One of life’s comforts is reading the Economist. The magazine is generally optimistic about the world’s prospects for growth and improvement. An article typically takes the following form:
- problem is identified
- straightforward solution is offered
- discussion of why some countries don’t have the political will to implement the solution
- example of one country that behaves rationally
This is comforting because it is then clear that there is a lot of low-hanging fruit. If our politicians could wean themselves from the diet of special interest money, our problems could be quickly and painlessly solved.
One example is automobile pollution. The U.S. government regulates the amount of pollution that new cars can emit, but actually encourages people to keep old cars on the road (through sales tax and property tax, in addition to the inevitable higher insurance rates of a new and more valuable car). So we get into a situation where 95 percent of the pollution comes from 5 percent of the cars. The rationalists at the Economist would point out that cars are being inspected annually. Why not hook up a meter to the tailpipe, measure the amount of pollution, and charge a tax that is proportional? This would give owners of old cars a financial incentive to buy a new Honda Accord.
Another example is automobile congestion. Two of society’s most valuable resources are the road network and everyone’s time. We let drivers waste both of these by crowding onto roads at peak times and make no effort to discourage them. The Economist would explain that a congestion fee would encouraging car-pooling and time-shifting of non-essential errands as well as boosting revenue for cash-hungry governments (enough to lift California out of bankruptcy?). Examples of the smart and successful folks in Singapore and London then close out the article.
I therefore couldn’t resist buying the April 9-15th issue of the Economist at the supermarket. The cover story promises “a special report on pensions”. I figured that I would be comforted by learning that this alarming problem has a simple solution.
The magazine gives a comprehensive overview of the problem. The most important number is the support ratio, between the number of working people and the number of retired people. In the U.S. it was 4.6 in 2010, trending to 2.6 in 2050; Australia is very similar. Japan is already living our future, with 2.6 today and trending to 1.2. Turkey’s prospects are bright today, with a 9.8 ratio, but trending towards only 3.2 in 2050; Mexico has similar numbers. The numbers give some insight into the bankruptcy of Greece: a 3.4 ratio today, trending to 1.6 in 2050 (i.e., worse than the U.S.), a young average retirement age of 61.9, and pensions that are, on average, larger than a worker’s salary. Spain doesn’t look great by the numbers either, 3.7 today and 1.5 in 2050 (paying unionized public workers, such as air traffic controllers, more than $1 million/year probably hasn’t helped them either).
Perhaps the problem will correct itself as people work until they are older? In the world’s rich countries, the official retirement age is set to rise by about 2 years by the year 2050. Life expectancy, however, is predicted to rise by 3-3.5 years. So the challenge will be getting tougher, not easier. And with public workers retiring at 41 (Boston bus driver), 50 (fire/police/prison/sheriff workers nationwide), or slightly older, plus disabled workers dropping out young, healthy private workers will have to stay on the job to age 80+ in order to bring the average up above 70, which is where it will need to be, according to the Economist.
The U.S. Social Security system has been running at a cash deficit since 2010. What’s the true cost of Social Security? The first recipient was Ida May Fuller, who paid in $24.75. She received $22,889 in benefits until her death at age 100. A couple retiring at age 66 can get a benefit of $4,692 per month for life, indexed to inflation. MetLife would charge them $1.2 million for an annuity with the same characteristics. What do folks save if left to their own devices? The average in Britain is about $44,000 (though these people know that they can count on a Social Security-like program as well and that number includes workers of all ages; the comparable U.S. figure is $58,350; the figure for workers in their 60s was less than $200,000).
Who can escape the coming pain? State and local government workers in the U.S.! Courts have held that they’re entitled to continue accruing pensions under whatever scheme prevailed at the time they were hired. Since government workers almost never quit, that means that a 22-year-old hired in New York City in the boom year of 2007, when Mayor Bloomberg and union cronies in Albany were handing out lavish pensions, will accrue those benefits until retirement at age 50 or 60. Britain is not in any better shape. Their current funding shortfall for government workers is roughly 81 percent of GDP (about $11.4 trillion if measured against the U.S. economy; whereas we have a $3 trillion shortfall at the state/local level).
Municipal bondholders will not escape the pain. When Vallejo, California went bankrupt, bondholders got 5-10 cents on the dollar. Public employee pension benefits were unchanged.
How about the example of the one successful country full of smart people? Among rich nations, the only example the magazine could find is the Netherlands. They have “a higher ratio of pension assets to GDP than any other country”, with 100% funding, basically, for the actuarially predicted costs. They retire younger than Americans (age 62.1 versus 65.5). Part of the magic is that they don’t promise unlimited inflation indexing. If their country gets poorer, the pain will be shared by the working and non-working alike. The same is true in Sweden, Germany, and Japan. But mostly the Dutch have deferred consumption. Overall, the countries that have at least some plan and hope for paying what they’ve promised are the Netherlands, Switzerland, Sweden, Australia, and Canada (this doesn’t include developing countries such as China, which has $3 trillion in cash and hasn’t made any long-term promises).
What’s missing from the issue is any hope of an easy, quick, painless, or cheap fix. The article assumes that public workers will be protected by the politicians that they paid to elect, which means private workers must shoulder a previously unimaginable burden of taxes and an extra decade chained to a desk (my article on early retirement will be read by ever-fewer people in developed nations).
[One option that the article did not mention is that U.S. state and local governments could simply fire all of their existing workers. They may not have the constitutional power to reduce benefits being accrued by workers going forward if the worker was hired in, say, 1998 or 2005, but states have the power to eliminate agencies or fire everyone. The states could then hire people as needed under new terms and conditions. (I sat next to a senior administrator from a Colorado school system. She said that the salaries they offered were so much higher than a market-clearing wage that she could replace all of her teachers within a week or two, except for some math and science positions.) Politicians who receive donations from public employee unions aren’t likely to do this, of course, but it does seem to be the way out of the fiscal trap.]
I’m pinning my hopes on this:
http://en.wikipedia.org/wiki/Post_scarcity
iRobot, the AI Lab, and hopefully Mr. Fusion to the rescue!
Beyond: That’s an excellent point! The Singularity is near and no human, of any age, will have to do any work. There’s probably at least as good a chance of the Singularity happening as of state pension funds delivering the investment returns that they’ve been assuming.
Phil, I have read The Singularity Is Near, and while I am skeptical, Ray Kurzweil does try to give evidence of why he thinks it will happen. What makes you so sure it won’t? I’d appreciate a few links…
Murali: I wrote about the Singularity in http://philip.greenspun.com/blog/2009/02/04/singularly-stupid/
I am an enthusiast for technological innovation. I wish that I could find the source, but someone wise and now dead said something to the effect that for the time time in human history we had a way of becoming wealthier without simply taking something away from someone else.
However, continuous technological innovation is already built into worldwide GDP growth assumptions. So we won’t escape from our pension burden inventing and adopting at the same pace that we invented and adopted new technology in the past.
I know that the Singularity is about machines inventing new machines, but our current machines are so dumb that I can just as easily imagine faster-than-light space travel as I can a computer program that invents a new and better battery technology.
Maybe this discussion should be broken down by age groups.
For people like my parents(50+), they will do nothing, because they probably won’t be around by the time the situation deteriorates to that point(unless they live to 100).
For people like me(25<age<40), maybe we should adopt a state religion such as Catholicism that discourages the use of birth control, along with more restrictive immigration laws. Then we'll have more potential tax payers in the future who can't easily escape, and will have to toil in the wheat fields to support people like me.
More realistically, what's to prevent future working taxpayers, sufficiently angry and motivated, to vote for special taxes that are applicable only to retired public employees, to collect the money back?
What's to prevent the government from just turning on the presses and printing "mini-dollars" as you call it, and giving these "mini-dollars" to the retired public employees, while at the same time adopting a parallel, less-inflated currency(food stamps for example) and paying the working population with that?
If things keep going as there are now, I think this will play out like so:
1) Print more money and pay the bills
2) Lie about inflation
This is the course of action that is least likely to be voted against.
> Life expectancy, however, is predicted to rise by 3-3.5 years.
You should be looking at life expectancy at retirement, which is a different and lower number than life expectancy at birth.
> current machines are so dumb that I can just as easily imagine faster-than-light space travel as I can a computer program that invents a new and better battery technology
It is indeed difficult to get your head around exponential growth. Current computers have the processing power of insects and perform roughly at that level or better. Multiple this power by 10,000-100,000 and the game changes. Algorithmic progress is needed but exploiting current levels of hardware performance has not been a problem to date.
> The first recipient was Ida May Fuller, who paid in $24.75. She received $22,889 in benefits until her death at age 100.
One aspect of the retirement pension dilemma is that it represents, among other things, a *huge* transfer of resources from (mostly) working men to (mostly) retired women – women pay less taxes and live longer and therefore collect more pensions in return for lower contributions.
Here in Australia the retirement scheme is mostly accumulation based. You get back what you paid in plus investment returns. The fall-back is a not-very-generous aged pension scheme.
The assets of the US social security scheme are government bonds. Which are not actual assets, but just pieces of paper.
People often posit increased population growth as a solution to the pensions problem. This is however a Ponzi scheme and cannot last very long. If nothing else, 1% growth for 3,000 years would require humanity to expand outwards at more thatn the speed of light, which violates the laws of physics.
There is a relatively simple solution which will almost certainly be employed in the future. This solution will essentially be inflation. It is common that even when necessary and economically beneficial on the whole that individuals will not give up hard won salaries or benefits. Similarly individual saving / spending patterns also often lead to bad feedback loops. In such cases central bankers can adjust things all at once by changing the money supply. This is typically done by changing interest rates or in more extreme circumstances printing money. Inflation solves the retirement problem by devaluing benefits of non-working people, while working people can demand higher salaries (but effectively the same purchasing power). People’s savings are typically hurt significantly (though young retiree’s can protect much of their savings with appropriate investment strategies), and bond holders are also hurt as the dollars they are paid back in are worth less than those they invested. This is the continuous version of a default, and is possible to us because we borrow in our own currency.
If managed correctly the consequences will be that suffering is shared essentially in proportion to however much the central bankers wish as they have the control knobs. Working people end up with somewhat less purchasing power, retirees also end up with less purchasing power, and borrowers lose money on their investment. Depending on the severity of the correction needed the dollar’s reserve status may or may not be affected (it’s importance should diminish to some extent regardless just because there are now other stable currencies with enough scale to be relevant). If it is done incorrectly one could have runaway inflation and all kinds of badness.
A few notes:
I am not sure what percentage of pensions are inflation adjusted but I expect whatever methods are used will still significantly rob those of value.
Much of the problem is demographic in nature. A growing population can easily support generous pensions while a shrinking one cannot really support them at all, and a static one can only support very modest ones. Where one is born on this curve is mostly luck, just as is being born into a rich country, poor country, or rich family, or poor family…after all if you inherit a billion dollars it is unlikely that any of this will cause you personal hardship. People who were fortunate to be born just after world war II have had a pretty good run of things (those who had to die in it less so). So while some of it was poor planning and structural problems in the way politicians are elected and what not, much of it is just the luck of when people are born and demographic trends.
People often forget that private savings have the exact same problems that government savings do: if you’re going to save for retirement now, you’ll need to sell some asset to younger people who want to buy it. If there are fewer younger people and they’ve got less money to buy assets, you’ll find the value of your assets drop.
People also forget that the flip side of unsustainable debt is unsustainable savings. One individual might be able to save, say, $5 million and have a easy retirement, but collectively, I think the financial system as a whole isn’t capable of delivering on all the promises that people wish it would deliver on.
I got mad one day when I looked at the board of directors of a ‘2030’ fund and noticed that the youngest person on the board was 54. Most of the people on the board won’t be alive in 2030 — they aren’t people who have a stake in the future. Having a healthy economy in 2030 isn’t a matter of asset allocation between stocks and bonds, but it’s about investing in solutions to problems such as fuel depletion, global warming, global terrorism and sustainable development.
Inflation predictors: You’re being proved right by the markets. Today gold hit $1500/ounce for the first time in history. The official inflation number that is used to adjust Social Security and government retiree pensions remains low… because it doesn’t include gold, gasoline, food, or much of anything else that you might want to buy! The government’s low CPI will be a comfort for me today as I spend $80 to fill up my four-door Japanese sedan with Venezuelan fuel.
Innocent Bystander: I think that most of the Economist section was looking at life expectancy starting from age 65, just as you suggest.
if you’re going to save for retirement now, you’ll need to sell some asset to younger people who want to buy it.
In theory I could buy a lifetime’s supply of salted pork and barrels of oil and consume them directly.
Skipping back one abstraction layer, I could buy pork futures and oil futures. Commodity futures are an excellent way to prepay for future consumption. (In fact, that’s about all they are good for.)
Actually, food and fuel are included in the CPI, which is used to determine adjustments to Social Security benefits. See http://www.bls.gov/dolfaq/bls_ques3.htm
Apparently, rents are rising very slowly. Also, house prices have been falling for years and haven’t stopped. A family member who is a realtor in Central Florida tells me that small condos in cheap neighborhoods can be had for $35,000. So people approaching retirement who are worried about Social Security’s viability and their own shrivelled 401(k) accounts do have something to look forward to.
Paul Houle: Private savings don’t have the same problems government pensions have, as private savings can be invested globally. Rich countries might have low birthrates and rapidly aging populations, but lots of developing economies in Asia/Latin America/Africa are full of young workers.
I don’t really understand the theory behind ‘unsustainable savings’, so I won’t argue that it can’t be a problem. On the other hand, the average American currently has $58 000 in savings, so we probably won’t have to worry about it for a while.
Yeah and the Netherlands is a place where working people don’t have to turn over everything they’ve earned over the course of their lifetimes to the University for their children’s education (it’s paid for through taxes) and their first significant health emergency (it’s paid for through taxes).
So in other words, they don’t spend their working lives in terror and fear of being ruined because they get sick, lose their job or want to educate their kids.
So despite the taxes- wait make that because of the taxes- they actually have more real economic freedom and security and their country just works.
Who would have supposed that collective action and foresight could produce such results? Surely readers of your blog are well acquainted with the evils of big government and taxation.
It’s a mystery! Perhaps the Economist can solve it to your satisfaction.
Anonymous: I’m not sure that you’ve found a good argument for higher taxes in the U.S. Mostly I think you’ve found a good argument for the U.S. to turn over government to the Dutch. If we gave the U.S. government more money (higher taxes), they would presumably use it to do the same things that they are currently doing, e.g., start additional foreign wars, enrich cronies of politicians, bankrupt future generations with unfunded pension promises (for cronies of politicians or politicians themselves!), etc.
Tax dollars spent by the Dutch government will not have the same effect as tax dollars spent by the Zimbabwean government. I guess there is some debate about where the U.S. government falls on that spectrum, but these unending and pointless wars make me think that we’re closer to Zimbabwe than most realize.