Known Unknowns

Make American Risky again

Hello,

Welcome to Known Unknowns, a newsletter fighting to make the economy riskier.

Future of the Welfare State

We just experienced a huge shock where the world felt much riskier. In the past, big negative shocks were followed by large expansions of the welfare state. We did this after the Depression and the Financial Crisis. There is a natural instinct to reduce risk after you experience something terrible and unexpected so it never happens again. To some extent that is good instinct. Economies change, and that creates new winners and losers, and the old safety net no longer serves us. Big shocks tend to highlight these changes. The Depression revealed the vulnerabilities of an industrialized urban work force that was more prone to systematic risk – and that justified the creation of the modern welfare state.

So it feels inevitable we are looking at a $3.5 trillion budget that claims to be about infrastructure but is really a big expansion of our welfare state, you can say that investing in people is infrastructure, too. From a budget perspective, however, there is a world of difference from a bridge that only takes a few years to build and an ongoing entitlement. That is not only true in terms of cost, but how it impacts people’s behavior, the choices they’ll make about work, education, and saving.

It seems crazy to me we are debating the politics of how a budget will get passed and not what’s in the actual bill. It seems that, if we want to commit to a major expansion of our welfare state, it is something we should discuss – and I don’t just mean the size of the expansion, which is a huge issue, considering the financial pressures from our current entitlement states is considerable (did you see the New Trustees report – yikes!). We do have finite resources, and contrary to what’s being sold, you can’t have a European-style welfare state and expect only the top 0.1% to pay for it, unless you want fully commit to the bet that rates will stay low for the next 50 to 70 years.

Has anyone even asked if these are the best programs to spend our money on? Free community college sounds good, but community colleges have a terrible track record at preparing people for work. Even universal pre-k has a mixed record. It feels like people assume more welfare is better, especially if it has nice sounding objectives like child care and education. But how you structure benefits and which ones you offer really matters.

My report on reforming the welfare state came out last week. I’ve been working on it for more than a year. It is my attempt to start the discussion I wish we were having. First, before we change anything, we need to take stock of the state of the labor market, how the economy has changed, who is falling through the cracks, and what role can the state play. I know, crazy.

I think the problem isn’t too much risk, it is too little. Even with pandemics, we have never lived with so little risk. Wage risk, or wage volatility, has been trending down for everyone but the highest earners. We don’t move, change jobs, or start new businesses enough – and that means more stable, predictable wages. That may sound good, but it is not surprising wages have stagnated, as assets don’t grow as fast when you don’t take risk. Wage stagnation is the cost of more predictability.

The current budget doubles down on removing risk. It is heavy on guarantees: universal benefits and guaranteed jobs. These kinds of benefits will be expensive and counterproductive, because guarantees reduce risk-taking, while insurance encourages it. Insurance only pays off when an adverse event happens; guarantees pay off no matter what. Insurance is not only cheaper, it is more efficient. Insurance has also normally been the character of our welfare state. This sounds like an esoteric distinction, but it is important. It’s like the difference between offering everyone a bond that pays 2% a year or a put option on the S&P 500 and access to an index fund. Which one would make people richer?

We’re doubling down on guarantees in spite of the fact that the economy has the potential to reward risk like never before. It is changing, and the pandemic did reveal weaknesses, mainly that the labor market is not flexible enough. It is built to provide risk protection for regular employees; people who have stable jobs where it is easy to claim unemployment and get sick leave. This leaves everyone but the richest shut out of risk and a labor market that doesn’t fit the new economy. I propose a different way to think about the safety net, one that offers more insurance instead of guarantees for everyone and some policy ideas. This can enable risk-taking (with downside protection) throughout the income distribution.

The report is a little long, but I hope you’ll check it out.

Also, there are a few good things in the budget, like making it easier to buy an annuity with your retirement account.

The Future of the Fed

Risk removal is not just infecting the welfare state. There is also more pressure – and an intellectual fashion – for monetary policy to remove all the big bad risks in our lives. It was bad enough when it became the Fed’s responsibility to prevent recessions or even a dip in the stock market. But now it is climate change and income inequality, too. Though the Fed can’t do much about the risks associated with either. It has not even clearly defined the risks inequality poses. Taking on these issues will certainly politicize the institution, which will make it harder to do its job, i.e., making the economy less risky by smoothing out business cycles.

It feels like there is this big drive to remove risk to the economy, along with a belief there are no costs to it. Economies change and so do the risks we face. That creates new opportunities and also the need for our institutions to evolve. But one thing never changes, the most fundamental truth we know about risk from markets: There is no free lunch! If you can reduce or remove risk, that comes at a steep cost.

Until next time, Pension Geeks!

Allison