By Edmund L. Andrews
New York Times
WASHINGTON, March 30 - In barnstorming the country over Social Security, administration officials predict that American economic growth will slow to an anemic rate of 1.9 percent as baby boomers reach retirement.
Yet as they extol the rewards of letting people invest some of their payroll taxes in personal retirement accounts, President Bush and his allies assume that stock returns will be almost as high as ever, about 6.5 percent a year after inflation.
"For the life of me, I can't imagine why anybody would argue against young workers having the ability to invest and build a better retirement for their future," Treasury Secretary John W. Snow said Wednesday in a speech in Bozeman, Mont.
A growing number of economists, however, including many who favor personal accounts, say Mr. Bush's assumptions are optimistic.
Many believe that stock returns will be lower than they have been in the past, closer to 5 percent than 6.5 percent, and that returns on a balanced mix of stocks and bonds will be much lower than that.
"Most economists would argue that, over a long period of time, there is a linkage between what the stock market will return and how well the economy does," said David Blitzer, chairman of the Standard & Poor's index committee, which oversees the S.&P. 500 stock index.
The statistical battle is politically important. If investment returns are just one percentage point lower each year than predicted, a person would end up with 35 percent less money than she expected after 30 years of saving.
Under Mr. Bush's plan, moreover, people would need to earn at least 3 percent a year after inflation just to make up for automatic cuts in traditional Social Security benefits.
In a paper to be presented on Thursday at the Brookings Institution, three economists who are longtime critics of Mr. Bush argue that stock returns are likely to be about 4.5 percent if economic growth slows as much as the administration predicts.
"We find it arithmetically very difficult to construct scenarios in which asset returns are at their historic average values and real G.D.P. growth is markedly slowed," wrote the economists, Paul Krugman of Princeton University, whose Op-Ed columns in The New York Times have long been sharply critical of Mr. Bush's plan; J. Bradford DeLong of the University of California, Berkeley; and Dean Baker of the Center for Economic Policy and Research, a liberal research organization in Washington.
To make the numbers work, the economists contended in their paper, domestic profits would have to grow far more rapidly than they have in the past, or American companies would have to become huge exporters of capital to faster-growing countries. At the moment, the United States is a huge net importer of foreign capital.
Administration officials and many independent analysts disagree, saying the link between overall economic growth and investment returns is weak.
But many Wall Street analysts warn that stock returns are likely to be significantly lower in the future for a separate reason: stock valuations are high relative to expected earnings, and they are likely to remain that way.
The S.&P. 500 index is currently valued at about 20 times earnings, which translates to an expected return of about 5 percent a year. The historical average is about 15 times earnings, or an expected return of more than 7 percent.
William C. Dudley, chief United States economist at Goldman Sachs, estimates that stock returns are likely to be about 5 percent in the future, because investors are accepting lower "risk premiums."
Other experts agree. "My view is that stocks really can't deliver the same returns in the future as in the past, unless we have a major decline in stock prices," said John Y. Campbell, a professor of economics at Harvard University and an adviser to the Social Security trustees on the issue in 2001. "But what we see is valuations bouncing around 20 times earnings, which is higher than historical levels."
Two recent computer simulations, one by Robert J. Shiller at Yale University and one by the Congressional Budget Office, suggest that even historical stock returns are no guarantee against losing money.
Under Mr. Bush's plan, workers would be allowed to divert up to 4 percent of their payroll taxes to personal retirement accounts. But people would have to earn at least 3 percent a year after inflation to break even, because their traditional benefits would be reduced by the amount of their contributions, plus 3 percent a year in interest.
To protect people from stock market volatility, the government would also offer a "life cycle" investment account that would gradually reduce the share of stocks relative to conservative Treasury bonds as they neared retirement.
Mr. Shiller, using financial data going back to 1871, found that people who enrolled in life-cycle accounts would have lost money 32 percent of the time. The median annual return was 3.4 percent, barely above the break-even point in Mr. Bush's plan.
The results highlighted the inherent trade-off: higher returns come with higher risks.
The Congressional Budget Office recently ran similar computer simulations. Analysts there took historical stock returns and average volatilities and simulated stock returns for thousands of artificial 20-year periods. The result was that stocks earned less than Treasury bonds about 20 percent of the time.
Stephen Goss, chief actuary for the Social Security program, defended the administration's assumptions.
"Keep in mind that we are trying to make projections over a very long time, 75 years," Mr. Goss said. "I would suggest that 5 percent at the moment makes perfect sense. But if you buy at another time, when the price-earnings ratio is 10, you would expect a higher return over time."
Many experts agree that slower economic growth in the United States does not mean lower rates of return. Confronted with lower demand in the United States, companies can spend less money on expansion and more on dividends. Or they can invest more heavily in countries with faster-growing populations.
"Growth might slow in developed countries, but it's not clear to me that world growth is going to slow down at all," said Jeremy J. Siegel, a professor at the Wharton School of the University of Pennsylvania and a leading analyst of long-term stock trends. "I think world growth will go up."
But White House officials may be revising their assumptions. N. Gregory Mankiw, who recently stepped down as chairman of the Council of Economic Advisers, said Mr. Bush's proposed break-even rate of 3 percent on personal accounts may be too high. The yield on inflation-protected Treasury bonds is about 2 percent.
White House officials say they are open to proposals for changing the break-even point, which would raise the plan's cost, but Democratic lawmakers remain fundamentally opposed to Mr. Bush's plans.
"The basic arguments are over the extent to which people ought to be given more freedom over their risk and return choices," Mr. Mankiw said. "Returns on the stock market may affect the choice people make, but the question of whether they should be given a choice is broader than the issue of returns."