- Comments and Discussion
Jeffrey R. Brown:
David Wilcox's paper on the Pension Benefit Guaranty Corporation and its reform is a pleasure to read. Despite the enormous complexity of the topic, this paper provides a thorough, careful, and clear description of the many problems that are deeply embedded in the structure of the nation's defined-benefit pension system.
In addition to describing the problems with great clarity, Wilcox takes the bold next step of making normative policy recommendations about how to reform the system. To the many interest groups that have a direct financial stake in the future of the PBGC, these policy recommendations will be seen as provocative, both relative to the status quo and relative to the reforms that will likely be enacted. Indeed, as an economist with a strong preference for market-based solutions, I must confess that my own initial reaction to the paper (based on an initial, cursory read) was that the proposals seemed heavy handed: they mandate solutions for nearly every aspect of pension plan funding, including in which assets a plan may choose to invest.
After reading the paper carefully, however, I realized that these proposals follow perfectly from the analysis. Indeed, it is hard to argue with them at all if one accepts Wilcox's three axioms plus one further condition. The three axioms that Wilcox identifies are that workers should be able to view their DB pension as risk-free, that taxpayers should be fully compensated for any risk they bear, and that low-risk sponsors should not have to subsidize high-risk sponsors. Anyone who rejects any of these axioms will also likely have a different view about the appropriate policy response.
The additional condition, which these proposals implicitly assume, is that reform efforts should be focused on making the PBGC work, as opposed to scrapping it completely and replacing it with something altogether different [End Page 286] (such as mandatory private DB insurance). Given that this is a politically realistic condition, at least in the short run, the Wilcox proposals may be viewed as a good standard against which other reform proposals should be evaluated. Although Wilcox does briefly mention the idea of private insurance as a possible last step in the reform process, a case can be made that it should be the first and possibly the only step.
The natural starting point for any economist thinking about government intervention is to ask, "What is the market failure that the PBGC was designed to address?" After all, if consumers were fully rational, forward looking, and well informed, there would be very little need for government intervention. Firms and workers would negotiate an optimal compensation contract, and firms that credibly committed to a less risky DB promise would be able to provide lower compensation than would firms with a riskier promise. Barring market failure, the equilibrium outcome would be efficient.
The market failure here seems to be that the average worker is not fully rational, forward looking, and well informed. Given the increasing body of evidence suggesting that average workers have a low level of financial literacy,1 and that they make optimization mistakes even in much simpler contexts,2 it is reasonable to think that the average worker is unable to fully process the information required to assess the risk of his or her pension plan. Indeed, given how complex the required calculations are, it is probably unreasonable to think that anyone outside of a small subset of experts could make an appropriate assessment of the risk of a given DB plan. After all, it is not enough to know the net present value of plan assets and liabilities. One must also know about the stochastic properties of both the assets and the liabilities, the future funding behavior of the plan sponsor, the distribution of plan sponsor insolvency risk, and how these factors are correlated with the individual's marginal utility of income in future states of the world.
Of course, even if one accepts that most workers have inadequate information or suffer from bounded rationality, it does not necessarily follow that the solution is for the government to...