The union plan for worker retirement.

Workers Need Pensions, Not Lottery Tickets

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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American public pension funds are a disaster. That's not news to anyone who reads this blog -- they have, on average, just 67 cents for every dollar they owe to future pensioners. This is noted in a recent New York Times article, which compares our shambles with the sensible Dutch system of funding pensions very conservatively. Most of the funding is taken from workers, who save almost 20 percent of their salaries into the pension system. As a result, companies are not dunned for huge sums every time the market crashes, or tempted to terminate their pension plans in order to get rid of a growing liability.

Regardless of who should pay the bill, this article left me with a lingering question: how come the left, and particularly labor groups, haven't supported Netherlands-style reforms? Instead, they're usually among the most vocal opponents of better funding, which they call a plot to destroy public sector pensions. The labor movement is supposed to help safeguard workers' interests. Instead, for decades, they have allowed these pension funds to be disgracefully underfunded. In Detroit, the union has called for a return to the lunatic "13th check" bonuses that left Detroit pensions in such parlous condition.

When pension funds collapse, the effect on retirees can be disastrous. Why would organizations established to look out for worker interests allow -- indeed, encourage -- governments to underfund?

We could look to the classic "principal agent problem" for an explanation: In theory, union leaders are there to protect workers; in practice, their interests are not exactly the same as those of the workers. The workers want the biggest possible future pension checks; the union leadership wants to keep their jobs. They probably achieve that end best by promising bigger future checks, and letting their successors deal with the fallout.

But there's another way to understand the behavior of union officials: That is, they are engaged in a high-stakes gamble because they think the expected value of gambling is higher for the workers than a safely funded pension.

For these pensions to be fully funded, one of two things would have to happen: Workers would have to pay more out of their paychecks, or taxpayers would have to cough up a bunch of extra cash. Taxpayers might chafe at this. They might even pass referenda capping the value of taxpayer contributions, or elect politicians who promised to reduce the pension cost. Worker pensions would be much safer -- but they would also be much smaller.

By lowballing the pension commitments, union officials get a promise of bigger future payments. And since shedding pension obligations is difficult, in many cases these benefits will be paid, albeit at potentially ruinous cost to the taxpayer.

What's not to like about this strategy? Well, there's the sizeable risk that the pension will go to zero, as happened in Prichard, Alabama, or at least, that it will be reduced substantially, as state and local governments hit the limits of their taxing power, and must choose between paying pensions, or providing services to everyone else.

People who worked 30 years with the expectation of a comfortable retirement will suddenly find themselves with much smaller checks than they counted on. By then, it will be too late for those people to do the extra saving that could have kept them in groceries and bingo nights. And since state pensions are not covered by federal pension insurance, and some state workers opt out of Social Security, pensioners risk ending up in the kind of poverty that has been mostly eliminated among the elderly in America.

Labor's advocates seem to be counting on political and legal resistance to make that impossible (state pension benefits are often enshrined in the constitution, making them extraordinarily difficult to cut). That's not a crazy bet. But if pensions start seriously encroaching on the services available to everyone else, or forcing the government to slap double-digit tax hikes on every citizen ... well, laws can change, and constitutions be amended.

When resources are scarce, people are often tempted to gamble -- but this is often the worst possible time to go for broke. If labor leaders and left-wing activists really want to protect worker interests, they should advocate for better pension funding, even if that means smaller pension promises. Otherwise, they're not giving workers a pension; they're giving them a lottery ticket.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor on this story:
James Gibney at jgibney5@bloomberg.net