Coping with the consequences of ageing

Economics Department
Page 11 

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The long-term picture for the US economy very much depends on one thing: how policies are developed to deal with ageing and the shifting structure of the population. 

"The economy, stupid" has been a proud motto in US politics in recent years, and with good reason. But for it to work in the years ahead, the demographics had better not be forgotten. The next forty years will see a major change in the structure of the US population: the number of elderly is expected to increase markedly while the growth of the working population should slacken.

The number of people over the age of 65 for each person of working age could almost double. The US changes are predicted to be much less severe than in many other OECD countries, since the US population will benefit from relatively high fertility and immigration. Nevertheless, the economic implications are still serious.

There is also likely to be a slackening in economic expansion owing mainly to slower growth in the labour force. If that happens, with the elderly consuming more than the working population, personal savings may keep declining in the longer term, which, despite capital inflows, could result in lower growth of the capital stock and productivity. And that will affect living standards.

Taking the strain

Fortunately for the United States, the private sector runs a well-developed pension saving industry, so lessening the strain on public finances, at least compared to other OECD countries. Most notable has been the successful experience with 401 (k) defined-contribution plans, introduced in 1978 to induce people to accumulate assets in preparation for their retirement. At the end of 1997, more than $1.8 trillion was invested in 401 (k) and similar plans, almost three times the size of the Social Security Trust Fund portfolio. Two positive aspects of this "success story" are worth noting: 401 (k) plans have improved the ease with which retirement saving can be preserved when changing jobs, which is good for labour flexibility; and second, they have also given individuals more responsibility as to their own investment decisions for retirement purposes.

But there will be strains on public finances. In the next four decades, according to official projections, social security pension payments and health care costs for the elderly seem likely to expand by 2.25% and 4% of GDP, respectively. As a result, by 2034, actuarial estimates suggest that there will be no assets left in the Social Security Trust Fund. However, while Social Security and Medicare may be running large deficits, the remainder of the federal budget should be generating significant surpluses. Over the very long run, with no policy changes, Social Security and Medicare could be running deficits equivalent to 0.8% and 1.3% of GDP.

Increases in Medicaid for the elderly will also add 0.3% of GDP to the deficit -- a total deficit due to ageing of 2.4% of GDP. On the other hand, the remainder of the budget has room for tax cuts amounting to 1.6% of GDP -- provided that Congress sticks to the President's spending plans. This illustrates the importance of viewing the government sector as a whole, rather than just focusing on the ageing components of the budget.

While the likely overall surplus in the remainder of the budget may be sufficient to ensure the future of Social Security, it cannot finance both Social Security and Medicare. Structural changes to both of these programmes are required, rather than just book- keeping adjustments. The scale of the changes that need to be made to public finances is, however, relatively small -- less than 1% of GDP compared to the improvement in public finances seen over the past six years.

The President's proposal for saving Social Security involves creating a reserve to prolong the life of Social Security. This planned reserve should ensure that the unified budget (including Social Security) remains in surplus and adds to national saving. This is a positive development because international experience shows how difficult it is to sustain and increase a budget surplus.

As yet, no proposals have been made as to how to safeguard Social Security over the very long term. This would likely require consideration of some of the following options: some acceleration in the planned increases in the retirement age, some linking of retirement age to life expectancy and perhaps lower cost of living adjustments. Moreover, part of the President's proposal rests on obtaining high, and far from certain, returns from investing part of the Social Security Fund in equities. In addition, this part of the President's plan may lead to the government holding 4% of each and every US quoted company, so raising issues of corporate governance.

Another element of the President's plan, the creation of Universal Saving Accounts, would be a step to boosting the saving of low-income families. It may be appropriate to build on the proposed voluntary individual savings accounts in order to safeguard the well-being of the elderly beyond 2059 when, even with the proposed transfers, the Trust Fund will be exhausted. To this end, the accounts could be redesigned as mandatory.

The biggest gap in current policy relates to Medicare. Progressively moving Medicare towards a managed care framework would seem appropriate, using the federal employees' health care plan as a basis for Medicare reform. In this regard, the proposals that were made by the Chairman of the Medicare Commission appear reasonable. But reform is also necessary in the area of integrating the long-term care services provided by state and federal governments and supporting more home and community-based care systems for the elderly, but with strict control over home-care assistance.

Increasing participation in the labour force is another way to provide increased resources to meet the costs of ageing. Already, far-reaching reform has substantially reduced welfare rolls and a strong economy has boosted the employment of disadvantaged groups. A lasting improvement in the position of the least advantaged will require an enhancement of their educational opportunities. The Survey points out that one way of achieving this is to lessen the extreme variations in spending among different school districts.

Elsewhere, legislation underpinning financial regulation should be reformed. The Glass-Steagall Act, dating from the Great Depression, created barriers between banks and other financial institutions, which should be removed. In addition, artificial barriers between over-the-counter markets in derivatives and futures exchanges should be lifted by relaxing the prohibitions of some activities of regulated exchanges.

A lot to do therefore. But the mathematics suggest there is little choice, as well as little time, to get the policies right. Certainly, in future years, keeping demographics close to the heart of US economic thinking and strategy would be a wise move. Neglecting it would not. Perhaps there is a clever motto in there too somewhere. n


Maintaining Prosperity in an Ageing Society, OECD Paris, 1998.

United States Economic Survey, OECD Paris, 1999.

©OECD Observer No 217/218, Summer 1999 

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