Wednesday, December 22, 2010

Demographic Stress Tests

For some time now, I've been convinced that US government employee unions and various social wealth transfer schemes, e.g., Social Security, Medicare and Medicaid, will have to accept significant reductions in promised benefits due to unchecked growth in said benefits due to unrealistic contract terms and poorly-designed programs.

On the weekend after Thanksgiving, Nicholas Eberstadt of the American Enterprise Institute and Hans Groth, senior director for Healthcare Policy & Market Access for Pfizer Europe, wrote Time for 'Demographic Stress Tests,' an editorial in the Wall Street Journal which describes some of the potential consequences if my expectations are not realized.

The editorial paints a dark picture, beginning,

"Financial crises can erupt suddenly and unexpectedly. Demographic pressures, by contrast, gather slowly and predictably—but over just a generation they can transform the economic and social landscape irreversibly.

Such a transformation is already underway in the developed world. Twenty years from now, Western economies will be characterized by stagnating populations, shrinking work forces, steadily increasing pension-age populations, and ballooning social spending commitments. These demographic changes will mean major increases in public debt burdens and slower economic growth, as savings are diverted from investments and innovation that enhance productivity."

For example, they write,

"The U.S., meanwhile, can expect to see continuing population and manpower growth between now and 2030, thanks to relatively high birth rates and a robust inflow of immigrants (roughly half of them legal). America will remain the most youthful Western society, although its 65-plus population will be about 19% of the total, up from 13% today.

Nevertheless, entitlement liabilities—especially the unfunded liabilities in the health-care system—are on course to skyrocket in the decades ahead. The country's recently enacted health reform will make the burden heavier.

At present, the ratio of gross U.S. public debt to GDP is nearing 100%, and the country is running annual deficits of around 10% of GDP. The Congressional Budget Office projects gross public debt to be 200% of GDP by 2020, and the BIS sees it hitting 300% of GDP by 2030. By the BIS estimates, restoring the U.S. public debt burden to 2007 levels would require budget surpluses of 2.4% of GDP for the next 20 years.

Maintaining economic growth in the face of these demographic trends will require rethinking current approaches to work and retirement, pension and health-care policies, and government budget discipline."

Music to my ears, most assuredly. I've become certain that, for the US to avoid fiscal calamity on a society-wide scale, the 1930s- and 1960s-era social safety net programs, all sharing design flaws, must soon be seen as a temporary taking leave of economic senses by a country careening between deep despair and post-war elation. They will have to be halted, dismantled, or severely capped, to be replaced by more restrained, individually-based, defined-contribution, rather than defined-benefit approaches.

Eberstadt and Groth provide similar statistics for other countries, including Germany and Japan, which, together with the US, the authors note comprise "half of the West's output and nearly 30% of the world's GDP."

All three are projected to experience public debt/GDP ratios of over 200% in just twenty years. Japan's would hit 600%. These are stunning numbers, when you are used to the US running no more than about 50% on this ratio in past decades.

The authors suggest, in conclusion,

"Thanks to the recent financial crisis, we're now familiar with the concept of the "financial stress test" used to evaluate the soundness of banks and allied institutions. A "demographic stress test" for Western economies is now in order, so that voters and their elected representatives can cope with aging populations and declining work forces.

Such an exercise would assess how manpower availability, labor force participation rates, aging and budgetary commitments would, over the next 30 years, affect key measures of national economic well-being like growth and productivity, fiscal balances, and government debt. It would also indicate the extent to which adverse "baseline" costs and consequences could be mitigated or offset by changes in lifestyle, personal behavior and public policy. These could include, for example, later retirement thanks to healthy aging, increased attention to preventive health care, enhanced personal savings, and adjustments to health and pension schemes.

Every Western country will have to determine how to pursue a future that is grayer but healthier and more affluent. The sooner we pay serious attention to the demographic challenge, the likelier we will be to meet it successfully."

Even these pundits avoid what ought to be obvious to objective observers of these predictions. Most large Western country pension, social safety net and health care schemes will have to be radically redesigned and reduced in scope and cost. There's just no way, after several decades and generations in which expectations have been so heavily affected by citizens' knowledge of social benefits replacing their own savings, that younger, working citizens can or will sustain these obligations.

Who in their right mind expects people to work from 21-70, then live for another 15-20 years at similar standards without having saved substantial amounts of their prime years' compensation? Especially when you add in the demographics of shrinking young Western populations- except for the US- which make the burdens so much more heavy?

Reading a non-partisan, cold-eyed piece like Eberstadt's and Groth's really opens your eyes to the magnitude, across most of the West, of the size of the shortfall and drag on economic activity that old, ill-conceived social spending obligations for pensions and health care will have in a comparatively short time.

More than in past years, we are now, for many countries, on the cusp of moving irrevocably into financially dangerous territory if we continue to allow badly-designed, unsustainable social programs to remain in place.

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