TCS Daily

Paul Samuelson's Reverse Ponzi Scheme

By Tim Worstall - November 1, 2005 12:00 AM

I always find it interesting to speculate on whether seemingly unrelated events are in fact correlated. Of course, most of the time I'm wrong but there are three that have popped in recent weeks that do make me wonder.

We had the award of the 2005 Nobel for Economics which went to two distinguished (and, of course, with their new prize, even more so) game theorists, Mssrs. Aumann and Schelling.

Delphi the auto parts manufacturer (and formerly part of General Motors) went into Chapter 11 bankruptcy proceedings and a large part of the blame was laid at the door of excessive high health care and pensions costs for retirees.

Mere days later (a week actually, a whole week!) GM was able to announce that it had reached agreement with the United Auto Workers on reductions in its health care expenses for both current workers and the retirees:

        GENERAL MOTORS, the world's biggest carmaker, reached a landmark 
        deal with its biggest union last night that cuts $15 billion (£8.5 billion) 
        from its workers' healthcare plan and is expected to set a precedent 
        for its US rivals Ford and DaimlerChrysler.

One doesn't have to be the complete and total cynic that I am to think that there might be the occasional game theorist out there flashing a wry grin or two, perhaps the odd muttered "Well, that worked then didn't it?".

I should also go on to point out that I'm cynical, not heartless. I have every sympathy with those who find themselves, whether at Delphi or GM, with less than they thought their contracts entitled them to just as I do with the shareholders who got scalped and the bondholders who are going to have to take a haircut.

However, the various groups being put forward as those who should carry the can are not, certainly not exclusively, to blame. The real problem is best demonstrated by this piece from Newsweek (in 1967 no less!) by Paul Samuelson:

        The beauty of social insurance is that it is actuarially unsound. Everyone 
        who reaches retirement age is given benefit privileges that far exceed 
        anything he has paid in -- exceed his payments by more than ten times 
        (or five times counting employer payments)!

        How is it possible? It stems from the fact that the national product 
        is growing at a compound interest rate and can be expected to do so 
        for as far ahead as the eye cannot see. Always there are more youths 
        than old folks in a growing population.

        More important, with real income going up at 3% per year, the taxable 
        base on which benefits rest is always much greater than the taxes 
        paid historically by the generation now retired.

        Social Security is squarely based on what has been called the eight 
        wonder of the world -- compound interest. A growing nation is the 
        greatest Ponzi game ever contrived.

Yes, I know he's talking about Social Security but there's not all that much difference between the two systems on the specific point I want to make, which is the dependency ratio: How many productive workers are there per retiree?

According to The Times:

The health care plan at GM alone takes care of 750,000 past and present employees and their families at a cost exceeding $3 billion a year.

As we know, lifespans have been increasing in recent decades so the number of retirees is growing relative to the number of workers. Or would be, if the workforce was static itself. According to these two (rather leftist sites but always fun to quote from the other side, eh?) the GM workforce, up to 1998 had:

        .... gone from 520,000 to 223,000 since the 1970s.


        General Motors will cut 25,000 jobs over the next three years, according 
        to Chair and Chief Executive Rick Wagoner -- almost one in four of the 
        hourly blue-collar jobs left at the biggest of the U.S. automakers. GM will 
        be left with 86,000 hourly workers in 2008 -- about the same number 
        of workers the company employed 30 years before in the city of Flint, 
        Mich., alone.

Longer lifespans and thus longer retirement periods could have been dealt with if there were still half a million people working to do so, without too much pain anyway. It's also true that greater provision for the pension costs would have helped but the effect on the health care costs (which were unforeseen, both the lifespans and the separate and higher inflation rate for those services) would have been unaffected.

Yet that is not the situation we find ourselves in. Unlike Samuelson's joy at the way in which Social Security operated in the 1960s we're now in a reverse Ponzi scheme: we have ever fewer people working to provide income and benefits to ever more. There is no cute and easy way out of this, none at all.

Tim Worstall is a TCS contributing writer. He is editor of 2005 Blogged.


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