Dean Baker has made a very strong claim about Andrew Biggs:

It is interesting to note that the economists’ concern with pension fund accounting just happens to coincide with a major push by the right-wing to attack public sector workers and especially public sector pensions. State pensions have been assuming 10 percent nominal returns on their pension’s stock holdings for decades. This fact never seemed to trouble economists previously.
Interestingly, many economists had argued the exact opposite position in the context of Social Security privatization. Andrew Biggs, one of the economists who has been very prominent in the debate for lowering the return assumptions on public plans, explictly argued for assuming a high rate of return for the stock held in privatized Social Security accounts. Other proponents of privatization took the same perspective, which was the main benefit of their proposal.

Baker linked to an IBD op-ed from July of 2000 that included the following:

This link between per capita GDP growth and stock returns affects the debate over personal accounts, since the economic slowdown projected by Social Security’s trustees stems almost entirely from reduced labor-force growth. Productivity increases — the other main component of economic growth — will remain at the 1969-98 average of 1.5 percent annually and GDP per capita growth will be respectable. Jorion found that a 1 percent change in per capita GDP growth correlates with a 0.7 percent change in equity returns. If true, we can expect future stock returns to be less than one percentage point below their 1926-97 average of 7.2 percent.
Of course, the real benefit from reforming Social Security through personal accounts is not simply higher rates of return. It is increased savings, the building of wealth and the independence that comes from personal ownership and control. But historically high market returns will make the transition to a system of personal accounts easier and will lead to a lower tax burden and higher retirement incomes in the future.

Aha! Baker caught Biggs suggesting that stock returns could prove pretty healthy over time! But wait a second. Shouldn’t it matter if the taxpayers are actually guaranteeing returns, as they are in the case of public sector defined benefit pensions? And what has Andrw Biggs said about public guarantees for stock returns? We actually know the answer to this because Biggs co-authored a paper for NBER on this subject with Clark Burdick and Kent Smetters. Here is the abstract:

A number of proposals to introduce personal accounts to the Social Security program contain provisions that would guarantee account-holders against relatively poor investment performance that would make their total benefits fall below the level scheduled under current law. Presently, most policy focus is placed on the expected cost of such guarantees, as few estimates are published evaluating the potential market cost of insuring against the associated risk. This paper demonstrates how a simple modification of parameter inputs used to calculate the expected cost of guarantees would allow analysts to estimate the market cost of the underlying risk.

From deeper in the paper:

In summary, the consensus in the academic literature is that it is unlikely that the government has much, if any, advantage in risk sharing relative to the private market. Moreover, even if the government did have an advantage, especially between generations, it is not obvious that the optimal direction of risk shifting is from older retirees to younger workers, as implicit in a benefit guarantee.
As a result, policymakers arguably should not treat risk much differently than individual investors who consider both expected outcomes and risk. For instance, an individual deciding his own 401(k) investment strategy would not focus solely on expected outcomes. Rather, she would consider that stocks, bonds and other investments offer combinations of risk and return. Moreover, periods of low returns from a risky asset are likely to be correlated with poor outcomes in other areas, such as labor income. [Emphasis added.]

Does this strike you as salient? I think it should. Indeed, that last sentence brings to mind the Josh Barro reply to Dean Baker we discussed yesterday.

I’d love to see Dean Baker offer this context and a clarification.

P.S. Turns out that Baker has replied to Biggs, sort of:

To start, we should be clear on what exactly is at issue. Andrew and I are not debating the expected rate of return on stocks. Both of us agree that the pension funds are at least close to the mark in their assumptions on stock returns. Rather, Andrew feels that their return assumption does not correctly account for the risk associated with stock returns. He notes that the higher return on stocks comes in exchange for higher risk. Since the pension obligation is an absolute commitment, he argues that pensions should assume a risk-free rate of return on their assets.
My contention is that because a state or local government is essentially an infinitely lived entity, it need not be as concerned about the variance in returns as individuals. Therefore state pension plans can make their projections based on the expected value of their stock holdings.

Biggs proceeds to address – some might say dismantle — Baker’s argument. We’ll see if the exchange continues. Biggs made a few points that seem particularly important to me:

[I]f a government cannot go out of business, that makes it more likely that it will pay the pension liabilities it has accrued. Using standard financial economics, a liability that’s more likely to be paid should be discounted using alower interest rate, not a higher one. …
While government can help diversify certain risks across the population, market risk is not diversifiable. For instance, we today see taxpayers and public employees making larger public contributions solely in response to a decline in the market value of pension assets. It seems absurd to say that “the government” has borne these risks; rather, people have. And so we should value risk the way that stakeholders do, meaning, on a market basis. …
[W]hile there are certain instances in which government can ignore risk—as the Arrow-Lind Theorem outlines, when those risks are both small and uncorrelated to the government’s other liabilities—holding a trillion dollars or so in equities simply doesn’t qualify. I don’t know of research concluding that government can simply ignore risks of this magnitude. Even economists who endorsed investing the Social Security trust fund in equities—such as Peter Diamond—made a much more involved argument than Dean is making. …
[E]ven if government can ignore risk over the very long term, most public-pension liabilities occur in the short term—over the next 15 years or so. There’s no way a government pension can guarantee 8 percent returns over such a short time period. (It can’t actually guarantee those returns over any time period, but I’m trying to be generous here.)

I wish that Diamond could weigh in on this disagreement. I would greatly enjoy reading his thoughts on Baker’s argument.