I am catching up on the mountains of things I have to read. It is a pointless task – the pile rises faster than my eyes can process it. But I try. There was an article in the June 25, 2009 edition of The Economist entitled A slow-burning fuse, which carried the by-line “Age is creeping up on the world, and any moment now it will begin to show. The consequences will be scary”. It definitely might be scary getting old but the discussion that needs to be had is nothing remotely like the discussion that dominates the current policy debate about the ageing society.
The Report starts with this:
STOP thinking for a moment about deep recession, trillion-dollar rescue packages and mounting job losses. Instead, contemplate the prospect of slow growth and low productivity, rising public spending and labour shortages. These are the problems of ageing populations, and if they sound comparatively mild, think again. When the IMF earlier this month calculated the impact of the recent financial crisis, it found that the costs will indeed be huge: the fiscal balances of the G20 advanced countries are likely to deteriorate by eight percentage points of GDP in 2008-09. But the IMF also noted that in the longer term these costs will be dwarfed by age-related spending.
The main hypothesis of the Report is that the slow ageing of the World’s population will have “vast economic, social and political consequences” as labour forces shrink and pensioners rise. You can also hear an interview by Barbara Beck the author of the Special Report.
My first reaction to articles like this before I even think modern money is to conjecture that the threat of unemployment and underemployment as a weapon to discipline the workers and avoid paying them a fair share in productivity growth will be dramatically reduced. Over the last thirty years the distribution of national income in favour of profits has changed significantly (in Australia the wage share has gone from high 50 per cent to low 50 per cent) over the last 25 years.
So as the labour force contracts, firms will have to invest in labour-saving technology which will increase productivity and provide better real wages growth for workers who will have more bargaining power.
My second reaction is that unemployment will be reduced significantly and this might see us return to true full employment.
My third reaction is that the more of us not working means the more of us are playing. Both of these last reactions signal good times to me.
But that is not the way the mainstream thinks.
The two factors that are contributing to the ageing are that people are living longer and having fewer children. The Total Fertility Rate (TFR) (that is, children per woman) has dropped dramatically. It is 2.6 on average globally and “1.6 in rich countries”. The Report notes that the “The UN predicts that by 2050 the global figure will have dropped to just two, so by mid-century the world’s population will begin to level out.”
The other factor to consider is the baby boomer bubble (BBB) that began in 1945 and is now manifesting in increasing retirements. So this bubble will dissipate in around 20 years anyway as we all die.
Interestingly, I read something not long ago that conjectured that the BBs are less happy in retirement than their forebears because they find it harder to live on a diminished income. So this effect will likely see more BBs stay attached to the labour force to supplement their incomes to maintain the rate of growth in gadget purchases.
After providing a pile of not uninteresting demographic information about the developing countries (particularly China), the Report then heads into my territory – macroeconomics. It says:
Macroeconomic theory suggests that the economies of ageing populations are likely to grow more slowly than those of younger ones. As more people retire, and fewer younger ones take their place, the labour force will shrink, so output growth will drop unless productivity increases faster. Since the remaining workers will be older, they may actually be less productive.
Well you don’t need macroeconomic theory to tell you that. First, the labour force will shrink somewhat but then the system cannot provide enough jobs anyway given the failure of governments to use their policy capacities in a sensible way.
Second, it is highly likely that productivity will increase significantly over this period as firms are forced to invest in labour saving technology and also pay higher wages (as the labour force contracts). As noted above the bargaining power will swing towards workers as they become relatively scarce. That will provide a boost to dynamic efficiency and stop the race to the bottom in advanced western countries that have exploited the neo-liberal deregulation agenda to casualise and dumb down their workplaces. This low productivity strategy was never sensible given the population projections.
Third, there is no macroeconomic theory (credible or otherwise) that says that older workers are less productive. Logic says that experience and maturity peak as the worker became older. The old agricultural worker problem where the ageing labourer could not physically maintain the pace of work hardly applies to the majority of workplaces now or over the next 40 years.
Then we get pointy. The Report says:
For the public finances, an ageing population is a huge headache. In countries where public pensions make up the bulk of retirement income, these will either swallow up a much larger share of the budget or they will have to become a lot less generous, which will meet political resistance (and remember that older people are much more inclined to vote than younger ones) … What can be done? As the IMF puts it, “the fiscal impact of the [financial] crisis reinforces the urgency of entitlement reform.” People in rich countries will have to be weaned off the expectation that pensions will become ever more generous and health care ever more all-encompassing. Since they now live so much longer, and mostly in good health, they will have to accept that they must also work for longer and that their pensions will be smaller.
We have to be very careful when we start talking about costs. Here the modern monetary theorist departs from the mainstream which is obsessed with budget numbers on bits of paper. This problem has been at the heart of the fallacies perpetuated by the various governments around the world and international agencies like the IMF.
In Australia, the 2002 Intergenerational Report, which the then government published (as part of the Budget Papers) to provide a justification for their pursuit of budget surpluses, was the first major document to promote the ageing population-fiscal burden nexus.
The IGR (2002: 1) said in relation to the surpluses at that time that
Commonwealth government finances are … [presently] … strong … The Commonwealth Budget recorded an accumulated cash surplus of $23.7 billion from 1997-98 to 2000-01 … During this period, Commonwealth government net debt, already one of the lowest among the industrialised economies, has fallen from $82.9 billion to $39.3 billion.
From a modern monetary perspective, federal finances can be neither strong nor weak but in fact merely reflect a “scorekeeping” role. We have learnt that when Government boasts that a $x billion surplus, this is tantamount to saying that non-government $A financial asset savings recorded a decline of $x billion over the same period.
Thus the IGR claim that the Commonwealth “recorded an accumulated cash surplus of $23.7 billion from 1997-98 to 2000-01” is equivalent to saying that non-government $A financial asset savings declined by $23.7 billion over the same period.
Equally, the IRG claim that net debt was very low over some period is equivalent to saying that non-government holdings of government debt fell by the same amount over this period. In other words, private sector wealth was destroyed in order to generate the funds withdrawal that is accounted for as the surplus.
The IGR expressed the standard perspective that the accounting record of surpluses exhibited:
… sound fiscal management … [and] … provided the platform for vigorous, low inflationary growth … generating jobs and higher incomes for Australians.
However, once we appreciate the equivalents noted above we would conclude that this draining of financial equity introduces a deflationary bias that has slowed output and employment growth (keeping unemployment at unnecessarily high levels) and has forced the non-government sector into relying on increasing debt to sustain consumption.
These insights help us understand the errors in the logic underpinning the intergenerational issue in general. Financial commentators often suggest that budget surpluses in some way are equivalent to accumulation funds that a private citizen might enjoy. This has overtones of the regular US debate in relation to their Social Security Trust Fund.
This idea that accumulated surpluses allegedly “stored away” will help government deal with increased public expenditure demands that may accompany the ageing population lies at the heart of the intergenerational debate misconception. While it is moot that an ageing population will place disproportionate pressures on government expenditure in the future, it is clear that the concept of pressure is inapplicable because it assumes a financial constraint.
A sovereign government in a fiat monetary system is not financially constrained.
There will never be a squeeze on “taxpayers’ funds” because the taxpayers do not fund “anything”. The concept of the taxpayer funding government spending is misleading. Taxes are paid by debiting accounts of the member commercial banks accounts whereas spending occurs by crediting the same. The notion that “debited funds” have some further use is not applicable.
When taxes are levied the revenue does not go anywhere. The flow of funds is accounted for, but accounting for a surplus that is merely a discretionary net contraction of private liquidity by government does not change the capacity of government to inject future liquidity at any time it chooses.
The standard government budget constraint intertemporal analysis that deficits lead to future tax burdens is also problematic. The idea that unless policies are adjusted now (that is, governments start running surpluses), the current generation of taxpayers will impose a higher tax burden on the next generation is deeply flawed.
The government budget constraint is not a “bridge” that spans the generations in some restrictive manner. Each generation is free to select the tax burden it endures. Taxing and spending transfers real resources from the private to the public domain. Each generation is free to select how much they want to transfer via political decisions mediated through political processes.
When modern monetary theorists argue that there is no financial constraint on federal government spending they are not, as if often erroneously claimed, saying that government should therefore not be concerned with the size of its deficit. We are not advocating unlimited deficits. Rather, the size of the deficit (surplus) will be market determined by the desired net saving of the non-government sector.
This may not coincide with full employment and so it is the responsibility of the government to ensure that its taxation/spending are at the right level to ensure that this equality occurs at full employment. Accordingly, if the goals of the economy are full employment with price level stability then the task is to make sure that government spending is exactly at the level that is neither inflationary or deflationary.
This insight puts the idea of sustainability of government finances into a different light. The emphasis on forward planning that has been at the heart of the ageing population debate is sound. We do need to meet the real challenges that will be posed by these demographic shifts.
But if governments continue to try to run budget surpluses to keep public debt low then that strategy will ensure that further deterioration in non-government savings will occur until aggregate demand decreases sufficiently to slow the economy down and raise the output gap.
It is clear that the goal should be to maintain efficient and effective medical care systems. Clearly the real health care system matters by which I mean the resources that are employed to deliver the health care services and the research that is done by universities and elsewhere to improve our future health prospects. So real facilities and real know how define the essence of an effective health care system.
Clearly maximising employment and output in each period is a necessary condition for long-term growth. The emphasis in mainstream integeneration debate that we have to lift labour force participation by older workers is sound but contrary to current government policies which reduces job opportunities for older male workers by refusing to deal with the rising unemployment.
Anything that has a positive impact on the dependency ratio is desirable and the best thing for that is ensuring that there is a job available for all those who desire to work.
Further encouraging increased casualisation and allowing underemployment to rise is not a sensible strategy for the future. The incentive to invest in one’s human capital is reduced if people expect to have part-time work opportunities increasingly made available to them.
But all these issues are really about political choices rather than government finances. The ability of government to provide necessary goods and services to the non-government sector, in particular, those goods that the private sector may under-provide is independent of government finance.
Any attempt to link the two via fiscal policy “discipline:, will not increase per capita GDP growth in the longer term. The reality is that fiscal drag that accompanies such “discipline” reduces growth in aggregate demand and private disposable incomes, which can be measured by the foregone output that results.
Clearly surpluses helps control inflation because they act as a deflationary force relying on sustained excess capacity and unemployment to keep prices under control. This type of fiscal “discipline” is also claimed to increase national savings but this equals reduced non-government savings, which arguably is the relevant measure to focus upon.
Dependency in Australia – now to 2050
To give you some idea of the demographic shifts that will occur in Australia, I dug into the ABS modelling data. The following graphs for Australia are all based on the ABS Series A or High Population growth model. It assumes that the total fertility rate will reach 2.0 babies per woman by 2021 and then remain constant, life expectancy at birth will continue to increase until 2056 (reaching 93.9 years for males and 96.1 years for females), Net overseas migration will reach 220,000 by 2011 and then remain constant, and large interstate migration flows. So worst case scenario and probably overly optimistic.
Update – To see how the population by age groups project out to 2050 under these assumptions the following graph is interesting. All the lower lines currently are the older cohorts and over the period shown they become more dominant especially the 85+ (blue line with the rapid upward slope around 2030).
The dependency ratio is normally defined as 100*(population 0-15 years) + (population over 65 years) all divided by the (population between 15-64 years). Historically, people retired after 64 years and so this was considered reasonable. The working age population (15-64 year olds) then were seen to be supporting the young and the old. This is what I call the unmodified dependency ratio in the graph below.
The reason that economists believe the dependency ratio is important is typically based on false notions of the government budget constraint. So if the ratio of economically inactive rises compared to economically active, then the economically active will have to pay much higher taxes to support the increased spending. So an increasing dependency ratio is meant to blow the deficit out and lead to escalating debt.
The mainstream approach to the higher dependency ratios is to increase the retirement age (because people live longer they should work longer); redistribute population via migration from younger to older countries; and/or reduce the real value of public entitlements and force increasing numbers to provide retirement income privately.
However, all of these remedies miss the point overall. It is not a financial crisis that beckons but a real one. Are we really saying that there will not be enough real resources available to provide aged-care at an increasing level? That is never the statement made. The worry is always that public outlays will rise because more real resources will be required “in the public sector” than previously.
But as long as these real resources are available there will be no problem.
First, the unmodified dependency ratio as defined is problematic because persons above 65 years of age are increasingly remaining active. This has led to a modification of the formula to take the active older workers (over-65s) out of the numerator and add them to the denominator – these modified computations provide “real dependency ratios”.
The first graph provides some information about this issue because it shows the labour force participation rate of those who are above 65 years of age (a 12-month moving average to disclose trends). It has clearly been rising since 2003 and is now over 10 per cent. It will be expected to rise further in the coming decade as this cohort seek ways to attenuate the wealth losses that the GFC has wrought on their retirement funds. So it is not out of the question that 20 per cent of this group will remain active in the labour force by 2050.
So I computed three real dependency ratios based on a status quote (10 per cent participation by over-65s), 15 per cent average and 20 per cent average over the period between now and 2050. The next graph shows the results. The blue line at the top is the unmodified dependency ratio. The real dependency ratios below it assume increasing participation by the over-65s. If the highest participation is accurate (and it probably won’t be) then the dependency ratio would be 49.3 per cent by 2050 rather than the 45.9 per cent now (with an actual 10 per cent). Even if there is no further rise in participation by the over-65s, the dependency rate would rise from 46 per cent now to 68 per cent by 2050.
The idea that it is necessary for a sovereign government to stockpile financial resources to ensure it can provide services required for an ageing population in the years to come has no application. It is not only invalid to construct the problem as one being the subject of a financial constraint but even if such a stockpile was successfully stored away in a vault somewhere there would be still no guarantee that there would be available real resources in the future.
Discussions about “war chests” completely misunderstand the options available to a sovereign government in a fiat currency economy.
Second, the best thing to do now is to maximise incomes in the economy by ensuring there is full employment. This requires a vastly different approach to fiscal and monetary policy than is currently being practised.
Third, if there are sufficient real resources available in the future then their distribution between competing needs will become a political decision which economists have little to add.
Long-run economic growth that is also environmentally sustainable will be the single most important determinant of sustaining real goods and services for the population in the future. Principal determinants of long-term growth include the quality and quantity of capital (which increases productivity and allows for higher incomes to be paid) that workers operate with. Strong investment underpins capital formation and depends on the amount of real GDP that is privately saved and ploughed back into infrastructure and capital equipment. Public investment is very significant in establishing complementary infrastructure upon which private investment can deliver returns. A policy environment that stimulates high levels of real capital formation in both the public and private sectors will engender strong economic growth.
If we adequately fund our public universities to conduct more research which will reduce the real resource costs of health care in the future (via discovery) and further improve labour productivity then the real burden on the economy will not be anything like the scenarios being outlined in the “doomsday” reports. But then these reports are really just smokescreens to justify the neo-liberal pursuit of budget surpluses.
As a final irony, for all practical purposes there is no real investment that can be made today that will remain useful 50 years from now apart from education. Unfortunately, tackling the problems of the distant future in terms of current “monetary” considerations which have led to the conclusion that fiscal austerity is needed today to prepare us for the future will actually undermine our future.
The irony is that the pursuit of budget austerity leads governments to target public education almost universally as one of the first expenditures that are reduced.