Known Unknowns


Welcome to Known Unknowns, a newsletter about the risks that we face both today and in the future, and how to insure against them.

New President and entitlement state

Since the last newsletter, we elected a new President, which in many ways will bring more certainty to our lives, but more uncertainty in other ways. Most of the attention right now is on what it means for the fiscal stimulus in the midst of very nasty second (or third) wave of the coronavirus. I am hopeful a deal will be made. Stephen Moore said that he doubts a lame duck Trump will sign anything because he doesn’t want the extra $2 trillion debt on his record. But the President has never struck me as one to shy away from debt, either as president or in his business dealings—so I’m not sure I buy that reasoning.

Mitch McConnell says that getting a deal made will be priority number one, and with many harsh economic restrictions likely to come, I’m hopeful that they’ll get it done. Odds are that it will be smaller than $3 trillion—probably more in the neighborhood of $2 trillion. Hopefully small businesses will get more support and they’ll extend unemployment benefits, which are set to expire for people who lost their jobs last spring and can't return to work.

However, the longer term is more interesting and with higher stakes. Generally, large economic shocks are followed by the expansion of entitlements, which tend to be permanent. The legislation that comes through in the next two years will be quite consequential, and I don’t think that’s necessarily bad. Economies change and get richer, which means that we can both afford new entitlements and face new risks. Big shocks expose areas of risk and new vulnerabilities, which is why we should reassess our safety net after each shock. And ideally we would expand parts of it—and pull back other parts—but the pullback never actually happens.

However, this time I hear a different tone. We need new ideas, but most of the new ideas are bad. The safety net should be in the form of insurance, or the payments or benefits that you get when something bad happens, like if you lose your job. Most of the new ideas, UBI or guaranteed jobs, are more like guarantees—they pay off no matter the state of the world, or whether you lose your job or not. They also effectively increase the risk-free return to economic participation, and are not only more expensive and poorly targeted, but will have consequences for risk in the economy. Higher risk-free returns tend to decrease risk-taking, while insurance increases it. And I don’t think that decreasing risk in necessarily a good thing.

Here’s another way to think about the difference between a guarantee and insurance. Imagine that we gave every household a check that they had to invest in order to build wealth. We could either require them to invest it in a government bond that paid 5% (which is sort of what we did with the myRA program), or we could offer an S&P 500 index fund as an investment, and instead of paying for the above market guaranteed return, we could give people put options on the S&P 500. What would generate more wealth?

In any case, a likely Republican Senate will put the brakes on any massive expansion of entitlements. But these issues aren’t going away, and in the coming years, we need to think about the role that risk plays in the economy and how to harness it for growth.

The future of work

Bad shocks do expose cracks in the safety net, which tells us where new insurance is needed. I think that this bad recession exposed how vulnerable people in the service sector really are. Contingent and gig work doesn’t offer the same protections as traditional employment, such as the ability to take sick or care-giving leave.

And while many people agree that this is a problem, the proposed solution has been to outlaw contingent or gig work and make everyone an employee (or expensive, and required to work regular long hours), such as with AB5 in California. This is another bad idea. Gig work and fissure reflect a changing economy, and technology has a way of changing the nature of work. It did so in the last industrial revolution, which brought people to factories and created the long, stable, paternalistic employment relationships that we have today. But now technology is changing the nature of work yet again. I think that this will be even more apparent coming out of the pandemic, since circumstances forced everyone to adopt technology more quickly than ever before. I suspect that what would have otherwise been a 20-year economic transition just happened in the last 8 months.

Thankfully, California voters recognized this and voted to allow rideshare and delivery workers to continue using the gig model. If only other contract workers in California were so lucky! Making all of these people employees is like trying to fit a square peg into a round hole. It would be more productive to think about how we can insure against the shocks that contingent workers face.

The state of retirement

One group that is doing well, at least economically, are retirees. Social Security and a booming stock market mean that they’re faring better than workers at the moment, at least financially. So, as we rethink entitlements, it’s interesting that expanding Social Security is on the list.

Now, I understand that people don’t save enough, and defined contribution plans put more risk on individuals. But retirees have never had it so good (at least financially—not counting the deadly pandemic which has disproportionally targeted this population). The golden days of defined benefit plans only included 30% of the population, and because defined contributions plans are cheaper, more people have them. All of this means that retirement income is higher across the income distribution, and old age poverty is at an all-time low.

The ideal retirement programs share risk with individuals, government, and to some extent, employers. But relegating all of the risk to the government, like expanding Social Security aims to do, makes about as much sense as UBI.

Speaking of, sad news from Chile, maybe we can't have nice things.

Until next time, Pension Geeks!