Recently, I was thinking about a question you may have asked: whether it is more fuel efficient to cool a car during a drive by running its air conditioner or by rolling its windows down and leaving the air conditioner off. The answer, just like many things in life, isn’t a simple one. It depends on the car’s speed and its design: the faster you’re driving, or the more aerodynamic your car, the better off you are rolling up the windows and using the air conditioner.
At ICI, we are often asked questions about complex topics that don’t have simple answers. President Harry Truman’s famous quip about wanting a “one-handed” economist (“All my economists say, ‘On the one hand…on the other hand’”) sometimes crosses my mind. And yet, Truman’s two-handed economists were doing their jobs when answering questions about complex topics.
We live in a complicated world. Although we strive for one-handed answers when possible, it’s not always what our world allows. Sometimes simple answers can be fundamentally wrong and lead to public policies that can do more harm than good.
At ICI, we are fortunate to work for an organization whose members support careful, comprehensive, evidence-based analysis of complex public policy issues.
This winter, ICI published a book authored by one of my colleagues, Peter Brady. How America Supports Retirement tackles a complex topic through substantive, painstaking work. Peter challenges the conventional wisdom about who benefits from tax deferral and Social Security, two mechanisms that the federal government uses to help Americans prepare for retirement. As he points out, the combined effect of these two programs is poorly understood, leading to the false notion of an “upside-down” retirement system that benefits only the wealthy.
Discussions of retirement policy often ignore the substantial benefits that Social Security provides to households with low and moderate lifetime incomes. These discussions also focus on the reduction in taxes from tax deferral while ignoring the higher taxes workers will pay in retirement when they draw down their savings or receive income from a defined benefit plan. Peter’s innovative work illustrates that “evaluated as a whole, the U.S. retirement system is progressive,” with lifetime benefits proportionately higher for workers with lower lifetime earnings.
Why is this holistic approach important? Because “who benefits from the retirement system?” is a complex question, and simple answers can lead to harmful policies. As Peter explains, recent tax proposals could actually make the system less fair. For example, several prominent proposals would further limit employee contributions to retirement plans or change the tax treatment of these contributions. Such changes would disadvantage private-sector workers—who rely more on defined contribution plans than do public-sector workers—as well as workers who save on their own in an IRA or whose employers do not make contributions to their retirement plans.
In another line of substantive ICI research, my colleague Shelly Antoniewicz has shown that the risks of using derivatives are often misunderstood. As she points out, one common misperception is that “funds that use derivatives are leveraged, and therefore are riskier than funds that don’t use derivatives.” But a fund’s use of derivatives does not necessarily translate into leverage. Leverage is a measure of how a fund increases or amplifies the gains or losses that its shareholders are exposed to. As Shelly concludes, a fund that makes greater use of derivatives may be “more risky, less risky, or equally risky as a fund that has no exposure to derivatives.”
In addition, derivatives have many benefits for funds and their investors, including hedging risk, enhancing liquidity, managing cash, or gaining or reducing exposure to certain markets or asset classes. Such activities may be more difficult, or costly, or even impossible to execute with direct holdings of securities alone. Therefore, a fund’s total exposure to derivatives does not provide a very useful measure of its risks. Indeed, such a simple measure of risk could lead policymakers, regulators, and investors astray.
These two examples of ICI analysis are good reminders that in a complex world, simple answers don’t always work. At times the dialogue may frustrate policymakers who want a quick and simple solution, but an informed conversation among legislators, regulators, and stakeholders is necessary to understand the nuances and intricacies of a problem and its solutions. It is our job as economists to use our comprehensive analysis to find answers to questions and to help avoid harmful outcomes.
The 56th Investment Company Fact Book is yet another ICI contribution to a discussion that leads to better public policies that affect funds, their investors, and financial markets. I hope that it helps you in your quest to find comprehensive, evidence-based analysis to address today’s vexing policy questions. Thank you for your continued interest in our research and publications.