Government-Controlled Investment: The Wrong Answer to the Wrong Question

SOME ARGUE THAT PERSONAL RETIREMENT ACCOUNTS would be a mistake and that the government instead should set up its own investment fund to help finance future benefit payments. The good news is that this indicates a growing awareness that “pre-funding” (i.e., accumulating assets) is a necessary component of Social Security reform.

The bad news, however, is that government-controlled investment is the wrong answer to the wrong question. It assumes that policymakers should focus solely on balancing the program’s revenues and expenditures. This ignores the other Social Security crisis—the fact that the tax burden on today’s workers is extraordinarily high compared to the benefits received (often referred to as the rate-of-return crisis).

But even if balancing Social Security’s long-term finances were the only goal, government-controlled investment would be the wrong answer. This is because a government-controlled pension fund would not face the competitive pressure and legal obligation to make investments solely for the economic benefit of future retirees. As Nicole Gelinas in the Winter 2005 issue of City Journal has explained:

[U]nlike a private fund manager, who only wants to see the value of his investment rise and who will sell it if he loses confidence in the company or its managers, highly political public pension trustees are free to pursue political as well as economic objectives.

Giving the federal government that power and control would create large risks for the economy and for the retirement security of today’s workers. The Congressional Budget Office warned, in a 2003 paper, “Acquiring Financial Assets to Fund Future Entitlements”: Government ownership of stocks could affect corporate decision making, interfere with the nation’s competitive market system, and impede the operation of financial markets—potentially limiting economic growth.

For example, evidence at the state and local levels with public employee pension funds—as well as evidence from similar arrangements in other nations—demonstrates that politicians and their appointees often are tempted to steer the government-controlled pot of money toward special interests, political allies, or corporate contributors.

In addition, even well-intentioned policymakers are not qualified to invest funds and manage money. Simply stated, they do not face the bottom-line pressures that force private businesses and investors to allocate resources wisely. Yet poor investment decisions have serious consequences. Most important, workers would earn lower returns on their money, and even small differences in rates of return translate into less retirement income.

It certainly would be difficult for workers to wind up with less than they are promised currently from Social Security. Nonetheless, it would be a mistake to enact a policy—such as government-controlled investment—that offers less in return and risks more. Federal Reserve Board Chairman Alan Greenspan has testified before Congress that such approaches “would arguably put at risk the efficiency of our capital markets and thus, our economy.”

The Risks of Politically Driven Investment Politics

The Social Security system is actuarially bankrupt and will not be able to meet its future obligations. Over the next 75 years, the program will face a cash shortfall of $27 trillion. If no changes are made in the program’s design, bringing Social Security into balance will require a monumental policy change: a 50 percent–plus increase in payroll tax rates, a 33 percent reduction in benefits, a big hike in the retirement age, or a combination of these three possibilities.

These choices are economically risky and politically unpopular. Moreover, tax increases and benefit reductions would serve only to exacerbate Social Security’s other crisis—its poor rate of return—and make it an even worse deal for American workers. Many younger workers today already face negative returns from the taxes they pay into the Social Security system, after adjusting for inflation. Forcing them to pay more to receive even less hardly represents fair and compassionate public policy. On the other hand, policies that would increase the current system’s rate of return, such as reductions in the tax rate and increases in benefits, would drive the system into bankruptcy even sooner.

Faced with this Catch–22 dilemma, many Washington policymakers are considering a shift from the current “pay-as-you-go” program to a pre-funded system. For example, all 13 members of the 1994–1996 Advisory Council on Social Security endorsed some form of investment in private assets as a way to address the program’s long-term unfunded liability.

An important debate is occurring, however, over how best to tap the benefits of private investment. Opponents of reform argue against personal accounts and assert that the current Old Age and Survivors Insurance program can be salvaged by allowing politicians and their appointees to invest excess Social Security payroll tax revenues. This is the option supported, for instance, by the AARP.

There are, however, four broad concerns about such government-controlled investment proposals.

Concern #1: Government-controlled investment would mean the partial nationalization of major businesses, which would allow politicians direct involvement in the economy.

Under a system of government-controlled investment, the government would be able to purchase a significant percentage of publicly traded companies. Once it had become a dominant shareholder, the government could use its power to insist, for example, that a company place politicians on its board of directors. Even if politicians were not placed in positions of direct power, they could use their voting power to impose control. And when politicians control business decisions, political incentives become more important than economic ones. Invariably, this leads to less prosperity.

Consider the experience of other countries. Much of Western Europe suffers from stagnation and high rates of unemployment. High tax rates and excessive welfare benefits certainly deserve part of the blame, but the widespread direct and indirect state control of business has had severe consequences too.

Concern #2: Government-controlled investment invites crony capitalism—industrial policy that allows politicians to control the economy indirectly by attempting to pick winners and losers.

The managers of private pension funds are legally obligated to make investments that are in the best interest of workers. In other words, they must try to get the highest possible return, adjusted for risk. Would such a standard apply under a system of government-controlled investment, and could it even be enforced? This is a significant concern because legislators sometimes believe that the marketplace is not producing the right results; they try to help or punish certain industries or companies through spending programs, tax breaks, and regulatory exemptions. They also can do this by providing special access to capital—another risk that would arise if politicians controlled how retirement funds were invested.

The downturn in Asia during the 1990s illustrates the danger of this approach. Decades of industrial policy, or crony capitalism, left these countries with debt-laden banking systems, inefficient industries, and companies that cannot compete.

Concern #3: Government-controlled investment opens the door to corruption by allowing politicians to steer funds toward well-connected interest groups or corporate contributors.

Politicians frequently use the levers of power to counteract markets by steering resources in certain directions. These same levers of power could be used for more narrow political purposes as politicians provide favors or steer resources to constituents and allies. A large pot of government-controlled money would create the opportunity to divert money to satisfy the demands of special interests. This is what has happened in many countries in the less-developed world.

Advocates of government-controlled investment argue that U.S. political institutions are too transparent to allow blatant corruption to exist. This is a fair response, but there is an ill-defined boundary between special-interest investing for purposes of industrial policy and special-interest investing that is done in exchange for campaign contributions and political support.

Concern #4: Government-controlled investment invites “politically correct” decisions at the expense of retirees because politicians could forgo sound investments in unpopular industries (such as tobacco) to steer money toward feel-good causes that are likely to lose money.

When operating private pre-funded systems, fund managers pick well-balanced portfolios designed to maximize long-term returns. This is a legal requirement, largely because it is the best way to ensure that workers will have a comfortable and secure retirement. Fund managers may or may not approve of the goods and services produced by the companies in which they invest, but their fiduciary responsibility is clear: They must invest with the workers’ interests in mind.

Regrettably, it is not clear that managers in a system of government-controlled investment would have the same incentives. Politicians routinely go after certain industries and/or companies, and withdrawing investment funds would be one way to show their displeasure. Conversely, some causes are politically popular. Allocating investments to these ventures, even if they are expected to lose money, could be advantageous for politicians.


Some proponents of government-controlled investing assert that the Thrift Savings Plan for federal employees is a model for Social Security. This is true, but only if workers are given personal retirement accounts. As the Congressional Budget Office explains:

A crucial feature of the TSP is that its assets are owned by federal workers, not the government. The board that oversees the program has a fiduciary responsibility to manage those assets for the sole benefit of the owners of the individual accounts.

The AARP and other interests want the opposite: to have the government make private investments in order to increase government’s control of national economic output. This would be the wrong approach. It would not help workers get a better deal from Social Security, but it would open the door for political mismanagement and intervention in America’s capital markets.

Daniel J. Mitchell is McKenna Senior Fellow in Political Economy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.