1


Introduction

The population of the United States will age substantially over the next four decades owing to the drop in fertility following the baby boom and to steadily rising longevity. Population aging will have profound fiscal effects as well as effects on the broader economy. Although longer life is a highly desirable improvement in human well-being, it also stresses our economic system because older people consume a great deal more than they earn through their market labor. To the extent that people have prepared for this stage of life by earlier saving and accumulation of assets, the problem is reduced, but in fact older people are substantially supported by public transfer programs such as Social Security, Medicare, and Medicaid.

The generation that reached retirement age in the 1970s and 1980s benefited from a number of favorable factors that supported their standard of living in retirement. The coverage rate for defined-benefit pensions, which expanded after the Second World War, was higher than for previous, or subsequent, cohorts. The level of benefits provided by Social Security rose substantially in real terms during the early 1970s. The introduction of Medicare in 1965 reduced the costs of health care for retirees relative to what they might have planned for earlier in their working careers. Real house prices rose sharply during the 1970s and the 1980s, offsetting the poor performance of the U.S. stock market until 1982. And for those whose portfolios included corporate stock, the bull market that began in 1982 and lasted for over two decades helped to boost their postretirement wealth.

Those reaching retirement age in the coming decades will not benefit from the same tailwinds that supported their predecessors and instead will face a number of headwinds. The historically large deficits of the last



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1 Introduction The population of the United States will age substantially over the next four decades owing to the drop in fertility following the baby boom and to steadily rising longevity. Population aging will have profound fiscal effects as well as effects on the broader economy. Although longer life is a highly desirable improvement in human well-being, it also stresses our economic system because older people consume a great deal more than they earn through their market labor. To the extent that people have prepared for this stage of life by earlier saving and accumulation of assets, the problem is reduced, but in fact older people are substantially supported by public transfer programs such as Social Security, Medicare, and Medicaid. The generation that reached retirement age in the 1970s and 1980s benefited from a number of favorable factors that supported their standard of living in retirement. The coverage rate for defined-benefit pensions, which expanded after the Second World War, was higher than for previous, or subsequent, cohorts. The level of benefits provided by Social Security rose substantially in real terms during the early 1970s. The introduction of Medicare in 1965 reduced the costs of health care for retirees relative to what they might have planned for earlier in their working careers. Real house prices rose sharply during the 1970s and the 1980s, offsetting the poor performance of the U.S. stock market until 1982. And for those whose portfolios included corporate stock, the bull market that began in 1982 and lasted for over two decades helped to boost their postretirement wealth. Those reaching retirement age in the coming decades will not benefit from the same tailwinds that supported their predecessors and instead will face a number of headwinds. The historically large deficits of the last 5

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6 AGING AND THE MACROECONOMY 3 years, in part caused by efforts to help the economy recover from the deep recession that followed the financial crisis in 2008, have unfortunately coincided with the leading edge of the baby boom generation's retirement. More broadly, the rate of defined-benefit pension coverage is declining. Social Security, Medicare, and Medicaid face long-term fiscal challenges. The taxes that finance these programs must rise, or the benefits they de- liver must be trimmed, at least for some households, to preserve long-run fiscal balance. Health care costs that are rising faster than other prices are also raising the burden of out-of-pocket medical care costs. Although the run-up of house prices during the first decade of this century generated large capital gains for many households now approaching retirement, the post-2008 decline in house prices has left many households with much less housing equity than they had expected to have. The weak economy that has followed that global financial crisis has ended many working careers prematurely, while also lowering the value of many other components of household net worth, such as corporate equities. Moreover, the prospec- tive returns on assets such as inflation-indexed bonds suggest that capital market returns may be low for a prolonged period, making it difficult for "near-retirees" to accumulate assets for their later years. Fortunately, as life expectancy has increased, rates of disability at most ages have fallen, so that older people today are healthier and more vigorous than their counterparts a few decades ago. Unfortunately, the improvement in elders' functional status appears to have leveled off in the past decade, and the future outlook is uncertain. Longer and healthier lives are a great benefit, not in themselves a cost. But it does not follow that these added years of healthy life can all be taken as postretirement leisure; some may have to be devoted to working longer, postponing retirement, or working longer hours before retirement. If they are all taken as leisure, then con- sumption at all ages must be considerably reduced to pay for these new years of leisure: Either savings or taxes will have to rise. Longer life is only a part of the story. Lower fertility causes slower pop- ulation growth, and this is also a major contributor to population aging. It makes younger age groups smaller relative to older ones, so there are fewer young people to support old people through taxes or private transfers. The shifting balance of older and younger population groups has given rise to an increasingly contentious debate within U.S. society about how to address fiscal deficits. Projected costs of public entitlement programs seem daunting, particularly in the context of economic recession. Much of the de- bate about Social Security solvency, for example, has focused on financing issues--whether the program should continue to be financed solely through the current pay-as-you-go structure or whether personal accounts or other innovations should be introduced. In 2010, the National Research Council and the National Academy of Public Administration convened an expert

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INTRODUCTION 7 committee to look specifically at the nation's fiscal issues. The committee's report, Choosing the Nation's Fiscal Future, outlined the long-term chal- lenges of achieving a sustainable national budget and discussed a number of options for government spending and revenue policy that could lead to sustainability. The fiscal problems facing our society are daunting. At the same time, it is imperative to understand how macroeconomic changes brought about by population aging affect fiscal imbalances. It is useful here to distin- guish between the fiscal effects of aging--that is, effects involving changes in government revenues and expenditures driven largely by demographic change--and the macroeconomic effects of aging (see Box 1-1). The latter involve consideration of how factors such as savings rates, stock market exposure, productivity, consumption patterns, and global capital flows react to demographic shifts. These factors must be inputs to any analysis of the solvency of entitlement programs. It also is important to note that the fiscal situation in the United States depends in no small measure on what happens in the rest of the world. The U.S. economy is integrated in the global economy, and population aging is a global, not merely a national, phenomenon. The last 30 years have witnessed important changes in the global economy with implications for workers' job security, wages, and benefits. Globalization, driven by rapid BOX 1-1 A Macroeconomic Perspective This report takes a macroeconomic perspective on the ramifications of our aging U.S. population. Macroeconomics focuses on broad overall movements and trends in the economy, as opposed to microeconomics, which focuses on factors that influence decisions made by individual people and businesses. Accord- ingly, this report's emphasis and its conclusions center on average or aggregate phenomena. The reader who is not familiar with this approach might find some assertions to be nonintuitive. For example, from a macroeconomic perspective one expects the postretirement cohorts of the population to have accumulated more assets than younger cohorts. This reflects the tendency of people to pay off their home mortgages as they age and to set aside resources for retirement, both of which increase their assets. It implies a rosy picture for the older population. However, within the overall older population there will be many individuals who have not accumulated assets for later life, as well as many who are spending down their assets in retirement in ways that they would rather not. Furthermore, the relative well-being of today's older population might be quite different from that of previous and future cohorts. In reporting on aggregate behavior, the committee is identifying a variable (amount of assets) that affects the overall economy but not the very real individual stresses often associated with that variable.

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8 AGING AND THE MACROECONOMY technological change, has radically reduced the need for spatial proximity of companies and consumers and has reshaped the organization, manage- ment, and production of companies and industries. Trade and financial flows produce ever closer linkages across nations. In analyzing the conse- quences of population aging in the United States, one must consider this aging phenomenon in the broader context of a globalized economy. There are likely to be substantial spillover effects of international trends on our country, and global conditions will influence macroeconomic variables. The goal of this study is to provide a factual foundation for the social and political debates that will intensify. These debates, centered on deficit reduction, will focus heavily on policies involving public entitlements such as Medicare and Social Security. This report will not address the details of entitlement programs, as this has been done at great length elsewhere, nor will it offer specific policy recommendations. Rather, the intent here is to understand the broader and more fundamental factors related to popula- tion aging, to clarify policy-relevant issues, and to suggest policy levers that could be useful in designing responses to population aging. This study will also serve as a springboard for a follow-on project that will incorporate modeling and projections to develop new insights on the long-run macroeconomic effects of the aging U.S. population. Owing to funding and time constraints, the present study was unable to undertake all the analyses that the committee thought were important. For example, it would be useful to more fully explore the interplay between demo- graphic and labor force factors when considering whether an increasing share of what workers produce will have to be diverted to people who are economically inactive. The next study will seek to better characterize the sensitivities of projections and the interactions between macroeconomic variables. It will delve more deeply into how the uncertainties associated with existing demographic forecasts--which are addressed in Chapter 3 of this report--complicate predictions of economic behavior and macro- economic performance. Presenting the complexity of that interplay in the current report would have required a degree of detail that adds little to its main messages and might interfere with their clarity. The next study will focus in part on intergenerational trade-offs and will generate quantitative illustrations of specific policy choices. It will also identify the most impor- tant available policy levers to influence the adequacy of retirement income and, where possible, identify interactions and complementarities among these policy levers. CHARGE TO THE COMMITTEE In the context of deep uncertainty about societal responses to shifting demographics, the U.S. Congress asked the National Academies to form

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INTRODUCTION 9 a committee to enumerate and describe the broad macroeconomic forces that will affect, and in turn be affected by, an aging U.S. population.1 The mandate of the Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population was to construct a foundation upon which Congress can base its policy debates and also attract popular interest and support for the debate process. The committee was asked to consider a large body of academic research and distill it for congressional and public consumption. The committee also was asked to write its report for a general audience rather than an academic one, much in the spirit of the United Kingdom's Pension Commission reports published between 2004 and 2006. Those documents, commonly known as the Turner Commission reports, were designed to reach out to nonspecialist readers and to capture the public imagination. Given the asset losses and economic turmoil of recent years, the hope is that many more people in this country will be more receptive to such a discussion now than they were a decade ago and more engaged in it. In addition to informing the social and political debate, this report also suggests where additional research on the macroeconomics of aging would be useful. The development of recommendations on research was made in response to a request from the Division of Behavioral and Social Research of the National Institute on Aging (NIA), a cofunder of this report. The NIA leads the federal government in conducting and supporting research on aging and the health and well-being of older people, and the results of this report should serve to inform NIA's strategic research plans to improve our understanding of the consequences of an aging society. This committee was charged with setting out a framework for evaluat- ing the long-run macroeconomic implications of population aging. Specifi- cally, it was asked to carry out the following tasks: Examine the main sources of existing long-run U.S. demographic pro- jections, with particular focus on increasing life expectancy, rising numbers of the "oldest old," trends in fertility and net immigration, and changing dependency ratios. Identify the degree of uncertainty associated with existing demographic forecasts and how it complicates predictions of economic behavior and macroeconomic performance. Quantify in detail the influence of the baby boom generation on the path and likely end point of long-run trends in dependency ratios. Investigate trends in retirement ages and the prospects for people work- ing longer. Evaluate the implications of projected demographic changes on Ameri- can living standards, focusing on factors affecting income security in 1This study was mandated as part of P.L. 111-117, The Consolidated Appropriations Act for FY2010.

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10 AGING AND THE MACROECONOMY old age such as aggregate demand savings, and investment, how they interact, and the aggregate burden on society across all public and private channels through which transfers flow. Investigate the capabilities for government to maintain current levels of publicly funded support for older people. Investigate trends in private pension provisions and how those trends might be related to the transition to an older society. Investigate what levels of personal savings would be necessary in order for people to sustain their living standards in retirement for various assumptions about retirement ages, health care cost growth, public sup- port for older persons, and the effects of increased national savings on investment returns. Summarize the evidence regarding savings adequacy for different age cohorts. Investigate the impediments to people saving adequate amounts. Develop research recommendations that address knowledge gaps and anticipated data needs identified during Committee deliberations and which reflect an understanding of international differences. ORGANIZATION OF THE REPORT The report seeks to consider how well prepared we are as a nation for population aging and to discuss the ramifications of underlying trends in demography and health. Because aging of the U.S. population is still largely in the future, the committee was careful to consider how certain we can be about future developments. The committee also considers some possible policy responses to population aging and trade-offs among them. Chapter 2 has a dual purpose. Because aging has many effects on both the private and public sectors, it is easy to get lost in a mountain of detail and to lose sight of the big picture. Chapter 2 initially provides a frame- work for thinking about the broad consequences of population aging and the options we have for dealing with changing demographic realities. The chapter also serves to synthesize the committee's deliberations, weaving the main points from subsequent chapters into a coherent whole that summa- rizes the committee's primary findings. The demographic trends that give rise to population aging are explained in Chapter 3. Particular attention is given to the debate about the future trajectory of life expectancy in the United States. The population projec- tions of the committee presented in the chapter incorporate assumptions that are somewhat different from those underlying official U.S. government projections. The chapter also illustrates age patterns of consumption and income as a means of understanding why population aging matters to the nation's fiscal health. Chapters 4 through 8 examine a range of factors that affect the impact of population aging. Changes in the prevalence and severity of functional

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INTRODUCTION 11 impairments will have major implications for health care costs, and Chap- ter 4 considers recent trends in functional status and their relationship to socioeconomic variables and to disability. Chapter 5 examines patterns of labor force participation and retirement, highlights some of the attitudes and institutional features that influence employment behavior, and assesses the macro-level implications of longer working lives. Chapter 6 explores the intersection of population aging, technological innovation, and productiv- ity; discusses what is known about the impact of a changing population age distribution on overall economic productivity; and suggests several path- ways from a shifting age distribution to greater productivity and income. Chapter 7 tackles the complex relationship between aging populations and long-run rates of return on investments. The discussion considers various ways in which population aging affects capital markets, and emphasizes the importance of a global perspective. Chapter 8 looks at patterns of saving and wealth in the United States, considers whether saving is likely to be sufficient for future needs, and discusses several approaches to enhancing retirement security. Chapter 9 examines the impact of population aging on federal and state budgets, noting that the projected imbalances between revenues and expen- ditures are only partially explained by demographic change. The discussion outlines a strategy for analyzing the macroeconomic effects of a given policy trajectory. The strategy includes estimation of the inter- and intragenera- tional distribution of changes in resources and marginal tax rates under the policy, the timing of anticipated policy changes, and the possibility of alternative policy paths and how they could impact economic trajectories. From the committee's deliberations emerged four clusters of topics on which additional research is recommended. The committee hopes these ideas, which are presented in the final chapter, will foster research that can better inform the relationships among the key variables discussed in this re- port. It hopes as well that such research will translate into macroeconomic modeling that allows us to identify and quantify the potential impact of policy changes on the well-being of the nation and its people.