Sunday, October 29, 2006

US: The Coming Demographic Tsunami

by Edward Hugh

Well, reading through this account of a recent speech by David M. Walker, head of the US Government Accountability Office, I have only one thing to say: Demography Really Does Matter.

Walker has committed himself "to touring the nation through the 2008 elections, talking to anybody who will listen about the fiscal black hole Washington has dug itself, the "demographic tsunami" that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government".

Walker is, it seems, more or less auditor general for the United States. Personally I couldn't speak with any authority about the dynamics of the US deficit, but I imagine Charles Walker can, and he should know what he is talking about, and if he doesn't, then he shouldn't be in the job he is in. T

The interesting thing about all this is that the US is one of the better cases (in terms of the general sustainability of its economic path). So is France, and look what Michel Pébereau recently said in his recent authoritative report for the French government:

Pébereau does not mince words: over a quarter of a century century French public policy has accumulated for itself a national debt has neither supported economic growth nor reduced unemployment. The debt is “asphyxiating” and unless the State acts to reduce its spending now France will “lose control of the financial situation” before the end of the decade.

And these are the moderate cases, there are far worse ones, Italy for example.

And as Walker himself says:

"You can't solve a problem until the majority of the people believe you have a problem that needs to be solved".

And it seems that the majority of people, in the US and elsewhere, are in denial on the problem:

Polls suggest that Americans have only a vague sense of their government's long-term fiscal prospects. When pollsters ask Americans to name the most important problem facing America today — as a CBS News/New York Times poll of 1,131 Americans did in September — issues such as the war in Iraq, terrorism, jobs and the economy are most frequently mentioned. The deficit doesn't even crack the top 10.

So the big fear is that something, somewhere will end up 'happening', and then people will start to wake up. I simply hope that the 'happening' in question will not be prove to be too dramatic and devastating for those history has appointed to serve as example. Meantime, here's some more from the Walker speech:


Walker's challenge is to get people not just to think about it, but to pressure politicians to make the hard choices that are needed to keep the situation from spiraling out of control.

To show that the looming fiscal crisis is not a partisan issue, he brings along economists and budget analysts from across the political spectrum. In Austin, he's accompanied by Diane Lim Rogers, a liberal economist from the Brookings Institution, and Alison Acosta Fraser, director of the Roe Institute for Economic Policy Studies at the Heritage Foundation, a conservative think tank.

"We all agree on what the choices are and what the numbers are," Fraser says.

Their basic message is this: If the United States government conducts business as usual over the next few decades, a national debt that is already $8.5 trillion could reach $46 trillion or more, adjusted for inflation. That's almost as much as the total net worth of every person in America — Bill Gates, Warren Buffett and those Google guys included.

A hole that big could paralyze the U.S. economy; according to some projections, just the interest payments on a debt that big would be as much as all the taxes the government collects today.

And every year that nothing is done about it, Walker says, the problem grows by $2 trillion to $3 trillion.

People who remember Ross Perot's rants in the 1992 presidential election may think of the federal debt as a problem of the past. But it never really went away after Perot made it an issue, it only took a breather. The federal government actually produced a surplus for a few years during the 1990s, thanks to a booming economy and fiscal restraint imposed by laws that were passed early in the decade. And though the federal debt has grown in dollar terms since 2001, it hasn't grown dramatically relative to the size of the economy.

But that's about to change, thanks to the country's three big entitlement programs —
Social Security, Medicaid and especially Medicare. Medicaid and Medicare have grown progressively more expensive as the cost of health care has dramatically outpaced inflation over the past 30 years, a trend that is expected to continue for at least another decade or two.

And with the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses of those two programs are about to increase dramatically due to demographic pressures. People are also living longer, which makes any program that provides benefits to retirees more expensive.



One last point. This is not simply a question of a 'boomer generation'. The whole point of this blog is to examine why the phenomenon is much bigger than this, and to examine the implications of this fact. As Ben Bernanke says, we are in the midst of a demographic transition


As a consequence, the anticipated increase in the share of the population aged sixty-five or older is not simply the result of the retirement of the baby boomers; the "pig in a python" image often used to describe the effects of that generation on U.S. demographics is misleading. Instead, over the next few decades the U.S. population is expected to become progressively older and remain so, even as the baby-boom generation passes from the scene.

Indeed here even the phrase "and remain so" may itself be misleading, since the median age may well rise and rise and rise, depending on the future evolution of fertility and longevity in the US. So of this transition all we are able to say at this point is destination uncertain, end-point unknown.

7 comments:

Anonymous said...

Edward, the man you quoted is shilling for the administration (for reasons unknown).

Demography does matter. Quite a lot. But that's why your leadoff piece is a masterwork of obfuscation. The problem that Walker is talking about does not come a program called Socialsecurityandmedicare, it comes from Medicare. And Medicare's problem is overwhelmingly driven by rising health care costs, not rising numbers of Medicare recipients relative to taxpayers. In other words, demography isn't the problem.

In fact, Social Security itself only faces a problem if productivity growth slows dramatically. Should that occur, the system would require a tax hike of only 2 percent of GDP to get back in balance. That's not even close to a tsunami.

Of course, the U.S. does indeed face a coming fiscal tsunami. The main reason for that, however, is that we're building up debt at an unsustainable rate because we refuse to tax ourselves enough to pay for our current spending. A secondary reason is that we have no idea how to deal with skyrocketing medical costs. Demographic change comes in a far distant third.

In other words, demography matters. And it matters a lot for a lot of issues. But that's not a reason to claim it matters in all issues. The U.S. fiscal future is one of those issues.

Best,

Noel

Edward said...

Noel,

"Edward, the man you quoted is shilling for the administration (for reasons unknown)."

Well OK, but I'm not batting for either side here, just trying to get a purchase on the realities which lie behind the surface.

OTOH it is the case that the left tend to try to reduce the importance of the demographic impacts since they don't fit the mindset, while the right take them more to their bosom since they like the idea of having to cut back on social programmes.

I try to remain more or less neutral here, since I think both sides tend to miss the point, it's just that they do this in different ways.

I don't think it's helpful at the end of the day to think about any of this ideologically. I mean we can be right or we can be wrong in the way we individually assess a situation, but we should try hard not to be wrong simply because we have an ideologically skewed version of events, whichever type of skew we might be talking about.

"The problem that Walker is talking about does not come a program called Socialsecurityandmedicare, it comes from Medicare."

Yes, I agree, but this is to do with the particular way the transition is affecting the US. Very low fertility isn't a problem, but health is.

"And Medicare's problem is overwhelmingly driven by rising health care costs,"

Yes, but why are health care costs rising? One argument is that this is due to inefficiencies in provision, but another issue would be the changing health pattern of the US population itself. Undoubtedly the observed outcome is a combination of these two factors.

I can't really go into this very much here (posts will come), but I think what we have in the US is now the presence of two different phenotypes both placing demands on the health system at one and the same time.

You have the longer-lived phenotype (which is essentially the by-product of the demographic transition we keep talking about, since it is a life expectancy and a fertility transition) as represented by the present boomer generation, but you also have the presence of a second - metabolic syndrome, obesity/diabetes - phenotype which is ageing prematurely, and suffers from higher levels of ill-health at earlier ages. So the US may find itself having to pay for two generations (or a generation and a half, or whatever combination you like) at one and the same time.

If this is so then however much you make health spending more efficient there is still a burden to carry, and there is a problem. Which is why I don't think:

"In other words, demography isn't the problem."

Basically demography is part of the picture here, although we still need time to work out exactly how. This is a very complex picture, so you will have to bear with me a bit and await justification, which you can then certainly disagree with.

In the meantime you could try googling "Jay Olshansky and obesity" to get some sort of idea. Essentially this is all the substance of debate between Olshansky and Vaupel, so there is clearly more than one point of view and interpretation possible here.

"is that we're building up debt at an unsustainable rate because we refuse to tax ourselves enough to pay for our current spending."

Yep, well neatly sidestepping the political questions this raises, you may also like to think about the fact that all our economic/social systems are not the same. The US and (eg) Japan are very different. So systems respond differently to different stimuli. The eurozone and the US, for eg, notoriously react very differently to changes in base interest rates. The US economy, as we can see at present, is very sensitive at this level.

Ditto changes in taxation.

The US is proud of the fact that it has a very honed-down machine, where a lot of advantages are leveraged from efficiencies in labour and financial markets. This has good and bad points (like almost anything, only ideologists can only see all good, or all bad). So the US may have an issue about changing levels of taxation, that say Italy or Japan (which don't leverage these kind of efficiencies to anything like the same extent) don't have, or don't have to the same extent.

So raising taxes may not be so easy in the US without more changes across the system, and in particular changes in how people see and respond to situations (expectations). Basically raising taxes may be associated with more "jobs burn" in the US than in other places. This is only a hypothesis, but it strikes me it could be the case. Time, I suppose, will tell.

Anonymous said...

Two comments, Edward, which I really do hope you seriously consider.

"Basically demography is part of the picture here, although we still need time to work out exactly how."

Are you sure that you're not looking for ex post rationalizations rather than testing ex ante hypotheses? It often seems as though you're looking for demographic explanations of everything --- that's not convincing social science.

I could be wrong, of course. It's merely the impression you give from quotes like the above.

"Raising taxes may not be so easy in the US without more changes across the system, and in particular changes in how people see and respond to situations (expectations). Basically raising taxes may be associated with more 'jobs burn' in the US than in other places. This is only a hypothesis, but it strikes me it could be the case. Time, I suppose, will tell."

I don't follow your argument. In theory, there are all sorts of non-distortionary ways in which taxes can be raised. In practice, the federal tax burden was significantly higher a mere six years ago with no visible bad effects on economic growth or labor market outcomes. Why are neither of these points convincing to you?

Best,

Noel

Edward said...

Noel,

"Two comments, Edward, which I really do hope you seriously consider."

I do. Or at least I try to. In order to maintain some sort of order I will post two separate comments.

"Are you sure that you're not looking for ex post rationalizations rather than testing ex ante hypotheses?"

Look, I am never sure of anything, if by "sure" you mean 100%, since I think some level of doubt is always justified. I think I am doing the latter, but none of us are perfect. This is certainly what I try to do.

OTOH there is always some sort of coming and going between the two, since you always need to look at what just happened in order to modify what you previously thought, and then formulate testable hypotheses for the future.

Claus and I formulated earlier in the year the idea that the recoveries in Japan and Germany would not be internal-demand self-sustaining. The theoretical reasons why not were pretty clear to us at least. 95% of the economics community went the other way. Now we are coming out smelling of roses.This argument about empirical testability is being applied asymetrically, the question ought also to be presented to those who say that demography isn't important in understanding what is happening in Germany and Japan to justify why it isn't, especially since they are permanently reading this situation wrong.

Indeed the curious thing about the demographic argument is that those who have thought about it to some extent (remember we here at DM are hardly alone) normally become convinced that something important is happening, while those (like Greg Mankiw in that post) who have scarcely considered it at all say the effects of demography are exaggerated. This is all far from satisfactory. Maybe the effects are exaggerated, but then you need to take the strongest evidence in favour of demographic impacts, and the strongest arguments used to back up the case, and SHOW that the impacts are being exaggerated. Given the importance of the topic this is the minimum you might expect. The absence of this level of seriousness already strikes me as being rather fishy.

I tend to stress Japan since this was really where I started on this journey, back in 1999. I couldn't for the life of me understand what was happening with the deflation there. In conventional theory terms it just didn't make sense.

Aristotle held that philosophy is born of wonder, I sometimes ask myself why more people are not prone to wonder more.

Anyway, I dug and dug, and started to get interested of the demography of the situation, to see if this might have something to do with what was happening. So then I got interested in fertility, and then in life expectancy. Then I came across the idea that the two might be interconnected somehow, with technology possibly as some sort of mediator, and well, here I am.

I also put forward for myself the idea that not only would deflation not disappear from Japan, but that it might well appear elsewhere (Germany being a very likely candidate).

Well, if you discount a 0.25% inflation rate achieved on the back of a huge oil and commodities boom, with the yen trawling along the bottom in exchange rate terms, Japan is still very much mired in deflation 7 years later, and we are about to see when we get into the next recession whether this phenomenon extends itself. My guess is that it will do, but I am open to the test.

The bigger question about the transition itself is harder to answer. Basically the first version of the theory has long been known to be unsatisfactory. There was always the issue of directionality with the causal arrows, with notably Easterlin and Caldwell arguing that it was modernisation which produced the transition, and not vice-versa.

Really I don't think that we need to be dogmatic here, there is interaction, two-way interaction.

Now that the transition has gone well beyond the expectations of the early theorists (with the sytematic arrival of lowest-low fertility in many countries, and life expectancy continuing to go up and up in most of the planet) there are grounds for taking a new look at the whole edifice, and this is what I try and do in the rethinking the demographic transition paper which I have on the research page of my website.

But this is still only work in progress, since all this interconnectedness is so complex that each time I start something new I find I then have to go back over most of what I have already done. So I hope you will forgive me if I cannot always be a fount of clarity: I too am confused, but like Socrates said, I've passed the first stage of the exam, since at least I know I am confused.

Ok, I hope that all this shows I am trying to take your point seriously. Stick around, since I hope the next year will prove interesting.

Incidentally on your "Catalan racism" concerns, you might like to know that José Montilla, who is the most probable next president here, was himself an immigrant, and was born in Andalusia, and is probably likely to be the strongest defender of our autonomy to date.

Edward said...

"I don't follow your argument."

Ok, Noel, this is something quite separate from my previous point. It is an economic intuition I have, a guess. I'm not asserting this strongly.

Basically I am arguing that each social and economic system is different (this is known to some extent as path dependency) and that the oil flows through the engine in different ways. Some systems are more 'tensed', others less so.

One of the difficulties in your seeing this may be that it goes in some sense against some of the of the founding principles of neo-classical economics, in the sense that neo-classicism usually discounts sociological and anthropological analysis right from the start.

I often think these things are central.

You can't understand the differences between the European and the US labour markets without taking kinship systems and structures into account. It isn't that one is right and the other wrong, or vice versa, but just that they are different, and the economic system - as Talcott Parsons at least realised - is built around such systems.

CapTvK is getting at something similar in a comment somewhere when he talks about the different family patterns between North and South Europe, and how these extend back over centuries. These things don't change in just 24 hours.

So I am saying that the US system is extremely tensed and leveraged in a global context. What this may mean (and I stress may) is that the employment generation machine may be much more sensitive to the phenomenon known as the tax wedge than it is elsewhere. The tax wedge is the non-wage cost element in each extra job created. My feeling is that you start loading this beyond a certain point in the US and you are going to feel it.

But like I said, this is only a guess, an 'intuition'.

Anonymous said...

Edward,

Thank you for the responses. Let me take them in turn.

(1) There is a philosophical problem when you say the following: "The question ought also to be presented to those who say that demography isn't important in understanding what is happening in Germany and Japan to justify why it isn't."

That's the equivalent of (pace Jon Stewart) saying that you can't convict somebody of a crime until you've proven that everyone else didn't do it.

If you want to pin Germany and Japan's current economic problems on demography, then you have to do three things. The first is clearly state what empirical facts would be inconsistent with your demographic explanation. The second is to show that the empirical facts are not, in fact, inconsistent with your explanation. The third is to show that the empirical facts are, in fact, inconsistent with the common alternative explanations.

Of course, you don't have to argue that way, but if you don't then you'll never convince anyone who doesn't already believe that you're correct. You also won't be able to convince anyone that you are open to evidence that might prove your explanation wrong.

In the same paragraph, you go on to write: "Especially since they are permanently reading this situation wrong." To which I respond: who are you talking about? Paul Krugman would merely be the most prominent economist who appears to have had a correct reading on Japan's poor economic performance.

I don't believe demographic explanations for Germany's current economic problems (as opposed, of course, to its future ones) for the simple reason that there are lots of countries with a similar demographic profile but without the country's poor economic performance. That is not to say, of course, that I couldn't be convinced otherwise. It is to say that I would need to see a logically-structured argument backed by empirical evidence.

I find demography fascinating, of course, and I think that your work raises some very interesting issues. That said, you might want to consider tightening up your arguments if you want to persuade a skeptical audience.

That, of course, is a different issue from the one addressed in your second post.

(2) "Like I said, this is only a guess, an 'intuition'."

Well, Edward, the thing is you completely ducked my question. First, you set up a straw man, by saying that most economists do not believe that institutions effect economic performance or that some countries have more flexible economies than others. (You probably did not intend to say that, but that is indeed what you said.)

Then you went on to say that different economies do indeed behave differently. I certainly do believe that.

Finally, you assert that the U.S. economy is tensed and leveraged. Well, I can't say that I understand what "tensed" means. I also can't say that I understand why the high levels of indebtedness in the U.S. would make the economy more sensitive to overall tax rates.

At which point you stop, without answering my question, which is, to repeat: Why do you believe that the U.S. economy is particularly sensitive to the overall level of taxation when it performed quite well under higher taxes a mere decade ago?

As far as intuitions go, intuiting that the U.S. economy would be particularly sensitive to overall tax rates seems rather ... well ... counterintuitive. So you still need to explain this one to me. Not the general point, which I think every thinking person accepts, but your specific intuition about the American economy.

I'll admit that I have some trouble convincing myself that you seriously believe that the U.S. can't tax itself more than it does without significantly worsening job creation.

Best,

Noel

P.S. Good news about the new provincial president over there. Let's hope we in America have similar good election results to report on Tuesday night. Knock on wood.

Edward said...

Noel,

"If you want to pin Germany and Japan's current economic problems on demography, then you have to do three things"

OK, lets try and run with this. Incidentally if you really want to assess for yourself the validity of what is being said here you really do need to follow Claus's blog, and especially the posts on Germany and Japan over the last six months (or mine on Bonobo or Afoe over the last several years, but I've been rather lazy on this of late since I am trying to get the theoretical side straight at the present time).

Now:

"The first is clearly state what empirical facts would be inconsistent with your demographic explanation."

Yep, that's easy, a sustained domestic demand-lead recovery. I'm saying this will never happen (and remember *never* here means never, Germany and Japan will never be young again). The reason for this is that the key demographic parameter in question is age structure, and in particular median age, and the point to note is what happens to the marginal propensity to consume as the median age of a country passes a certain point. This point has still to be empirically specified (ie I agree, research is of course needed) but it seems to lie before 44, which is where Germany, Japan and Italy are more or less now.

"The second is to show that the empirical facts are not, in fact, inconsistent with your explanation."

Well as Popper said you can never do this completely for sound logical reasons, but this situation has now more or less persisted in Japan for 17 years, and we still haven't seen that recovery. Still I can't *prove* that it won't come tomorrow.

"The third is to show that the empirical facts are, in fact, inconsistent with the common alternative explanations."

This is much easier, and this is what Claus has effectively been doing. Going further here requires a very long argument indeed which goes into the whole debate about Japan.

I personally am quite happy that I can, and will, time permitting, back-up substantially what I am saying, but I have other pressing theoretical priorities to resolve first.

Which brings me back to this:

"The question ought also to be presented to those who say that demography isn't important in understanding what is happening in Germany and Japan to justify why it isn't."

Which I still stand by, since I think the non-arrival of the promised recovery should lead those. like yourself, who like to ask difficult questions, to put those very same questions to those whose expectations have not been confirmed, as well as to those whose expectations have, to some extent, been confirmed.

"for the simple reason that there are lots of countries with a similar demographic profile but without the country's poor economic performance."

Well I'd be very pleased to hear which ones those are, since the key parameter here, as I've said, is median age, and the only similar countries to Germany at this stage are Italy and Japan, and even here 'similar' does *not* mean identical.

I will pull this out of the comments and post on it tomorrow, since I think the point is worth elucidating.

"To which I respond: who are you talking about?"

Again, have a look at Claus's blog: the FT, the Economist, the WSJ and family, Brad Setser and Nouriel Roubini, Stephen Roach, IMF staff economists, the Bank For International Settlements, the ECB, the BoJ. Is that enough for you?

"Paul Krugman would merely be the most prominent economist who appears to have had a correct reading on Japan's poor economic performance."

You raise an interesting name here, since it was in fact Krugman's work that first got me interested in the problem. In fact truth be known he was even the one who gave me the 'aha' experience, since in the "Ooops ists baaaack", paper he mentions at some point that "some have suggested the problem might be demography", and then presents a short back-of-the-envelope type model to show what happens to an asset price like house values in the context of shrinking generational cohorts. This is simply one simple and direct example of a demographic impact.

But I am surprised that you suggest Krugman has a 'correct reading' on Japan since his main work has been a technical consideration of how to jump-start an economy which is stuck in a liquidity trap, rather than an analysis of the problem as such.

Krugman is a great admirer of Irving Fisher on the side, and he mainly seems to rest his case on the presence of a Fisher-type debt deflation process (see the 2001 NYT piece "the Fear Economy" on his unofficial site for a summary of this). But Japan's crash was in 1989 - 17 years ago for God's sake - this is why I say we need a more substantial explanation. This issue is quite literally without precedent in the debt deflation literature.

Another US economist who has given a fair bit of thought to the Japan issue is Ben Bernanke, and he has moved IMHO some distance in the direction of the demographic understanding.

Bernanke starts out from a monetarist backround (which I don't share) but has been pretty pragmatic in feeling his way forward. He started by assuming you could get out of the liquidity trap by using something like 'helicopter money' (he was a Milton Friedman kind o guy at heart) and assumed that since they hadn't been able to get out then they must have been doing something wrong (like sterilising). Then I think he got more involved at the Fed, and came to realise that in fact they had a kind of monetary black hole on their hands where the velocity of circulation seemed to change as the volume of money in circulation did (something which simply isn't envisaged in the standard versions of quantity theory). So he started to learn and change tack. This was the epoch of the famous deflation alert at the Fed, which most observers have never really understood.

Bernanke also tested an influential paper by Mankiw, Weil and Romer on growth based on the Neo Classical supposition of steady state growth, and he tried this and found it wanting, while at the same time noting a lot of background demographic and human capital related 'data noise'.

So I think he has been moving, and continues to do so, and I see the savings glut argument (which again virtually noone seems to understand) in this context. The response to this speech was indeed curious since you have the person who is undoubtedly one of the most talented members (if not the most talented member) of the current generation of US economists coming out with new and stimulating ideas which the rest of the pack simply fail to understand. Like pearls before swine someone once said, but surely this would be rather unkind. But why can't those who understand less sometimes be prepared to calm down a bit and listen to those who understand a bit more? This is one of the more frustrating aspects of this whole situation.

If you want more references to economist interested in Japan you could tryt the Japan page on my website.

OK, I'm sure I haven't convinced you, but I guess there are some pointers here, and there will be more posts round and about trying to spell all this out in a bit more detail in a not too distant future.