January 12, 2011
Individuals are generally risk-averse. This is why they buy items like life insurance and health insurance. On average, people pay more for these protections than they get in benefits. This means that they fear bad outcomes (e.g. early death or severe illness) and that they are willing to forgo income to protect against this situation.
The fact that individuals are risk averse explains why state and local governments can benefit by offering workers defined benefit pensions. Since governments generally do not go out of business, they can provide pensions that smooth out fluctuations in the market. This is of great value to individual workers, who do not want to take the risk that the stock market will be down at the point when they retire.
Therefore, state and local governments can offer workers defined benefit pensions that impose little risk, if properly managed. Since the guarantee is of considerable value to workers, it means that these governments will have to pay workers somewhat less than would otherwise be the case. Therefore a defined benefit pension should save state and local governments money.
Washington Post columnist Steven Pearlstein has apparently never learned this basic economics lesson, hence his diatribe in the paper today.
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