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Noting that talented Bush-Cheney Alumni are working on many issues central to the work of the Bush Institute, the economic growth initiative launched the Guest Writer Program in 2014, whereby a different alumnus authors an article for publication on our website each month. This month’s guest writer is Dino Falaschetti, who is the Director of Operations at George Mason University’s Mercatus Center. He was formerly senior economist for the Council of Economic Advisers under President George W. Bush.
Retirement Security and Economic Performance
Are political-legal barriers compromising both?
In only three weeks, from September 19 to October 10, 2008, the S&P 500 Index fell almost thirty percent. The havoc from such a sharp drop is incredible. Retirees who were earning $4,000 per month from market investments faced a $1,200 cut. Had this loss-rate continued for two more months, those who remained invested would have lost seventy-five cents on the dollar.
Stock market valuations have more than recovered from the Panic of 2008. Economic performance has not. The National Bureau of Economic Research (NBER) dates the Great Recession as ending almost five years ago. But each recovery-year has fallen short of its potential by over $1 trillion.
This persistent output gap is raising popular concern that, rather than a quick rebound to normal, the Great Insecurity has replaced the Great Recession. A number of commentators have evaluated how we entered such a deep recession, and what might speed our abnormally slow recovery. Better governance of investment advice professionals, however, has received little attention.
Laws and regulations are sometimes characterized as necessary for investor protection. But they also precluded household savers from owning securities that offered insulation from the Panic of 2008, and continue to discourage various producers of investment advice from recommending such volatile investments as part of a well-diversified portfolio. Institutional protections may be exposing savers to large but avoidable losses.
A law and economics of “safe” investments
In addition to weakening retirement security, institutions like these may be compromising the type of economic dynamism that has let US economies quickly bounce back from recessions. Promoting a more rigorous competition for investment advice, not more watchful paternalism, could increase retirement security and strengthen economic performance.
How much we should save for retirement depends on how we save. Investing in short term US government bonds, for example, can appear safe when viewed through the lens of political-legal institutions that govern our retirement and other saving. But investing in such securities is unlikely to buy more in the future than our savings could have bought today. In other words, institutional constraints may be pushing savers to make due with less during their working years while promising little if anything more in the way of real returns during retirement. Viewed through a financial economics lens, this seemingly conservative strategy can put savers on the road to retirement insecurity.
Even more, to the extent that such institutions encourage such “safe” investment strategies, entrepreneurial projects that might expand economic opportunity can face constrained supplies of financial capital. By their nature, these ventures result in highly variable performance. While political-legal institutions can view this type of variability as exposing unsophisticated investors to undue risk, however, investing in such projects could let households enjoy more disposable income today and in retirement. A more competitive market for investment advice may let providers embrace this insight to financial asset pricing more confidently, and thus help retirement savers both benefit from and encourage strong economic performance.
Economic ideals versus political realities
Competitive markets do a relatively good job of reconciling conflicts of interest between buyers and sellers. And while we can imagine institutional arrangements that benefit the many by leveraging the wisdom of a few, actual political markets appear prone to doing worse.
Appreciating how our own interests conflict with each other reveals the deep roots of this political-economic difficulty. For example, we tend to prefer higher prices (e.g., salaries, wages, piece rates) when selling our labor services. When we instead play the role of consumer, however, our preference turns toward lower prices.
Something has to give, and how political-legal institutions reconcile this fundamental conflict says a lot about consequent economic opportunities. So, what type of system does a better job? Comparing governance systems like those in North and South Korea let us clearly see the equity and efficiency advantages of more competitive markets.
Can we do better?
Despite its relatively high level, economic opportunity in America has plenty of room to grow. A more competitive market for investment advisory services could help.
Institutions that govern this and other markets can encourage inefficiency in return for political favor. It doesn’t have to be this way. For example, advances in information technology now let us enjoy on-demand transportation, lodging, and other services. Not too long ago, the centralized licensing of taxicabs was supposed to ensure high quality car service at affordable prices. Tech-enabled reductions in transaction costs now let competition play a stronger role in reconciling these demands. As a result, consumers who used to stand in the rain flagging a politically constrained supply of cabs now enjoy services approaching those of a personal chauffeur.
Instead of embracing such technologies, or creating institutions that encourage competition more generally, our financial rule makers may be doubling down on tried and not true laws and regulations. The Financial Industry Regulatory Authority, for example, recently made the examination of “Automated Investment Advice” a priority. And rather than promote competition as a means for equitably and efficiently resolving conflicts between savers and advisers, the Securities and Exchange Commission is considering whether to broaden the scope of its fiduciary standard.
Competitive markets can productively express the wisdom of crowds. Political oversight, on the other hand, remains prone to seeking distributional gains from others’ losses. When it comes to putting one’s safety and comfort in the hands of car services, consumers appear eager for a more market-driven governance. If given less constrained choices of who to trust with their savings, households may also enjoy more secure retirements and a stronger economy.
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