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Further Thoughts on Whether or Not Social Security is Ponzi Scheme

Posted By Don Boudreaux On September 12, 2011 @ 10:48 am In Other People's Money,Social Security | Comments Disabled

Is Social Security a Ponzi scheme?  Celebrated scholars – left [1] and right [2] – have called it such, or at least alleged that it bears sufficient similarity to Ponzi schemes that the appellation is justly applied to Social Security.

But to call Social Security a Ponzi scheme is, of course, to draw an analogy between Social Security and private schemes of the sort that Charles Ponzi [3] made (in)famous.  Like all analogies, it’s not perfect.  What matters is the essence of the ‘thing’ (in this case, Social Security) that we’re trying to emphasize as being especially noteworthy and relevant.

At one extreme end, if the essence of a Ponzi scheme is that its chief salesman has a last name that begins in “p” and ends in “i,” then clearly Social Security isn’t a Ponzi scheme.  If, at the opposite end, the essence of a Ponzi scheme is that it is a device that people believe they can use to increase their wealth, then all investments are Ponzi schemes.

Clearly, the essence of a “Ponzi scheme” – as such schemes have come to be understood in common English in the modern world – lies somewhere in the middle of these two extremes.

What is that essence?  I submit the essence of a Ponzi scheme is

(1) its promise that contributions today to the scheme’s manager will pay off handsomely (that is, better than alternative investments) in the future to each contributor;

(2) that current contributions to the scheme are not invested but are spent – in particular, are spent to make good on promises made in the past to previous contributors who now expect their stream of pay-offs;

(3) that the manager of the scheme maintains his ability to pay the promised streams of pay-offs only by getting other contributors into the scheme, but

(4) the manager doesn’t let on to contributors (and would-be contributors) that the funds for paying off the promises come not from any profitable, productive investment of contributed funds – nor from any actuarially justified program for reallocating risks across persons or across time – but come, instead, simply from the hope that future contributors can be corralled into the system;

(5) that if future contributors do not arrive in sufficient numbers, the scheme has too little money on hand to pay off all promises;

(6) that the manager of the scheme, in short, successfully persuades his or her targets that the scheme is financially something that it really is not.

Note that I do not list “pyramiding” – a “pyramid scheme” – as being among the essential qualities of a Ponzi scheme.

On these points, Social Security strikes me (again, as it has struck even some of its illustrious champions) of having a great deal of Ponzi-ness about it.

…..

I dashed the above thoughts off rather quickly (as I’m occupied for much of the day with administrative work for GMU).  I’m prepared to add to, subtract from, and to modify the above list.

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URLs in this post:

[1] left: http://blog.scrivener.net/2005/02/beauty-of-social-security-by-paul.html

[2] right: http://www.hoover.org/publications/hoover-digest/article/7523

[3] Charles Ponzi: http://en.wikipedia.org/wiki/Charles_Ponzi

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