In the Financial Post, MLI senior fellow Philip Cross writes that while calls for Canada Pension Plan expansion are based on vague feelings of unease about the future, the evidence suggests that doing so could ironically threaten the long-term economic growth needed to secure incomes. Cross writes: “Ontario Premier Kathleen Wynne bases the need to expand CPP on ‘my understanding that there is a high degree of anxiety among people who are worried about their security in retirement.’ This ignores that people are genetically programmed to be perpetually anxious about their future standard of living”.
Philip Cross, December 12, 2013
There are a lot of specific reasons to oppose the proposed expansion of the CPP — it doesn’t target those most in need, it taxes many Canadians who already have adequate savings, it ignores large sources of wealth that could help fund retirement, it penalizes small businesses and youths, and so on. Let’s step back and look at the broader question of what is driving the alleged problem — is it real or is it the result of shaky assumptions? And what are the broader implications of higher taxes and pension benefits for long-run potential growth, the best assurance of future income security for everyone?
Start with the justification of the perceived problem by Ontario and PEI, the two leading proponents of expanding the CPP. Ontario Premier Kathleen Wynne bases the need to expand CPP on “my understanding that there is a high degree of anxiety among people who are worried about their security in retirement.” This ignores that people are genetically programmed to be perpetually anxious about their future standard of living. The PEI proposal is based on simulations from an academic model that show some middle-class earners will see a drop in income on retiring, although not enough for them to qualify for support from the safety net that the GIS provides for truly low-income seniors.
This raises the question about the usefulness of models for policy-making. Their recent track record is hardly inspiring. The same models being used to predict a pension crisis decades down the road forecast incorrectly that the welfare reforms of the mid-1990s would aggravate poverty.
Part of the problem is the inability of models to anticipate the complex range of reactions and intra-family transfers that characterize real life. Families, not government, are the quickest to help a member feeling the pinch of lower incomes. Not so long ago, papers were full of reports of how the boomer generation would be on the receiving end of the largest inter-generational inheritance of wealth in history, a transfer not accounted for in models.
Models have proved unable to predict broad changes in the macro-economy, never mind micro changes in household finance. Macroeconomic models famously failed to predict the 2008 recession, partly because of their inability to account for bubbles in the stock market and housing. In fact, an over-reliance on models contributed much to the recent downturn. After all, it was the notorious Black-Scholes model of options pricing and risk that opened the floodgates to trading in derivatives that helped trigger the financial crisis in 2007. Ratings agencies used statistical models to evaluate subprime mortgages packaged as AAA-rated debt, based on historical patterns of default.
Of course, models sometimes can provide useful insights, when their results are supported by theory: The Russian economist Nikolai Kondratieff (of the 50-year ‘Kondratieff wave’ fame) was executed on Stalin’s orders during the Great Purge of 1938 when his econometric model accurately predicted that collectivizing Russian agriculture would result in sharply lower farm output.
Alan Greenspan, former Chair of the Federal Reserve Board, has weighed in on the broader impact of social security benefits on long-term growth, the overarching theme of his new book, The Map and The Territory. He is emphatic that rising social security benefits have “crowded out capital investment at a virtual dollar-for-dollar rate that, in turn, has significantly lessened our rate of economic growth.” This is because the increase in social security benefits was used to finance higher current consumption, but every dollar diverted to social security was offset by lower domestic savings in the private sector. This lower private savings rate was reflected in reduced business investment, which led to the long-run erosion of productivity growth and incomes.
Ironically, Greenspan concludes, “the resources required to augment the benefits of the elderly came largely at the expense of the lower income quintile households, almost wholly through suppressed wage rate gains.” It is hard to imagine a clearer statement that opposing CPP expansion is not based on ideology, as some critics claim, but because it’s a direct threat to higher long-term economic growth that is ultimately needed to secure incomes.
Greenspan frames the fundamental question as “Do we wish a society of dependence on government or a society based on the self-reliance of individual citizens?” This is essentially the question posed by asking whether Canadians want to restructure retirement funding by expanding the CPP or relying on individuals to contribute voluntarily to Pooled Registered Pension Plans. One choice leads to expanding the ‘dead hand’ of bureaucracy, the other paves the way to increased self-reliance and fosters a spirit of entrepreneurship.
This is not the time to debate the pros and cons of evidence-based policy. It is noteworthy, however, that proposals to expand the CPP are based exclusively on feelings of anxiety or, worse, on incomplete and misleading models of income dynamics projected decades into the future. It would be folly to risk dampening long-term growth potential on the basis of such flimsy foundations.
Philip Cross is a Research Fellow at the Macdonald-Laurier Institute and the former Chief Economic Analyst at Statistics Canada
