Retirement Insecurity Is a Threat to the Economy

Co-authored by Dina DeCarlo. Dina is an Economics major at Siena College.

The 2016 presidential candidates have offered a variety of plans to deal with rising economic insecurity. Bernie Sanders' platform includes a higher minimum wage--a living wage--of $15 per hour. Hillary Clinton's platform includes lower taxes on middle class families. Donald Trump, who is frequently inconsistent in his plans, argues that more isolationist economic policies will benefit workers.

But these candidates have been silent on another issue that affects economic security--the ability to retire. The current generation of retirees will likely be the first to experience a lower retirement stand of living than their parents. Social Security, the main federal program that deals with retirement, keeps millions out of poverty, though some argue it isn't doing enough for those who need it. Despite claims to the contrary, Social Security is not going bankrupt. Simple policy fixes, such as raising the cap on taxable income, could allow for long-term program solvency.

Beyond equity concerns of ensuring that people have enough income to retire, why else should we be concerned with retirement policy? The answer is that when firms provide pensions for their workers, the entire economy benefits in the form of lower inflation and higher productivity.

Many firms used their bargaining power advantage afforded by elevated unemployment rates during the Great Recession, to reduce the generosity and scope of their pension programs, intensifying a trend that has been occurring since the 1980s. IBM, for example, shifted to a lump-sum payment plan to help in reducing retirement-plan expenses. During the decade leading to its bankruptcy, Hostess re-directed capital from pension funding to operating expenses.

This fraying of employment relations can be captured by a concept known as the social bargain. The social bargain is the implicit contract between firms and workers that includes non-wage compensation such as pensions, health insurance, and profit sharing plans. A strong social bargain suggests that employers will provide more than just wages to their employees, who are viewed as partners in the production process. A weak social bargain implies that firms view their workers as basic inputs to the production process, whose cost should be minimized.

Our research indicates that a strong social bargain has large benefits for the macroeconomy, namely lower inflation rates. When firms provide pensions to their workers, workers are willing to tradeoff wage gains today in exchange for future retirement income, reducing inflation. Workers gain because they get retirement security. Firms benefit because they can lower short-run labor costs and retain the most productive employees by offering a comprehensive benefits package.

Despite these benefits, individual employers are likely to further decrease the provision of social bargain programs to their employees, despite these programs benefitting the economy. Why? First, the weak labor market has depressed labor's bargaining power, allowing for firms to pare back both wages and benefits. Second, expectations of future cost pressures and competition will force firms to allocate resources away from employee compensation and toward lower prices or cost-reducing technology. Third, firms generally resist transferring increases in profits to employees. Finally, since low inflation can be considered a public good, individual firms will have the incentive to free ride on the willingness of others to provide pensions, while not themselves being excluded from enjoying the benefits lower inflation rates.

A weak social bargain has not always been the case. From the 1940s until the 1970s, the social bargain grew and the ability to retire was democratized--it was no longer a luxury for the rich. Strong unions were able to win defined benefit plans for its members, which provided retirement security. With the decline of union power and an overall shift in labor relations came defined contribution plans. These plans do not guarantee a fixed retirement income, as defined benefit programs do, but rather offer contributions from the firm to a worker's market-based retirement investment portfolio. In other words, defined contributions plans shift the risk of saving enough for retirement from the firm to the worker.

Since firms won't unilaterally increase pension provision and since Social Security provides only basic retirement income, what can be done to restore retirement security? Guaranteed Retired Accounts (GRAs)--an expanded form of Social Security--would replace private pensions with an expanded and modernized version of Social Security that could provide greater retirement security and greater labor market flexibility.

Similar to Social Security, GRAs would be mandatory through individual contributions of 5% of earnings deducted though payroll taxes. The system would be managed by the Social Security Administration and would take the $80 billion in annual tax subsidies for IRAs and redistribute it so that each individual would receive a $600 tax credit to offset their payroll contributions. GRAs would guarantee a minimum 3% real rate of return by investing in low cost, low risk assets like Treasury Bills. Upon retirement, but not before, workers would be able to withdraw their savings as an inflation-indexed annuity, eliminating the risk of withdrawing funds too rapidly. This system could increase retirement income from 40% of one's previous employment income to 71%.

The risk of not saving enough for retirement, working for firms that do not contribute to an individual's IRA, financial market volatility, outliving one's savings, inflation risk, and early withdraw risk are eliminated with GRAs because they can take advantage of pooling workers' savings. Since the government would manage GRAs, they would be portable across firms, workers could shift employers without incurring penalties or administrative costs.

GRAs can also be an effective automatic stabilizer because they would permit workers to retire and supplement their incomes during recessions. This would also increase productivity as elderly workers could exit the labor force and be replaced by younger, more productive workers with an updated skill set. Given the current weak labor market, this could lead to high levels of unemployment and unemployment duration for young workers, leading to both short and long-term economic costs. Also, elderly workers who lose their job and search for one during weak labor markets might find themselves unable to successfully switch industries due to the heightened pace of technological change.

Social Security is one of the most effective anti-poverty program in the United States. GRAs would improve upon this. To ensure that retirement does not again become a luxury for the wealthy, policy makers must rethink their approach to pension provision because retirement insecurity is a threat to a healthy economy.