Sovereign Wealth Funds as a Model for Increasing Trust Fund Returns

By law, the Social Security Trust Fund (“Trust Fund”) is required to invest only in special issue US government bonds,1 which recently earned an annual nominal return of 4.6%.2 However, over the long term, the stock market has an annualized nominal return of around 7.9%.3 In contrast to the US approach, many countries have recognized that the stock market yields higher returns and have successfully used SWFs to diversify holdings out of bonds and partially into stocks to help prefund their social insurance programs. Some countries using This Article takes the view that the US should follow the lead of other countries and create an SWF to help prefund its social insurance obligations. Social Security is facing a funding crisis and the Trust Fund will be exhausted by 2036.5 Many reform proposals have been floated, yet most involve some sort of benefit cut or tax increase.6 In sharp contrast, investing the Trust Fund in equities could reduce the financing deficit by over thirty percent without increasing taxes or reducing benefits.7 President Bill Clinton backed the idea, as did long-time Social Security Commissioner Robert Ball.8

Despite the economic logic behind diversifying the Trust Fund, policymakers and politicians have not considered diversification in the most recent round of discussions on how to address the imminent funding crisis.9 One concern voiced is that market volatility could lead to lower returns during some periods of time and this might result in some generations having to pay higher taxes in order to fund benefits.10 Additionally, conservatives oppose the proposal on philosophical grounds, arguing that government investment is a form of socialism, which may result in political interference in private enterprise.11 This Article seeks to address whether the success of non-US SWFs will lend credibility to the diversification proposal. The Article uses the methodology of new institutionalism to discuss what forces might help create the political will necessary to adopt this policy proposal. Part I of this Article analyzes the political opposition to government investment of the Social Security Trust Fund. The focus is to define the philosophical and pragmatic reasons behind the opposition to the proposal. Part II discusses new institutionalism as it relates to government investment, in order to give a framework to analyze how certain political economies change and adapt. The next two Parts look at forces that may drive change in the U.S. political economy. Part III addresses the Social Security funding crisis and Part IV discusses the gradual adoption of government investment as a policy matter over the last thirty years. Part V addresses the historical development of SWFs as financial intermediaries and the changing perceptions over their role in global financial stability. Part VI discusses SWFs as a model for the U.S. Social Security Trust Fund.

One of the most promising long-term reforms for the Social Security funding crisis is the full funding model, whereby social insurance would be funded not only by tax contributions but also by investments made by the government in a diversified portfolio of stocks, bonds, and other assets.12 Despite the financial crisis of 2007–2009, economists agree that over time, a diversified portfolio will outperform a bond-only portfolio.13 The obstacle in advancing a full-funding model is not in the economic realities but in the norms of a neo-liberal political economy. funding mechanism.14 The opposition is rooted in political beliefs about the proper role of government in a market economy. The argument advanced is that, when the government participates as a shareholder in private enterprise, four distinct issues threaten to disrupt a market-based economy: (1) the government’s lack of expertise in managing assets will lead to waste; (2) political interference will result in a lack of wealth maximization; (3) the government will coercively interfere in corporate governance, thus affecting firm efficiency; and (4) it is impossible for the state to act as both a shareholder and a regulator, since those roles result in an inherent conflict of interest.15  The fears of conservatives about government investment came true when the US Treasury made several investments through the Troubled Asset Relief Program (“TARP”) under the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 during the financial crisis of 2007–2009.16 The Treasury paid more for assets than private investors, thereby lowering the eventual return on investment.17 Political influence was exerted in the investment decision, and the executive branch was actively involved in corporate governance.