I am not sure that I understand your point. Index funds earn the market return (before fees) by definition. Actively-managed funds do not, but their fees are much higher. Even if actively-managed funds revealed a performance on average that barely justified their higher fees, they would still be unattractive to rational investors, since there would be greater risk with no increase in average reward.

My favourite example of the failure of financial markets is the prevalence of cash value (“whole life”) policies in the individual life insurance sector. I have some experience in this area, as long ago I was employed – for one year – as an actuarial trainee with a life insurance company.

There is no reason for anyone to purchase life insurance with a savings account attached, which describes a policy with “cash value”. According to the Life Insurance Marketing and Research Association (LIMRA), of all new premiums paid in 2012 for individual life insurance, 32% of expenditure was for “whole life” (WL) and 40% for its cousin “universal life” (UL). The remaining 28% of expenditure was for premiums on pure insurance (“term” policies) with no cash value.

For reasons that I do not understand, cash value policies are unknown for other types of insurance, such as automobile, health care, flood, earthquake, fire or theft.

Cash value policies are known to be a bad deal because of their high, front-loaded fees. The consumer would be better off purchasing term insurance, then purchasing bonds (or certificates of deposit) with the difference. Why, then, are so many cash value policies sold? Because they are sold by life insurance salesmen, who receive vastly larger commissions (total, and as a % of premiums) on cash value plans than they do on pure insurance. In contrast, term policies are the norm for group life insurance.

Full access to LIMRA statistics requires membership, or payment of an access fee. The information that I cited is ungated, from LIMRA, “Individual Life Insurance Sales Improve For Third Consecutive Year“, 7 March 2013.

See also Leslie Scism, “Weekend Investor: Life Policies: The Whole Truth“, Wall Street Journal, 8 June 2012.

Looking at the share markets in the broad, if we assume for a moment that all the equity managers are the market then, overall, the ‘before fees and other expenses’ returns from all the managers together will be about the market return. Taking fees and expenses into account, all the managers together will deliver less than the market. So, that is our starting point. Index managers have typically much lower fees and very few expenses so, if the before-fees return is the market, as we should expect, the after-fees return will be slightly less.

Having decided to be ‘active’, now comes the task of picking which manager will consistently achieve a return of ‘market + fees’. All the evidence over decades suggests that managers cannot consistently do better than the market, never mind the ‘market + fees’ index so the investor can expect, over longer periods to earn, on average, less than ‘market+ fees’ all the while enduring the uncertainties associated with doing worse than that.

Dr. Larry Willmore’s various papers and discussion has contributed insight and experience to the Hong Kong government throughout the whole process of securing a Universal Pension for retirees in Hong Kong; his presentation at the Legislative Council there, November 2011, stimulated a critical analysis inside and outside of the government on related issues. Thank you, Larry.

Your TdJ post on what Jimmy Wales says about boring University lecturers was echoed many years ago by this college professor who did a lot of experiments with children educating themselves with only a computer and no teachers. The results were extraordinary and have by now been duplicated in many countries around the world. Take a look at the You Tube TED talks video at the URL below.

http://www.youtube.com/watch?v=HE5GX3U3BYQ

Interesting thoughts. Falsifiability is, as you know, a solution to the problem of induction. However, as you quite rightly point out, much of economic theory consists of deductive reasoning. Hence falsifiability only gets us so far in terms of distinguishing between good and bad econ theories. That’s perhaps why methodological individualism has had such a good run – it’s a way of distinguishing between good and bad *deductive* explanations.

But I have two questions.

First, how do we distinguish the able-bodied poor from those who are not able-bodied? This would require another test in addition to (instead of?) income and wealth. I suggest “instead of” since we agree that income and wealth tests have very bad effects on incentives for work and saving.

Would you restrict SSI benefits to those who are totally blind or paralyzed? If not, what degree of physical incapacity should qualify an applicant, and how can we measure it?

Second, how can we determine on what goods and services taxpayer money is spent? The Detroit woman in our example could argue, with conviction, that she was purchasing marijuana with her own earnings, and using her tiny SSI pension only to purchase basic necessities.

Mexico City provides all residents from age 68 with a universal pension equal to 15 days of minimum wages each month. The pension is credited to a debit card that is in the possession of each pensioner. The card can be used at any of several supermarket chains, but only to purchase food and health care products. Purchase of tobacco products and alcoholic beverages is blocked. This makes taxpayers feel good, because government money is not used for purchase of unnecessary or harmful products. Since money is fungible, taxpayers of Mexico City are undoubtedly supporting vices, despite the attempt to prevent this. Using a debit card to purchase food allows a pensioner to purchase cigaretes and rum with cash that would otherwise have been needed for food and toiletries.

Let me mention I should have put forward ‘a limine’ my concern is not so much with the technical questions surrounding means tests as the implicit assumptions underlying discussions of this subject. I accept that means tests have all sorts of unhelpful disincentives to work and save and alluded to this in my comment. Let me also say my comments on income transfers were directed at able-bodied beneficiaries and not the elderly poor and disabled who I believe are ill served by the present system. Perhaps I should have been more explicit about the context of my comment.

I also mention I do not have any problem with a welfare beneficiary having a “rainy day fund” of $2000. Depending on individual circumstances this might be prudent. My comment in this regard should been seen as directed at those beneficiaries with a large capital account well beyond their current needs and/or those who use income transfers to further accumulate wealth.

Of course it is impossible to help poor people without transferring income to them. My comment here is not about the process but the purpose. My concern is the unstated assumption that a transfer to the poor is treated as manna from heaven with no effect on the average taxpayer providing the transfer. Of course it has. Money transferred to welfare recipients and used for consumption beyond their basic needs (trips to Disneyland and the like are not unknown) or to maintain and augment wealth positions will have been taken from people who could have better purposes for the money they paid in taxes than the able-bodied poor.

While it may be true taxes are paid predominantly by those who are more wealthy, it is also a meaningless statement as a matter of public policy or even basic morality. Average and even below average income households also pay taxes and are in effect transferring part of their income to the poor and to them the transfer is not insignificant. It may well be that a taxpayer is in the top 5 to 10 per cent of income earners. At the same time even the rich may well have heavy expenses important to their families such as tuition for their children, a need to accumulate saving to buy a house or a million other good reasons the tax they pay negatively affects their welfare. The blanket statement that “the rich can afford it” is nonsense both because not only the rich pay the tax and because taxes on the rich may have high opportunity costs to their households.

To clarify the point about transferring income: On the policy level there is a difference between a transfer intended to provide generalized purchasing power to the poor for any purpose and a transfer intended to provide a poor recipient with some minimal but socially acceptable level of living. In the first case, which we might refer to as “an unrestrained transfer of income”, saving — even using the grant for a trip to Disneyland — is allowed as a matter of policy because what is being transferred in generalized purchasing power for recipients to use as they wish. The second case, which we might refer to as “a transfer of resources in support of an adequate level of consumption”, would restrict how the transferred income is utilized because the purpose of the transfer is targeted and paying taxes has real opportunity costs to all taxpayers, and the tax burden should therefore be minimized.

Discussions of means tests in the academic literature presume an unrestrained transfer of money income. I suggest policy regarding support for the poor was originally intended to provide an adequate level of consumption and should be analyzed as a restrained claim on the taxpayer. In this case the question of the effects of means testing is secondary to what the level of the transfer should be and minimizing its cost to the taxpayer. Moreover, since income transfers are not financed by manna from heaven any discussion of means testing should address possible effects on the average taxpayer. As I mentioned in closing my comment, economics is about tradeoffs and scarce resources. There was no discussion of tradeoffs between the recipient and the taxpayer in the Tdj. On wealth means tests, one might well ask: Why should the average taxpayer reduce their consumption and saving so that a welfare recipient could maintain or augment their capital account? As a policy matter this is the question that should be answered.

Finally, I mention I have no comment on the example. How SSI or any other program is implemented and managed is beyond the scope of my comment. How much the poor should receive and how to deal with the complications of a terrible welfare system are beyond my comment and indeed the Tdj itself. I readily acknowledge the present system leaves many poor people in a condition of genuine want, the many programs now in place have perverse incentive effects, and efforts should be made to reform it. But these are questions of personal opinion and issues of politics to be weighed by legislative bodies. I make no comment on them here.

But SSI and other benefits are not intended to transfer income. Their purpose is to provide some minimal level of living that society deems adequate. In the example given below the woman had a part-time low wage job which, when SSI was added, provided her with current purchasing power above what she must have regarded as an adequate level of consumption. So, rationally, she could have saved the extra income or in this case seemingly irrationally spent it on marijuana. Her SSI should have been lowered to match her own evaluation of her consumption needs.

Now, the question before society is why would you want to reduce the level of consumption and potential saving of the average taxpayer so that someone like this woman, who by her very actions must be satisfied with her level of income, could save more and further build up her capital account? This policy in effect lowers the average taxpayer’s welfare so as to increase or maintain the capital account of people on the dole. Frankly, I have no idea why public policy would want to do this.

The same may be said for wealth means-testing. If people have saving in the bank why should others be asked to reduce their consumption and potential wealth to preserve the existing wealth of someone else? It’s not fair to the average taxpayer. Let people draw down on their wealth until they are truly in need.

Now if people receiving an grant want to work and are discouraged from doing so by the disincentive effects of taxation that is certainly unfortunate. But the bigger question is why the average taxpayer should continue to suffer cuts in their welfare when the level of living of the beneficiary rises above the standard society has determined as an adequate minimum.

To me, the entire discussion is premised on a false assumption: That the purpose of the transfers of the welfare state is to transfer income. No, it is not. Its purpose is to provide some minimum level of living, that is, some minimal basket of consumption goods for everyone who cannot provide it for themselves. Note: “Cannot provide for themselves”. Given its costs to the taxpayer, these transfers are not intended to preserve the wealth of the poor, who after all have the resources to purchase consumption goods on the own. Nor is it intended to supplement the resources a person has above the level determined as adequate to the rest of society.

Seen in light of the real purpose of support for the poor little in the comments made in the Tdj make sense.

Let me also note that the discussion says not one word about the costs to others of income support policies. Economics is about tradeoffs and scarce resources. There is no discussion of tradeoffs in this Tdj. In this sense, it is an incomplete discussion.