Deep discount
A few weeks ago I mentioned a book called Discounting the Future by Liliana Doganova. I was chatting with a friend who’s a historian of engineering (he’s writing a dissertation about the history of a big bridge in Portugal and how it was financed), and he asked me if I knew about any good books on finance and time, the future, temporality, etc. I thought immediately of Doganova’s book and asked my friend if he wanted to read it with me. He said yes and we did a little reading group.
I’d been interested in the book because, when I was sifting through teacher pension finance policies trying to understand it all, I found that so much about pension contribution costs come from calculation through a discount rate. I sort of understood what that meant, but not really.
What I knew was that discounting allowed pension managers to decide how much revenue they need now based on the value of their pension fund over time, including the future value of that fund, relative to the benefits the fund has to pay out to retirees over long stretches of time.
A discount rate is about value. One way to know the value of something is to think about what it’s going to be worth over time. If you want to know the value of something right now, you can speculate through different assumptions about what it’ll worth in the future, which tells you how valuable it is now.
If you think it’s not that valuable in the future, you’re discounting the future, literally you’re not counting the thing as having that much value in the future (and thus sort of not caring as much about the future). If you think the thing isn’t valuable now, but will be in the future, you’re discounting the present, because, again, you’re not counting the value of it as much in the present (and thus sort of not caring as much about the present). A discount rate is a percentage representing this assumption. It’s like an interest rate in reverse.
In a previous post, I used the film Interstellar as an allegory here, specifically the part where a couple astronauts go down from a spaceship onto a planet who’s gravity is such that time passes very differently for the people left on the spaceship. For every minute they’re on the planet, a year passed for the astronaut back on board the ship. They went down, did what they had to do in what felt to them like a few minutes, but by the time they got back to the ship their comrade had waited 23 years for them to return. (Also, as Doganova says, Kim Stanley Robinson’s The Ministry of the Future is based on this kind of insight.)
You have to operate in that kind of temporally-projected/specular mode of thinking when it comes to discount rates.
Pension managers have to do it too. Their job is to pay out defined benefits to their retirees. When a teacher retires, they get a percentage of their yearly salary every year as income. The pension has to pay that out. There are teachers retiring now who need their benefits, but there are teachers who will retire in five years, ten years, twenty years, thirty years, etc. How should the managers make sure they can pay out those benefits in the future based on what their pension fund has right now?
The big insight here is that pension contributions—which are actually causing districts big fiscal headaches right now—are calculated using something called an “assumed rate of return” which Equable, a nonprofit outlet that focuses on public pensions, defines helpfully:
Assumed rate of return is the single most important assumption that pension systems make to ensure they have enough funding to pay benefits promised.
To determine the amount of required contributions, a pension fund and its actuaries make educated guesses about how much they think they can earn by investing those contributions. That educated guess is called the assumed rate of return.
The higher the assumed rate of return, the fewer contributions teachers and their employers have to make. The lower it is, the higher contributions need to be in order to pay for the benefits promised.
I love this definition for several reasons. First, it makes the explicit connection between the discount rate and the contribution cost. The cost of pensions doesn’t come from nowhere. It’s not an immutable thing that just exists out there in nature that we can’t do anything about. We change it.
Second, the definition even further underscores that contingency with its language of the “educated guess.” Not only can you mess with discount rates, the people that set these rates are just guessing!
Third, the definition makes plain that these educated guesses are typically made from a distinct perspective: that of the investor. Even though teacher pensions serve educators, it’s not the educator’s perspective with which such decisions are made. It’s a kind of mythical ‘investor’ who’s only interested in the highest possible returns under different scenarios.
I mention all this because when I read Doganova’s book Discounting the Future it brilliantly unpacks all the history, sociology, economics, and politics of discounting, which, it turns out, is at the heart of financial capitalism (not just teacher pensions).
I can’t do justice to the book here in terms of a full review. I recommend you read it, full stop. But what I want to do here is lay out what I see as some of the most interesting parts of the book for teacher pensions and school finance generally.
1. Financialization
Doganova says that Irving Fisher came up with the basic concept of discounting as a definition of value in the early 1900s and she traces its history in capitalism as one way to understand what people mean when they talk about financialization. When discounting, as valuing over time, became all about returns to the investor—and the investor only, rather than the public—that’s what she calls financialization.
2.The Stern Review
She opens the book by talking about the Stern Review, which is when an economist proposed that, to properly account for climate catastrophe in contemporary economics, we should drop the discount rate to zero. This created a big kerfuffle in economics. Read about it! This sort of grounds my thinking about playing with discount rates for teacher pensions.
3.What Allende did
In the 1970s, when socialist Salvadore Allende came to power in Chile, one thing that his administration did was nationalize the copper mines, one of the biggest sources of income for the country’s economy. But what does nationalize mean exactly? The state took over control of the mines from private companies, expropriating the value of the mines. And how did they calculate the value of the mines, to figure out what, if anything, they owed the companies? They specifically didn’t use discounting at all—they didn’t talk about the future productivity at all. The socialists rejected this whole concept. Instead, they talked about past productivity, measuring value in historical outputs, and found that the companies owed them! Amazing. This reminds me of the economics of the Yasuni-ITT initiative in Ecuador’s government in early 2000s, which was one of my first analyses of creatively leftist economics. These also ground my thinking about teacher pension discount rate policy.
To wrap up, you should go read Doganova’s book. I’ve been singing its praises because it’s a wonderful, in-depth, and critical look at finance that has pretty immediate applications for today’s school finance struggles. For instance, I have to imagine all kinds of stuff in school bonds are calculated using discount rates, like yields, interest payments, coupons, and other magnitudes that you have to speculate about changing over time from the point of view of the present.
As a kicker, I wrote to Doganova to ask her about the situation in Chicago and how to advise officials there, and we had a nice correspondence about it. I think more people should engage with her work!