Ok my headline is a little dramatic, but the point is that former Fed chair Alan Greenspan is making the rounds in the media to discuss how he is worried about the long term growth prospects in the US.
At the heart of his argument is demographics. For a number of years from the late 90’s into the mid 2000’s the US bucked the trend of the rest of the rich world by seeing its population grow, albeit slowly, as opposed to places like much of Europe and Japan which were seeing their populations fall.
There are a number of causes to this which I discussed last year here but what is important to know is that, throughout the world, as countries tend to get richer, they also tend to make very different decisions when it comes to family planning. Most importantly women, when wealthier, in better health and better educated, tend to have less children.
If the replacement rate of the population is 2.1 children per woman (since men can’t reproduce, they need women to produce just over two children each to replace the current population), much of the rich world has experienced declining populations due to the fact that birth rates are well below this figure. The US has now joined this club, especially since the Great Recession. Covid just accelerated this trend downward to a point where the native US population, of all races and demographics, is now reproducing at a rate lower than replacement.
This in itself isn’t so bad per se, births per woman falling also means that investment per child increases. Modern economies require incredible investments in children: decades of school and then university or a skilled trade. The issue that Greenspan is pointing to is how the ratio of those working to those idle changes over time and affects, saving, capital spending and growth.
Source of Growth
A number of different factors can drive GDP growth in an economy but two factors play an in important part which are relevant to this discussion. The first is the growth in the overall labor supply: more people producing more goods and services. When the working age population is expected to increase this is called the demographic dividend.
The other is the output per worker per hour worked. This is the so called labor productivity. This figure is affected by the amount of investment through saving in the economy and this is where Greenspan is worried that demographics as well as entitlements are affecting the level of investment that push this figure up to compensate for slowing or flat growth in the overall labor supply.
Working age people tend to save, for future near term expenses and more importantly, for retirement. This savings gets turned into investment through our pensions, 401(k)‘s etc that then lend this on to companies who in turn invest a portion of this back in workers. However, if an increasing share of the population is not saving but rather surviving off entitlements such as Medicaid and social security, then the effect of paying out to these folks from those who work, tends to crowd out private savings when looked at in an aggregate basis. Social security and Medicare are expenses taxed from workers and then spent immediately by retirees, this is why economists call these entitlements transfers and not savings.
Politicians tend to fix these promises to pay to current workers, who then expect those benefits to be paid out many years down the line and not change. When the proportion of people working to people retired is high, like it was 50 years ago in the US, then this is an easy promise to make. As the retired population increases relative to the working one though, this dynamic shifts and the past spending promises get realized, taking up an ever bigger portion of all government spending. This is best illustrated by the breakdown of the US federal budget over time.
Entitlement benefits now make up half of the federal budget. What you see the politicians fighting about on TV is the discretionary budget which is essentially within that “other” category. Both sides of the aisle have been ignoring the elephant in the room, which is what Greenspan is referring to.
Another way to see how demographics is driving this increase in benefits spending is the old age dependency ratio. This is the ratio of retired people to working age population. This number is normally multiplied by 100 to track it. As it rises, more retirees are dependent on ever fewer workers and you can see it projected to grow in the coming years in the US.
What Can be Done
The demographic trend is pretty predictable. The retired age population is expected to grow at a rate greater than 10% in the US for the coming years and academics have studied the results of this trend in other rich economies where it has already happened.
These large increases have been shown to produce a drag on economic and productivity growth which we are experiencing now and can likely expect for the coming years.
The only factor that could disrupt this would be significant immigration of working age people from other countries, something that does not seem to be very politically viable given the current climate.
Barring this factor, we can expect to see weak economic growth due to a slow growth in labor supply as well as a drop in investment spending which can boost productivity. As increased current entitlements crowd out private savings and investment even more, they will eventually reach a tipping point without significant reform.
As the fiscal burden of paying ever more retirees increases and growth weakens even more, we may start to see the realization of what Greenspan is advocating for: an increase in the standard retirement age in the US, similar to what other European countries have had to grapple with in the past decade.
This is the option of least resistance for reducing the cost of current benefits because cutting them outright is almost unthinkable. Look for discussions to start to materialize in the coming years about increasing the retirement age to 67 or 68 and encouraging workers to stay in the workforce for a few more years to be able to have access to their retirement benefits.
In fact, there is some speculation that growth in the retired population is what is contributing to the political polarization in some parts of the country now. On a regional basis, some parts of the US such as in the Midwest, are already seeing the population of retirees increasing at rates greater than 10%, which in turn can sap regional growth and lead to regional stagnation. This is exacerbated by the exodus of younger workers to knowledge hubs like New York and San Francisco which hold they keys to higher paying jobs.
Remember that dependency ratio? Take a look at the below maps which track the change in dependency ratio by country from 2010 to 2019 and you will see that stagnation may be taking hold in many of the places that are becoming strongholds of populism.
Not an Easy Sell
It’s not that people like Greenspan are heartless in the sense that they want to take away social security or essentially reduce social security for a portion of the population but their argument for these policy changes rests on an argument for the greater good, that some of us will have to make some sacrifices to make sure that younger people have an opportunity to grow up and earn in an economy offering opportunity similar to those who are about to retire.
Yet, as is often the case with technocrats and eggheads, burying yourself in the data can ignore the human element to cuts like this. Many people do not save for retirement or are very underprepared for the expenses needed in retirement. This leads to outcomes which include working longer and even shortening lives if they cannot afford the care they need in old age. It doesn’t help that the people advocating for these changes are often the ones that will be least affected by it: highly educated elites who likely don’t fit the profile of the average American.
Changes like these will not be politically viable unless they are combined with other policy changes that people can get behind. One of the simplest and best of these suggestions recently was proposed by hedge fund manager Bill Ackman.
Ackman’s idea was for the government to invest $6,750 at the birth of each child in an index fund linked to the US stock market which would not be available to that person until they turned 65. Assuming 8% growth and the power of compounding every year, this would ensure that eventually every retiree would be a millionaire and would provide all citizens with a stake in capitalism. This would also be relatively cheap for the government to implement, costing $20-$30 billion per year.
His aim with this was to reinvigorate people’s connection to the capitalistic system but it also could provide an eventual window to whittle down the direct transfer system on which social security currently rests. Essentially, this would move the US towards a privatization of social security, especially if the retirement fund eventually replaced a majority of social security or just replaced it outright.
The last time this was seriously considered was at the beginning of the second Bush term when Bush was re-elected along with a majority in Congress. At that time, the idea was floated to start directing a portion of social security contributions to indexes linked to the stock market. Not in itself a radical idea, especially considering since most people who retire comfortably nowadays do this privately anyway, but Democrats and even Republicans shot this down when lobbies like the AARP politicized the issue with an effective campaign arguing that the Republicans wanted to “gamble your retirement on the stock market.”
While the can was kicked down the road for a policy change, demographics is making sure we are headed in a difficult direction no matter what. The only question yet to come is how we are going to handle it. Greenspan is one of the few people discussing it now, but this issue is set to become a wider issue in the coming years long after Covid has left, which is what is keeping him and other policy wonks up at night.
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