Economic Trends
Edited by Peter Coy
Social Security: The Long View
Each year, the actuaries of the Social Security Administration predict Social Security's financing needs for the following 75 years. In addition to their base-case scenario, they offer an optimistic projection and a pessimistic one, using different assumptions about fertility, longevity, economic growth, and other factors. The latest pessimistic forecast shows the Social Security Trust Funds running out of money in 2027, compared with a 2038 exhaustion date for the base case.
Is the Social Security Administration's pessimistic case pessimistic enough? No, says a new study by Ronald D. Lee and Ryan D. Edwards, both of whom are demographers and economists at the University of California at Berkeley. Unlike Social Security's actuaries, Lee and Edwards estimate the probability of every possible level for each relevant factor. Then they combine those to create a range of probabilities for the outcomes of interest.
They found that the chance of a really bad outcome is much higher than commonly expected. In the Social Security actuaries' pessimistic projection, the old-age dependency ratio--the ratio of elderly to working-age people in the population--reaches 56 per 100 in 2075. Lee and Edwards calculate there's almost a 25% chance the dependency ratio could go even higher than that. Indeed, they estimate there is a 2.5% chance that the dependency ratio could reach a crushing 82 per 100 or higher, if longevity rises and fertility falls over time. A higher ratio means the Trust Funds run out of money sooner, since there are fewer workers supporting each retiree.
To be sure, Lee and Edwards also differ with the Social Security actuaries on the other end of the scale. They calculate that there's a chance the dependency ratio could be slightly lower than in the actuaries' optimistic projection. Nevertheless, the relatively high probability of a bad outcome suggests politicians may have to deal with Social Security reform sooner than they now realize.
Debating Decimalization
The New York Stock Exchange converted to quoting prices in increments of pennies instead of eighths or sixteenths of dollars on Jan. 29, 2001. The Nasdaq followed suit in April. Most analysts agree that small investors have benefited from decimalization. Because of a narrowing in the spread between the highest bids and the lowest offers, the little guys can pay less when they buy stocks and fetch more when they sell them. However, big money managers complain that the narrow spreads don't help them. They say the volume of shares that can be bought or sold at the best prices is too small for their needs--partly because some big traders have been driven away by the narrower spreads.
A new study by Plexus Group Inc., a Los Angeles firm that advises big money managers, suggests another reason for the managers' problems. The study confirms trading costs for large stock orders did go up on the NYSE after decimalization, from $38 per $10,000 of order value in the third quarter of 2000 to $67 per $10,000 in the second quarter of 2001 (table). Mark Edwards, a Plexus managing director who wrote the study, says that may be happening because money managers haven't yet gotten the hang of trading in a decimalized world.
Edwards says traders may be unwittingly raising their trading costs by trying too hard to disguise their orders. Often, a big buy order will drive the price up or a big sell order will drive the price down. Worried that decimalization has made matters worse, traders have been dribbling out trades a little at a time. But slowing down the execution of trades can be costly for large institutional traders when they try to pile into rising stocks and dump falling ones. Plexus Group calculates that for orders of 250,000 shares or more on the NYSE, the cost of execution delays rose from an average of $9 per $10,000 of order value in the third quarter of 2000 to $40 per $10,000 in the second quarter of 2001. The delay cost is the loss when a stock price moves against a trader while the trader is waiting to place a trade.
Moreover, Edwards argues that dribbling out trades didn't even work, because other market participants realized what they were up to. Says Edwards: "If you're an elephant, you can't hide in the strawberries."
How Trading Costs Rose for Big Investors
COSTS OF EXECUTING ORDERS OVER 250,000 SHARES ON NYSE
DOLLARS PER $10,000 OF ORDER VALUE
3RD QTR. 2ND QTR.
COST 2000 2001
DELAYS IN EXECUTION 9 40
MARKET IMPACT OF TRADES 19 15
COMMISSIONS 10 12
TOTAL 38 67
Data: Plexus Group Inc.
The Economy's Bonus Setback
Since the last recession in 1990-91, the number of U.S. workers whose pay is tied to company performance has soared. With profits in the tank, many economists think bonuses will be way off--slamming personal income.
WorldatWork, a Scottsdale (Ariz.) association that tracks employee compensation, estimates that 77% of hourly employees receive profit-sharing payments or bonuses, up from 52% in 1997. The percentage of salaried workers receiving such pay has also reached 77%, from 60% in 1997.
Morgan Stanley Dean Witter & Co. economist Stephen S. Roach predicts that with aftertax corporate profits estimated to fall 21% in the fourth quarter of 2001 from a year earlier, variable pay will plummet. As a result, he predicts consumption will fall 1% in the first quarter of 2002, vs. the 0.3% decline estimated by economists polled by Blue Chip Economic Indicators.
There are certainly forces supporting the consumer, including lower oil prices, lower interest rates, and the rebound of the stock market. But the loss of pay combined with the growing level of layoffs will do more to undermine consumer spending, Roach argues. "At the end of the day, it's income stability that matters," he says.
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Copyright 2002 , by The McGraw-Hill Companies Inc. All rights reserved.
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