Funded and Unfunded Entitlements

There is a lot of talk in the political/economic sphere about the problem of unfunded entitlements. The ever excellent interfluidity offers a compelling perspective on price stability and the elderly. In that vein I wish to offer a different perspective on saving, and to do that, I will consider the following statement:

“In any closed economic system, there is no difference between a funded and unfunded entitlement”.

It seems intuitively obvious that an unfunded entitlement will impose a monetary burden on future generations, after all, they will be the tax payers who are paying it. However, such an intuition fundamentally misunderstands the role of saving in an economy. In particular, it is the division of current production among consumers that is the principle goal of all social security programs.

Consider a stylised model where generation A works, and when they retire their jobs will be taken over by generation B, but total production remains stable. In the case of an unfunded retirement, generation B, directly funds the retirement of A, by giving half of their consumption claims’, and hence half of their production, to A. In the case of a funded entitlement, generation A saves half of their consumption claims, however, the remaining half is still sufficient to buy all of the production while they are working. They are saving their claims, not their actual production. In a flexible economy, the amount of money in circulation (i.e. not saved) is always sufficient to buy all of the goods. When generation A retires, they liquidate their savings and attempt to buy B. However, this is simply increasing the number of consumption claims, without affecting the total production (which, by assumption, is stable). Thus, assuming their saving was sufficient, generation A still ends up consuming half of the production, and generation B is in an identical position.

Of course, the real world is not so simple. In particular, saving often means investing in assets which will increase the total production. Holding the total production steady is a very poor approximation to the real world. On the other hand, it does make clear that it is consumption that is important. The elderly will consume a fraction of our resources, regardless of whether their entitlement is funded or unfunded. I’m not sure if this means we can all be blasé about unfunded entitlements, or if we should be worried about the inflationary potential of the baby boomer generation liquidating their assets. My main point is that it doesn’t matter how we fund it, we are going to be giving a certain fraction of our production to caring for the elderly as our demographic changes, and the reality is that very little production can be stored up for later. Healthcare, for example, cannot be saved. Even semi durables like cards cannot be saved, as pensioners are unlikely to want 1970’s vintage cars as part of their share of consumption.

Let us refocus the debate where it matters: Maximising production, and sharing out claims on that production fairly.

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About worldofinterest

I know I live in my own world, but I like it: they know me here.

2 responses to “Funded and Unfunded Entitlements”

  1. Tom says :

    Excellent conclusion about maximizing production — as well as sharing the production “fairly”.

    But the fully funded retirement means the claims are shared out in the peaceful, contractually agreed to method. I see this as “fair”, altho a long term McDonalds worker will get a lot less than a long term auto worker when they retire.

    Funded means those doing the work 10 years before they retire, get the amount they agreed to when they retire, and that amount was set aside in some account in the agreed upon quantity. Nobody else has to then pay for the funded amount.

    Unfunded means that there was not the amount agreed to set aside peacefully, so somebody is going to be forced to pay, or else the recipient will get less.

    Forcing young people today to pay for current retired folk that accepted non-funding of their retirements is, because of the force involved, NOT peaceful. I also don’t think it’s fair.

    • worldofinterest says :

      I fear you may have missed the point Tom, retirement is always funded out of current production, because most assets cannot be set aside. What is really important for calculating the `burden’ of retirees on young people, is what percentage of national output the old people are consuming in a given year. If it comes from a funded retirement, then liquidating assets will increase the effective money supply, and drive up prices. Thus reducing the ability of workers to pay the higher prices.

      Look at it this way, if, in a given year, the retirees consume 1/3 of current production, then two thirds of consumption will be shared among the workers. This is true regardless of how the elderly find the funds to purchase their one third, from straight charity, to funded entitlements, to direct transfers through transactions.

      Of course, the real counter argument, is that the UK is only a small part of a world economy who are not all in the same place. A funded entitlement makes sense on in this case, as there may be parts of the world who are eager to swap the financial assets for current production. I have been meaning to write a post on this, but its complicated by exchange rate considerations, widespread liquidation of finanical assets in the UK to buy production from abroad, will weaken the exchange rate, and this will at least partially wash out the effect through effective inflation. My intuition is that this is very similar to the argument about inflation given above. But I am not completely sure.

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