Saturday, March 29, 2008

Research Digest # 1 - Ageing and Wages, Retirement Saving Crisis, and Income of Aged Cohorts

As Edward alluded in his introductory post for 2008 many of the main contributors of this blog were hard at work monitoring the ongoing events in global financial markets. We still are. However, we are also social scientists and this space is still a very important place in our minds where especially the scientific progress within the realm of demographic research commands a center role. As such, I am going to unilaterally venture a new tradition here at DM and one which I hope that I will be able to carry forward. In this way, the authors of this blog do in fact get a steady stream of links and references to research conducted in the sphere of economics and demographics. It is only because of the well-known shortage of time that these rarely reach the front pages here. This, I hope, is now going to permanently change. So, without further ado let us commence.

In this first edition of the research digest I am going to present a couple of papers which investigates a number of the hypotheses we are working with.

The Labour Supply of Older Americans - Alicia H. Munnell and Steven A. Sass (2007) Center of Retirement Research Boston College.

This paper summarizes what is known about the labor supply of older men defined as those 55 and over. The topic is of great interest because older individuals will comprise a much greater portion of the population, so their labor supply will have a significant impact on national output, tax revenues, and the cost of means-tested programs. Most importantly, a greater proportion of older individuals will need to work than do at present, because retirement income systems are contracting and working longer is the only way for most to ensure financial security in their old age. The focus is on men, because women’s work patterns reflect the increasing participation of cohorts over time as well as the factors that affect retirement behavior.

What is particularly interesting in this paper is of course whether the factors identified in the study represent factors that can be extrapolated to other countries and thus whether we can identify some universal points on the labour supply of ageing workers. As always, cultural differences may exert a considerable influence here and in a scientific light the issue of causality might be particularly difficult because it is difficult to see where culture begins and where it ends. Not surprisingly, the paper's conclusion is situated in the context of US regulatory context and here the paper notes that while the partipation of older men (say 55-64) has risen since the mid 1990s it is unlikely to grow at the same pace. The authors field a projection that by 2030 about 75% of men aged 55-64 will be in the labour force up from 70% today but, as the authors note, not near the 80% in the 1960s and 1970s where social security for the elder was not available to same degree. More importantly though in the context of the global forces of ageing the following excerpt describing the 'nature' of the elderlies' labour supply is quite important ...

Even today, with the elimination of the earnings test after the Normal Retirement Age and an actuarially fair Delayed Retirement Credit, the majority of workers continue to claim their benefits as soon as they become available. Another important factor is the increased mobility of older workers, which exposes them to the vagaries of the labor market. Extended and difficult job searches as well as the prospect of low wages may cause many older workers to simply give up. Moreover, older people have a strong preference for part-time work and flexible schedules, which to date employers have been reluctant to accommodate. Finally, 15 percent to 20 percent of older people are probably not healthy enough to work beyond age 62.

Now, the detail highlighted in bold is by no means unsignificant. In order to show this we need to remember that the US population pyramid remains one of the exceptions to the rule of rapid ageing amongst the developed economies. If we thus go to Japan the paper by Munnell and Sass seems to provide some kind of support for the hypotheis that one of the key tendenies of falling wages in a Japanese context quite simply is that as the workforce ages and once we get to the situation Japan is in with a median age of 42-43 (and counting) the ratio of part time jobs to regular jobs will increase thus in itself surpressing the aggregate income level.

Population ageing, Labour Demand and the Structure of Wages - Margarita Sapozhnikov and Robert K. Triest (2007) Center for Retirement Research at Boston College

One consequence of demographic change is substantial shifts in the age distribution of the working age population. As the baby boom generation ages, the usual historical pat tern of
there being a high ratio of younger workers relative to older workers is increasingly being
replaced by a pattern of there being roughly equal percentages of workers of different ages. One might expect that the increasing relative supply of older workers would lower the wage premium paid for older, more experienced workers. This paper provides strong empirical support for this hypothesis. Econometric estimates imply that the size of one’s birth cohort affects wages throughout one’s working life, with members of relatively large cohorts (at all stages of their careers) earning a significantly lower wage than members of smaller cohorts. The cohort size effect is of approximately the same magnitude for men and for women. Our results suggest that cohort size effects are quantitatively important and should be incorporated into public policy analyses.

Once again we get some interesting indications as to what happens to the aggregate wage structure of society as the ratio of older experienced workers to young workers climb. As the paper emphasises this is all about relative cohort sizes and how this affect macroeconomic variables. As with the paper above the this paper also enters the discussion of the marginal utility derived from working in old age relative to retiring where society obviously has a distinct interest in nuturing the former.

These results imply that older workers will face increasingly unfavorable relative labor market conditions as their ranks become crowded by the baby boom generation in the near future.

Is There Really a Retirment Savings Crisis? - Alicia H. Munnell, Anthony Webb, and Francesca Golub-Sass (2007) Center for Retirement Research at Boston College

The National Retirement Risk Index (NRRI) has shown that even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, nearly 45 percent will be ‘at risk’ of being unable to maintain their standard of living in retirement. That is, these households are projected to have replacement rates — retirement income as a share of pre-retirement income — that fall more than 10 percent short of a target rate designed to maintain their pre-retirement living standard.

As is implied by the snippet above this small brief enters the discussion of dissaving and asset price declines as the baby-boomers retire. Often, this discourse has furthermore been framed in the context of a global process of dissaving and subsequent 'asset-price meltdown' as a result of the joint process of ageing amongst the world's developed economies. I shall not enter this discussion here. The brief in question does however highlight the inescable truth that given the main underlying reason for the observed life cycle of saving and consumption to smooth consumption so that retiremen living standard does not deviate from work life standard households and savers will need to adjust.

Thus, a good report card for older households in 1992 is fully consistent with an NRRI of 32 percent for those 51-61 in 2004. And, unless households begin to save more or work longer, the NRRI will continue to increase as the Social Security Normal Retirement Age rises to 67, the shift from defined benefit plans continues, retirement periods become longer with increased life expectancy, and the one-income couple virtually disappears. Yes, there really is a retirement savings crisis.

Capital Income Flows and the Relative Well-Being of America's Aged Population - Barry P. Bosworth, Gary Burtless, and Sarah E. Anders (2007) Center for Retirement Research at Boston College

One way to assess the effectiveness of a nation’s pension system is to measure its success in bringing the incomes of the aged close to those enjoyed by the nonaged. The comparability of income estimates for the aged and nonaged depends, however, on the relative accuracy of the income reports for the two populations. Unfortunately, some income items that are particularly important to the elderly, including occupational pensions, income derived from financial assets, and returns on homeowners’ net equity in their principal residence, are either unreported or significantly underreported in household surveys. In this paper we assess the effects of unmeasured and underreported income flows on the relative incomes of the aged and near-aged.

This paper is a monster and very ambitious in the sense that what it really does is to provide recommendations for national income estimates and household survey methodology. What I am particularly interested in is the point that by including income earned from transfers and dividends (and other secondary asset income) the standing of the aged cohort is increased relative to the younger cohort who naturally earns the majority of its income from wages. This is very interesting I feel since the conclusions can be used to derive some general tendencies of the life cycle of aged cohorts in the sense that these will attempt to put their assets to work in order to yield cash flows. Recently, I treated this and related issue in the context of Japan where the main point was that the income earned by Japanese savers came from foreign assets. Whether this is the case in the US is dubious. Obviously, the US economy is still able to provide domestic return for its savers, at least for now. However, the evidence from this paper highlights one very important potential transmission mechanism that runs from the life cycle behaviour of ageing cohorts to international capital flows. The key here is the extent to which we observe a decline in home bias as the domestic economy steadily looses steam as a result of the effect of demographic changes ripples through. If the decline in home bias as we are currently seeing in Japan is universal we end up in a rather interesting situation since as the ratio of aged to young economies in the world is set to change in favor of the former how are all those savers going to earn yield and what will it mean for those few economies who are young. Can they be expected to keep their markets open?

Ok, that was enough for now. As the astute reader will have observed this first edition of the Research Digest was compiled by papers from the Center for Retirment Research at Boston College. This is a coincidence since the recent slew of refereces to hit my inbox was from this particular source. As I said in the introdution I hope that I will be able to do these on a semi-regular basis.

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