The population of the United States is aging due to a falling fertility rate and advancements in modern medicine allowing people to live longer lives. David Cutler, James Poterba, Louise Sheiner and Lawrence Summers express in their article, An Aging Society: Opportunity or Challenge? that the national savings rate will decrease, as it should.
“The ratio of retirees to workers will have risen by nearly two-thirds.” (pg. 1) In developing nations, this shift in age distribution has generated various disruptions in their societies. This is why the United States is beginning to take notice and plan counteraction. While the U.S does not currently have major issues due to the changing distribution, many economists are beginning to plan ahead. Cutler, Poterba, Sheiner and Summers feel that the most efficient manner to decide how to change the national savings rate is to focus on the optimal level of national saving and the current level, compare the two and modify the current level accordingly. In general, the authors agree that, “demographic changes will improve American standards of living in the near future, but lower them slightly over the very long term.” (pg. 2) They claim that the slowing population growth will cause a decrease in labor investment, “devoted to equipping new workers and housing new families, while making it easier for the United States to attract foreign capital.” (Pg. 2)
“The economic consequences of population again depend on the nature of the underlying demographic change as well as the relationship between the resource needs of individuals at different ages and their capacity for self-support.” In order to deal with this issue, many calculations are involved because this idea of an aging population with declining fertility is not that simple. While over the coming decade there will be little change, over the next fifty years, it is apparent that the percent population over 65 years of age will decrease, while that under 20 years will decrease.
According to the authors of this article, “declining fertility is the principle source of the changing demographic patterns”. (Pg. 6) While I agree, I also believe that reduced mortality, referred to as, “old-age mortality”, also contributes a fair share to the issue at hand. While his name was not mentioned, Richard Easterlin’s theory on fertility was mentioned as a description of the carrying fertility from World War II through the mid 80s. However, the four authors feel that any long-term fertility projection is uncertain for
An additional factor that must be taken into account is that of immigration. Fertility may be the primary influential factor, but immigration drastically affects the age structure. “The age structure of the population is sensitive to the level of immigration because immigrants on average are younger than nonimmigrants.” (Pg. 7) According to George Borjas, only 3.1% of immigrants were over 65 in the 80s. That would mean that 96.9% were younger than 65 and able to work. Despite the uncertainty and limited accuracy of future projections, there is undoubtedly a trend towards a rising average age, “ a greater number of dependent elderly, and fewer dependent children”. (Pg. 8) This is, according to the four authors, “indisputable”.
The relative size of the self-supporting and dependent population” is being affected by the economy’s changing consumption opportunities due to demographic shifts. In order to illustrate this, Cutler, Poterba, Sheiner and Summer offer an equation called the support ratio. This equation is,
where LF is defined as the labor force, and CON represents the effective number of consumers. However, this support ratio is influenced by the relative consumption needs of people of different ages, changes in the retirement age, labor force participation rates and the earning power of the workers. So, assuming that all people have identical resource needs, the authors offer a new equation for effective consumption. This is:
N is the number of people of age i. CON2 is an alternate equation that takes into account, the different resources people need at different ages. This contains “three parts; private nonmedical expenses, public education expenses, and medical care.” (Pg. 9) The way this is grouped is that for the nonmedical expenses, those under 20 years of age have the same needs of half of the adults grouped in the 20+ age range. For public education, the three groups are under 20, 20-64 and 65 and over. Each age group was assigned a per capita outlay. For medical expenses, another outlay was attributed to the groups 64 and under, and 65 and over.
Cutler, Poterba, Scheiner and Summers found that between 1990 and 2060, the support ratio declines by 7.8% when consumption needs are assumed to be equal for people of all ages. When consumption needs are adjusted using the needs-weighted measure, the decline is 11.8%. The authors found that in the next two decades, “there is a decline in economic dependency (a rise in the support ratio) because the declining number of dependent children more than offsets the rising number of dependent elderly.” (Pg. 13) This is to say that the labor force is growing faster than the dependent population. They also found that, “virtually all the improvement in the support ratio in the near term is from a shrinking share of children in the population. Most of the long-run decline is a result of rising numbers of elderly.” (Pg. 14) It was also determined that the changes in the support ratio between 1990 and 2060 were no larger than and often much smaller than those between 1960 and 1990. With the rise and decline of the support ratio, it is difficult to determine the ultimate burden due to the uncertainty.
Demographic change has two effects on consumption opportunities. “First, an increase in dependency lowers output per person, thus reducing consumption per capita. Second, slower labor force growth reduces investment requirements, thus reducing the need for saving and increasing consumption per capita.”
In order to measure the importance of these changes, k is the capital-labor ratio and f(k) is the output per worker. Here, n = the labor force growth rate. So,
To find the change in steady-state consumption, the expression is as follows;
Because there is a decline in the labor force population ratio, the level of feasible consumption per capita (given the economy’s capital stock) is reduced. Additionally, more consumption for a given capital-output ratio is permitted due to the decline in the growth rate of the labor force. Consequently, “society receives a ‘consumption dividend’ when it is able to invest less and still maintain a given level of per capita output.” (Pg. 18) This effect offsets the long-run dependency effect on per capita consumption. The authors found that, “reduced dependency and slowing labor force growth both increase consumption possibilities so that society will be between 3.4 percent and 6.3 percent richer, depending on the combination of labor force and needs measures.” (Pg. 19)
The results, through using these equations, found that in the short run, demographic changes will cause the level of consumption that can be sustained while maintaining the level of capital intensity to increase, while in the long run, they will reduce the sustainable level of consumption. From here, the question to answer is how society should modify its saving policy.
With the baby boomer population about to retire by the year 2020, and with social security being a “pay-as-you-go” system, the issue of dependency is predominant in society.Another important dimension of this situation is that of capital. Foreign capital flows have a significant effect on U.S. capital intensity. The speed of U.S population aging is much less dramatic as it is in other countries. Thus, according to Thomas Smith, these other countries are liable to experience a “decrease in their labor force growth rates, decreasing consumption and increasing savings, thereby creating a greater flow of foreign capital into the United States. The inflow of foreign capital, in addition to the slowing labor force growth considerably reduces the demand for domestic capital sources and points to a lower optimal U.S. national savings rate.
This does not fully compensate for the domestic reduction in demand for capital because capital simply provides a basis for worker productivity. There is no guarantee that capital will be used efficiently. So, from here, the slowing of labor growth rates and the scarcity of labor creates incentives for business to improve their productivity rather than waste money on hiring additional workers. The motivation of enhanced productivity comes in part from technological change. Cutler and his colleagues claim that there are empirical studies that prove that labor scarcity leads to higher productivity growth rates. The authors predict a 15% annual increase in U.S. productivity growth thereby further offsetting the increased dependency burden.
While dealing with demographic and economic factors, it is necessary to consider fiscal policy. The government is likely to have to increase expenditures from about 32% to 37% of GDP. Logically, this means that taxes will have to increase slowly over time, or be raised and held constant. A statistical study by the four authors holds that an increase in taxes is insignificant and would merely result in gains measured in tenths of a percent of GDP. This means that then national savings rate is the predominant factor in preventing any issues the U.S. might have in the future regarding the aging population.
It is important to keep in mind the idea of “the life cycle hypothesis”, which describes the elderly as dissevers due to health care and the inclination to spend money they cannot spend when they are dead. This controls the long term thereby decreasing the national savings rate.Due to a slowing labor force growth rate, foreign capital inflows and increases in worker productivity, the optimal long-run national savings rate is lower. In order to determine whether to raise or lower the national savings rate, it is necessary to compare the current rate with the optimal. Only then will the answer be clear.
Cutler, David; Poterba, James; Sheiner, Louise, Summers, Lawrence; An Aging Society: Opportunity or Challenge?, Brookings Papers on Economic Activity, Vol. 1, 1990, pp. 1-56.