July 17, 2003

ZPG and Europe's Social Insurance State

Zero population growth is not especially frightening. ZPG coupled with a very extensive social insurance state in which large benefits to the retired old are paid by the working young may well prove to be a politico-economic time bomb of amazing proportions. The Economist wakes up and looks at this issues.

A little more than a decade ago, Cutler, Sheiner, Elmendorf, Summers, perhaps a coauthor or two I've forgotten, and perhaps not all those I've named wrote a paper for Brookings on "The Aging society." IIRC, they concluded that having lots of old non-workers around was about as much of a burden as having lots of young non-workers around (i.e., children), that the old had special needs (medicine) and the young had special needs (education), and that the big problems arose not because of a declining fraction of the population in the labor force but out of social institutions (and perhaps human psychology? Is it correct to say that most people love and are willing to sacrifice more for their children than for their parents?) not adapted to the forthcoming change. I need to dig it out and read it again...

Posted by DeLong at July 17, 2003 12:39 PM | TrackBack

Comments

"Is it correct to say that most people love and are willing to sacrifice more for their children than for their parents?"

Important question. I think not at first thought, but will consider. I would sacrifice as much for a child as for a parent as for a husband [oh dear].

Suppose we change the question. Why do those who are older have to become a problem for us? My parents are far less of a problem than children [not sure about husband]. My parents are self-contained, independent, contented, and a help to all sorts of the rest of us. Why should that be unusual? PBS shows a number of pleasing comedies of older women and men who are as self-contained as the kids on "Friends." Why should that not be so in general?

Posted by: anne on July 17, 2003 01:01 PM

"Is it correct to say that most people love and are willing to sacrifice more for their children than for their parents?"

Judging from the federal budget, it sure looks like workers sacrifice through it a *lot* more to their parents than to their children.

Whether that's because they love their parents more than their children or because their parents vote while their children don't is another issue.

Posted by: Jim Glass on July 17, 2003 01:16 PM

One social institution that will probably have to be jettisoned is the notion that 70-somethings don't belong in the labor force. Life expectancy at 60 will soon be pushing 90, at least in rich countries. One may love one's parents as much as one's children, but childhood dependency starts to peter out (I hope) after 20 years or so. Should children be expected to subsidize their parents for much longer than that?

By the way, does anyone know if the following anecdote is true? The first country to enact social insurance legislation was Germany under Bismark. When the issue of the right retirement age came up it so happened that the Iron Chancellor had two cabinet ministers he wanted to get rid of, the younger of whom was 65.

Posted by: Aaron Gurwitz on July 17, 2003 01:56 PM

I would be curious to see the arguments. On the face of it, it seems preposterous that the burden of children is comparable to that of the elderly. Children don't maintain their own separate households with their own houses, cars, etc. If they lived with THEIR children, as often happens in the third world, the two might be comparable. Is that the kind of social institution that is meant here?

Posted by: maciej on July 17, 2003 02:35 PM

Isn't the theory that demographics may play havok with pay as you go retirement systems but fully prefunded retirement systems are not as savaged by such demographic deluges? Of course, my thought here assumes the Reagan-Greenspan Social Security reforms put us on a prefunded system even though I suspect it only partially got us there.

Posted by: Hal McClure on July 17, 2003 06:42 PM

Hal,

Isn't it basically still the same situation either way just with different accounting?

Posted by: snsterling on July 17, 2003 07:32 PM

Hal,

Isn't it basically still the same situation either way just with different accounting?

Posted by: snsterling on July 17, 2003 07:37 PM

The Economist woke up? They have been commenting on Europe's demographic for years.

Secondly, I will assert that the biological imperative is to place children ahead of parents. I see more folks putting old-timers in nursing homes than I do putting kids in creches.

Thirdly, I suspect that this is the paper:

Cutler, David, James Poterba, Louise Sheiner, and Lawrence Summers, “An Ageing Society: Opportunity or Challenge?” Brookings Papers on Economic Activity, Microeconomics 1990 (1): 1-56.

And a link? You got me.

Posted by: Tom Maguire on July 17, 2003 08:12 PM

The Economist woke up? They have been commenting on Europe's demographic for years.

Secondly, I will assert that the biological imperative is to place children ahead of parents. I see more folks putting old-timers in nursing homes than I do putting kids in creches.

Thirdly, I suspect that this is the paper:

Cutler, David, James Poterba, Louise Sheiner, and Lawrence Summers, “An Ageing Society: Opportunity or Challenge?” Brookings Papers on Economic Activity, Microeconomics 1990 (1): 1-56.

And a link? You got me.

Posted by: Tom Maguire on July 17, 2003 08:14 PM

Jim, it's true that a much larger share of the federal budget goes to retirees than to children. But the opposite is almost surely true of state budgets, as most education spending is by states. And the average family almost surely spends more privately on their kids than on their parents. So I don't think it has to do with retirees voting as much as with different sorts of needs, funded in different ways. (Although I suppose one could tell a story about why it is that adults would be negligent to fail to feed their children but not to do the same to their parents.)

Hal, I think it's right that the problems faced by a prefunded system would be smaller, or at least different, than by a pay-as-you-go system. With prefunding--once you build up the large balance to switch to that kind of program--the problems would have to do with the effect on equity markets of mass net withdrawals to fund retirement expenses. Since we have a mixed system--largely pay-as-you-go social security, with substantial private savings--we may see some of the disadvantages of each. I'm not sure I want to own real estate anywhere but Florida 10 years from now...

Posted by: Jesse R on July 17, 2003 09:07 PM

A buyer's market for real estate in ten years? Hmm. That is more or less my target date for upgrading from the living quarters I am in now.

Posted by: Steven Rogers on July 18, 2003 02:33 AM

Steven,

In 10 years this process will have only just started--the rate of retirement will be high but the old age dependency ratio will only be a couple of percent higher than it is now. So it's possible Jesse R was dating the beginning of the decline and not the bottom. You might want to wait until about 2030 when the demographic shift is near completion at which time there will be a large buildup of retirees wanting to relocate and maximum pressure will be put on interest rates and taxes.

Posted by: snsterling on July 18, 2003 05:34 AM

snsterling

Pre-funding is more than different accouting. Lack of pre-funding allowed the 1st generation to receive benefits which they did not pay for which is why the return to investment for subsequent generations had to be less. It's a matter of intergenerational transfers. It might have even adversely affected investment - but then a Ricardian might disagree.

Posted by: Hal McClure on July 18, 2003 06:23 AM

"Pre-funding is more than different accouting. Lack of pre-funding allowed the 1st generation to receive benefits which they did not pay for which is why the return to investment for subsequent generations had to be less."

Although in reality it wasn't the "first generation" that got the benefits they didn't pay for. FDR's SS program was funded.

Later Congresses created the "pre funding" by deciding to spend the tax money that was to be saved for funding on bigger current benefits, and on cutting the SS tax rate, rather than saving it as funding. ("Spending the Social Security surplus" hardly started in 2000 -- it started in 1939.)

The biggest winners at receiving more than they paid for in dollar terms were the people who retired in the 1970s and early 1980s -- which is why that's when SS went broke and had to be "saved" by the Greenspan Commission. FDR's SS was scheduled to have a $500 billion funding reserve by then.

It's useful to keep all this in mind for perspective during the political debates on SS. There's all this mythology around about how we're stuck with the SS financing problem as the cost of paying benefits backward to the "first generation" victims of the Depression, as per FDR's intentions and his New Deal. As part of a "compact between the generations" to help the poor of the Depression.

Not so. FDR created a funded program and took pride in it saying it would be "out of the Treasury forever". The payment of benefits backwards on the biggest scale went to the workers of the Swinging '60s and Stylish '70s.

Those *later generation* backward payments are the real reason why today's young workers stand to get negative returns from SS. (And being that FDR insisted that his whole SS be funded, it's unlikely that he'd greatly object to funding 2% accounts in SS today, as those radical Swedes have done.)

Posted by: Jim Glass on July 18, 2003 07:55 AM

Hal, you are right. My choice of words (accounting) was too hasty. I agree the things you mention are affected, especially when there are sudden changes in policy (or demographics?), but my guess is over the long term it matters less as the increased rates of return reboost investment.

One thing I like about the pay as you go method is that the situation becomes very straightforward. So the Europeans are already having fights over how to cope with a future with more demand and less supply.

With prefunded retirements it is much more tempting for people to kid themselves and not take the real situation into account. A period before a retirement crunch might bring an investment boom that initially seems to confirm retirement plans.

This is fantastic for the first ones out, because following an age appropriate portfolio, in their 50s they sell their stocks high and switch more to bonds which they sell high, then they sell their house high and continue to switch into cash just at the right time.

If your time happens to be many years later, everything is just going to seem to go wrong. Follow the usual age related pattern to find you bought stocks high, then bought bonds high and then sell those low along with your house. Even worse, the fact that you can't afford to lose your retirement money causes you to panic and dump asset classes earlier than you normally would.

For those even younger (say in their 20s now) I suppose they will have enough time to recover but they might overcompensate for current low returns or get turned off by investing. It would be nice if everyone with an IRA or running a pension would just take the effect of demographics on their portfolio into account, but really most people are not experts on this and react rather than anticipate, so you end up with transfers between age groups in a more chaotic way.

And politicians get fooled as well, so to prefund a gov't program will surprise with the same problem of low yields followed by high interest rates and market declines.

Posted by: snsterling on July 18, 2003 08:47 AM

"they concluded that having lots of old non-workers around was about as much of a burden as having lots of young non-workers around (i.e., children"

Then Brad, I'm afraid they reached a dubious conclusion. The liquidity constraints on the two groups are not the same. Society A, with lots of young non-workers can borrow on the anticipated future earnings of the young non-workers, and invest some of this in education. Society B can only effectively dis-save, or send the educated young out to work in more productive societies to send money back to employ less well educated migrants to care for their ageing parents. As Europe ages my guess is we will see growing out migration of young people towards certain favoured destinations, and probably something then resembling a generalised 'Ermoliev Urn Process' with positive feedback here and negative feedback there. Some winners and some losers, bigtime.

"Is it correct to say that most people love and are willing to sacrifice more for their children than for their parents?"

I would say no. In fact my research into Bulgarian migrants here in Spain suggests that they are leaving adolescent kids behind to care for parents, and thus sacrificing the young to help the old. It depends on culture more than psychology I feel.

Incidentally my anecdotal observation here in Spain is also that people find it tremendously hard to sacrifice their parents for the interests of their children. I guess its all about kinship systems and family ties. The US, being a society based on long-distance migration, where effectively ties are cut, may well have priviledged the interests of the next generation over the previous one. Come to think of it, this may explain all that consumption and debt you have, and why in Asia people tend to save more. It may not just be about confidence in financial institutions.

Posted by: Edward Hugh on July 18, 2003 10:43 AM

The grand-parents can help in bringing up their children offspring. Allowing both parents to realize money remunerated works at a lower cost than if they ressorted to external nursing.

DSW

Posted by: Antoni Jaume on July 18, 2003 11:22 AM

America has no use for parents, then England have no use for parents. Well, less use, since we are a part of Europe.

Posted by: Tony Blair on July 18, 2003 11:34 AM

BTW. On a technical point, it is not zero population growth we are talking about here, it is long term slow and steady population meltdown.

Antoni Jaume. Fine. But most Spanish young people can't move today Holland or Canada or wherever the growth and work might be in the future in search of better opportunities for their children because of a strong sense of family commitment. This I think is the point. For that matter they can't move from Andalusia or Extremadura to Madrid or Barcelona. The children are being sacrificed for the parents. (BTW Antoni, my wife agrees with you, she is, of course, Spanish).

Posted by: Edward Hugh on July 18, 2003 11:58 AM

Guys guys guys. Even in fierce fierce America we are not going to cook our parents, spinkle them with relish, and serve them to our children. Really. Although Mom seems oddly plump lately....

Posted by: anne on July 18, 2003 12:17 PM

The (mostly rhetorical, I suspect) issue of whether we care more for our children than our parents isn't really the point here. When Social Security and related programs were instituted, far more of the elderly were directly dependent on and living with their adult children than is now the case. With the program now older than most of us, it is an institution with its own political inertia. The points about various government programs, federal (mostly elderly) vs state (mostly children) may be correct, but there is the huge problem of tallying up private transfers. But again, there are institutions in place which take decisions out of the hands of individuals, make them collective, and provide them with constituencies which makes a simple majoritarian decision to change them unlikely. This is so much more complex than "whom do you love most?" that the question is almost a red herring.

Posted by: K Harris on July 18, 2003 12:33 PM

Yes yes. But, we had time to prepare for the aging of our parents. We still do, at least we would if there were some responsibility in the Administration

Anne

Posted by: anne on July 18, 2003 12:51 PM

http://www.cbpp.org/7-18-03bud.htm

Sanitizing The Grim News: The Administration's Efforts to Make Harmful Deficits Appear Benign

This analysis concludes that the Administration's figures understate the likely size of deficits in future years. The analysis also finds that tax cuts play a greater role in the descent from surpluses to deficits than do program increases.

Posted by: anne on July 18, 2003 12:54 PM

http://www.nytimes.com/2003/07/18/opinion/18KRUG.html

Passing It Along
By PAUL KRUGMAN

Here's another sentence in George Bush's State of the Union address that wasn't true: "We will not deny, we will not ignore, we will not pass along our problems to other Congresses, to other presidents and other generations."

Mr. Bush's officials profess to see nothing wrong with the explosion of the national debt on their watch, even though they now project an astonishing $455 billion budget deficit this year and $475 billion next year. But even the usual apologists (well, some of them) are starting to acknowledge the administration's irresponsibility. Will they also face up to its dishonesty? ...

Posted by: jd on July 18, 2003 01:16 PM

Where is the problem?

Start with a simpler formulation, where the working population is fixed, and working life is fixed at (say) 40 years. The retired population (whose members are immortal in our formulation) increases linearly at a simple annual rate of 1/40 (the "graduating class"), or 2.5% of the working population.

Economic output increases (as output is wont to do) exponentially at a compound annual rate of 2.5%.

(1 + .025)^N trumps 1 + (.025 * N), and there's no real problem.

Next consider the worst case formulation: zero-growth, zero-birth. After all existing juveniles mature (a 20-year lag), the workforce begins shrinking annually by 2.5% of its original size, and the (immortal) retired population increases by the same number.

This is potentially troublesome: 60 years from now the workforce shrinks to zero ... but we have the advantage of a 20-year pure exponential-versus-linear headstart, plus a 40-year mixed productivity-versus-attrition race. At some point during this interval, some of the immortals may be persuaded to produce, OR some of the adults may be persuaded to reproduce, OR the robots may take over.

Not much to lose sleep over, IMHO, whether we care more for children or for infinitely many generations of ancestors.

Posted by: RonK, Seattle on July 18, 2003 10:18 PM

Edward Hughes wrote:
"Society A, with lots of young non-workers can borrow on the anticipated future earnings of the young non-workers, and invest some of this in education. Society B can only effectively dis-save, or send the educated young out to work in more productive societies to send money back to employ less well educated migrants to care for their ageing parents."

I disagree here. Societies with an excess of young workers (case in point: Nigeria where 50% of the population is under 15, and 75% is under 25) are effectively large colonies of children and youths. Children have accumulated no capital. They have no experience or skills. They can offer nothing except unskilled manual labour. In agrarian communities this is fine. In the so-called modern economy, this is a disaster.

To put it somewhat simplistically, Nigerians cannot borrow against earnings of future generations because (i) there are no sources of capital to a first approximation, short of printing money, in a country where 75% of the population are either unskilled penniless youths or underage dependents (ii) until such a point in the future where the demographic outlook for Ngeria alters to include less dependents and more producers, a return on investment is not guaranteed. And the carnage AIDS is causing to life expectancy in sub-Saharan Africa is pushing that picture in the wrong direction.

Posted by: Elliott Oti on July 18, 2003 11:49 PM

Elliott Oti

Interesting example!
Thanks.

JD

Posted by: jd on July 19, 2003 07:11 AM

In real terms, net borrowing assumes the existence of a net lender. There is not extra-global lender, and most everybody on the globe at the moment wants to be a borrower.

Labor is the only real net lender of any significance ... workers willingly contribute current labor hours in exchange for tokens of purchasing power, which tokens are backed by real goods/services that do not yet exist.

On the token-economy surface, entrepreneurs seem to borrow money to buy labor. In the real-economy interior, entrepreneurs borrow labor to be repaid in (necessarily contingent, on some level) shares of future output.

Posted by: RonK, Seattle on July 19, 2003 10:17 AM

Elliott,

You are undoubtedly right about Nigeria at present. But at some stage or another Nigeria will have a demographic transition, and will likely enter a stage of economic growth, and possibly prosperity. But those societies which we are talking about have already past through this, they are now ageing, almost elderly societies, and it is not clear that they will ever be young again. This is my point. Maybe it would be better to compare Germany and Japan with Brazil or India which both might be about to 'take off', at least demographically.

You could try this URL and Swedish demographer Bo Malmberg:

http://www.framtidsstudier.se/aktuellt/SSHApaper001.pdf

K Harris, you're absolutely right. Both Brad and I have fallen into talking about love, maybe we're just ageing romantics at heart. Really what we should be talking about is bonding and kinship. Love, I guess, is purely subjective, and emotive. Kinship is widely and rigourously studied by anthropologists. Brad's throwaway did indicate what might be considered an American view. Certainly it helps explain the notorious 'labour market flexibility' you enjoy. As Antoni Jaume points out its easier for you Americans to leave the 'old folks back home' than it is for South Europeans.

This may also help explain the high return rates of would-be migrants from Southern Europe to the New World. Not 'sentimentality', but different kinship bonds. This, among other things, is why I find it difficult to do economics without sociology, anthropology and demography.

On the other hand the point about changes in familiy structure in the US since the time the social security system was created is an important and interesting one.

Posted by: Edward Hugh on July 21, 2003 10:51 AM
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