the Financial Times last spring
reported that the "rate of return [on individual accounts] would be higher — perhaps 6 to
8 per cent on past stock market performance, against the roughly 2 per cent the social
security system will produce." Similarly, Palacios and Whitehouse (1998) argue that
the higher rate of return under a private scheme "is an important reason for reform." As
in Myth #1, this myth conflates "privatization" with "prefunding." But in addition, most
simple rate-of-return comparisons conflate "privatization" with "diversification."
As Paul Samuelson showed 40 years ago, the real rate of return in a mature payas-
you-go system is equal to the sum of the rate of growth in the labor force and the rate
of growth in productivity. In the decades ahead, fertility rates are expected to remain
relatively low, and the world's population is expected to age. World population growth is
expected to slow from 1.7 percent per year in the 1980s and about 1.3 percent per year
currently to 0.8 percent per year, on average, between 2010 and 2050. As a result,
global labor force growth is also expected to slow, putting downward pressure on the rate
of return under mature pay-as-you-go systems. Assuming productivity growth of 2
percent per year, the long-run real rate of return on a hypothetical global, mature pay-asyou-
go system would be about 3 percent per year.
In a dynamically efficient economy without risky assets, the real interest rate must
exceed the growth rate. Therefore, in a dynamically efficient economy, individual
accounts -- even without diversification -- will always appear to offer a higher rate of
return than a pay-as-you-go system. But appearances can be deceiving. The simple rateof-
return comparison, even without the diversification issues discussed below, is
fundamentally misleading for two reasons: administrative costs and transition costs.
•Administrative costs. The simple rate-of-return comparison usually compares gross
rates of return, even though administrative costs may differ even under idealized
versions of the two systems and, ceteris paribus, higher administrative costs reduce
the net rate of return an individual receives. Myth #7 addresses administrative costs
in more detail. As that section explains (admittedly on an as-implemented basis),
administrative costs are likely to consume a non-trivial share of the account balance
under individual accounts -- especially for small accounts. Such administrative costs
imply that on a risk-adjusted basis, once the costs of financing the unfunded liability
under the old system are incorporated (see below), the rate of return on a
decentralized private system is likely to be lower than under the public system.
•Transition costs. Since individual accounts are financed from revenue currently
devoted to the public social security system, computations of the rate of return under
individual accounts need to include the cost of continuing to pay the benefits
promised to retirees and older workers under the extant system. Assuming that
society is unwilling to renege on its promises to such retirees and older workers, the
costs remain even if the social security system is eliminated for new workers and
replaced entirely by individual accounts. Since the payments to current beneficiaries
are not avoided by setting up individual accounts, the returns on individual accounts
should not be artificially inflated by excluding their cost.
The fundamental point is a simple one. If the economy is dynamically efficient, one
cannot improve the welfare of later generations without maki