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March 24, 2005

The Social Security Trustees Explain Their Productivity Assumptions

The Social Security Trustees explain their long-run productivity growth assumptions. From pp. 82-83 of the 2005 Trustees' Report:

1. Productivity Assumptions

Total U.S. economy productivity is defined as the ratio of real gross domestic product (GDP) to hours worked by all workers. The rate of change in total productivity is a major determinant in the growth of average earnings. For the 40 years from 1963 to 2003, annual increases in total productivity averaged 1.8 percent, the result of average annual increases of 2.5, 1.1, 1.5, and 2.0 percent for the 10-year periods 1963-73, 1973-83, 1983-93, and 1993-2003, respectively.

However, productivity growth can vary substantially within economic cycles. Therefore, it is more useful to consider historical average growth rates for complete economic cycles. The annual increase in total productivity averaged 1.6 percent over the last four complete economic cycles (measured from peak to peak), covering the 34-year period from 1966 to 2000. The annual increase in total productivity averaged 2.2, 1.2, 1.3, and 1.6 percent over the business cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively. The ultimate annual increases in productivity are assumed to be 1.9, 1.6, and 1.3 percent for the low cost, intermediate, and high cost assumptions, respectively. These are the same as the ultimate rates assumed for the 2004 report.

One would think that the fact that productivity growth has averaged 3.0% per year in the four years since 2000 would be worth a mention. One would expect some reason for completely throwing away the last four years' worth of data on productivity.

But it isn't there.

What would happen if the Trustees' Report had forecast productivity growth of 1.8% per year? How different would the numbers be? My back-of-the-envelope is that it would knock a bit more than a quarter of a percentage point off the 75-year actuarial deficit--reduce it down to 1.5% from the 1.8% of taxable payroll in the Trustees' Report.

Small differences, yes. But we've had good productivity news in the past four years: the Trustees' Report should recognize it.

UPDATE: Paul Krugman comments:

[T]he slight deterioriation in the near-term [Social Security] outlook is the result of a strange asymmetry between what is updated to reflect recent data, and what isn't.... [T]wo very recent events affect the projections for many years to come.... this year's [substantially] oil [price]-driven inflation rate leads to a reduction in the assumed real wage rate in all future periods... this year's low real interest rate leads to lower assumed earnings [on] the trust fund for a very long time.... On the other side, high productivity growth since 2000... seems like big news... [but] isn't factored in at all. The reason is that the trustees use an average over the past four "full business cycles," measured from peak to peak (Section IV.B.7).... [T]hey won't take the good productivity news since 2000 into account [at all in forecasting the future] until the economy [begins] another recession. There's something very wrong with that...

Posted by DeLong at March 24, 2005 01:35 PM