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AGING AND THE MACROECONOMY LONG-TERM IMPLICATIONS OF AN OLDER POPULATION Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population Board on Mathematical Sciences and Their Applications Division on Engineering and Physical Sciences Committee on Population Division of Behavioral and Social Sciences and Education

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THE NATIONAL ACADEMIES PRESS 500 Fifth Street, NW Washington, DC 20001 NOTICE: The project that is the subject of this report was approved by the Govern- ing Board of the National Research Council, whose members are drawn from the councils of the National Academy of Sciences, the National Academy of Engineer- ing, and the Institute of Medicine. The members of the panel responsible for the report were chosen for their special competences and with regard for appropriate balance. This study was supported by Contract Grant No. TOS10-C-004 between the Na- tional Academy of Sciences and the Department of the Treasury. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the organizations or agencies that provided support for the project. International Standard Book Number-13: 978-0-309-26196-8 International Standard Book Number-10: 0-309-26196-1 Library of Congress Control Number: 2012953334 Additional copies of this report are available from the National Academies Press, 500 Fifth Street, NW, Keck 360, Washington, DC 20001; (800) 624-6242 or (202) 334-3313; http://www.nap.edu. Copyright 2012 by the National Academy of Sciences. All rights reserved. Printed in the United States of America Suggested citation: National Research Council. (2012). Aging and the Macroecon- omy. Long-Term Implications of an Older Population. Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population. Board on Mathematical Sci- ences and their Applications, Division on Engineering and Physical Sciences, and Committee on Population, Division of Behavioral and Social Sciences and Educa- tion. Washington, D.C.: The National Academies Press.

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The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. Upon the authority of the charter granted to it by the Congress in 1863, the Acad- emy has a mandate that requires it to advise the federal government on scientific and technical matters. Dr. Ralph J. Cicerone is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of outstanding en- gineers. It is autonomous in its administration and in the selection of its members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineer- ing programs aimed at meeting national needs, encourages education and research, and recognizes the superior achievements of engineers. Dr. Charles M. Vest is presi- dent of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The Insti- tute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Harvey V. Fineberg is president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sci- ences in 1916 to associate the broad community of science and technology with the Academy's purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the Council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the government, the public, and the scientific and engineering communities. The Coun- cil is administered jointly by both Academies and the Institute of Medicine. Dr. Ralph J. Cicerone and Dr. Charles M. Vest are chair and vice chair, respectively, of the National Research Council. www.national-academies.org

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COMMITTEE ON THE LONG-RUN MACROECONOMIC EFFECTS OF THE AGING U.S. POPULATION RONALD LEE (Co-chair), Department of Demography, University of California, Berkeley ROGER W. FERGUSON, Jr. (Co-chair), Chief Executive Officer, TIAA-CREF ALAN J. AUERBACH, Department of Economics, University of California-Berkeley AXEL BOERSCH-SUPAN, Mannheim Research Institute for the Economics of Aging, Mannheim University, Germany JOHN BONGAARTS, Policy Research Division, Population Council SUSAN M. COLLINS, Gerald R. Ford School of Public Policy, University of Michigan CHARLES M. LUCAS, Osprey Point Consulting DEBORAH J. LUCAS, Financial Analysis Division, Congressional Budget Office OLIVIA S. MITCHELL, Wharton School, University of Pennsylvania WILLIAM D. NORDHAUS, Department of Economics, Yale University JAMES M. POTERBA, Department of Economics, Massachusetts Institute of Technology JOHN W. ROWE, Department of Health Policy and Management, Columbia University LOUISE M. SHEINER, Federal Reserve Board DAVID A. WISE, JFK School of Government, Harvard University Staff KEVIN KINSELLA, Committee on Population, Study Director BARNEY COHEN, Committee on Population, Director SCOTT WEIDMAN, Board on Mathematical Sciences and Their Applications, Board Director DANIELLE JOHNSON, Committee on Population, Senior Program Assistant Consultants ROBERT POOL, Digital Pens, LLC DAVID P. RICHARDSON, TIAA-CREF Institute v

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BOARD ON MATHEMATICAL SCIENCES AND THEIR APPLICATIONS C. DAVID LEVERMORE (Chair), Department of Mathematics, University of Maryland, College Park TANYA STYBLO BEDER, SBCC Group, Inc. PATRICIA FLATLEY BRENNAN, School of Nursing and College of Engineering, University of Wisconsin GERALD G. BROWN, Operations Research, Naval Postgraduate School L. ANTHONY COX, JR., President, Cox Associates BRENDA L. DIETRICH, Business Analytics and Mathematical Sciences, T.J. Watson Research Center, IBM CONSTANTINE GATSONIS, Center for Statistical Science, Brown University DARYLL HENDRICKS, Quantitative Risk Control, UBS Investment Bank KENNETH L. JUDD, The Hoover Institution DAVID MAIER, Maseeh College of Engineering and Computer Science, Portland State University JAMES C. McWILLIAMS, Institute of Geophysics and Planetary Physics, University of California, Los Angeles JUAN MEZA, School of Natural Science, University of California, Merced JOHN W. MORGAN, Simons Center for Geometry and Physics, Stony Brook University VIJAYAN N. NAIR, Department of Statistics, University of Michigan CLAUDIA NEUHAUSER, Vice Chancellor of Academic Affairs, University of Minnesota, Rochester J. TINSLEY ODEN, Associate Vice President for Research, University of Texas, Austin DONALD G. SAARI, Department of Mathematics and Economics, University of California, Irvine J.B. SILVERS, Weatherhead School of Management, Case Western Reserve University GEORGE SUGIHARA, Scripps Institution of Oceanography, University of California, San Diego EVA TARDOS, Department of Computer Science, Cornell University KAREN VOGTMANN, Department of Mathematics, Cornell University BIN YU, Department of Statistics, University of California, Berkeley Staff SCOTT WEIDMAN, Director vi

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COMMITTEE ON POPULATION LINDA J. WAITE (Chair), Department of Sociology, University of Chicago CHRISTINE BACHRACH, School of Behavioral and Social Sciences, University of Maryland JERE BEHRMAN, Department of Economics, University of Pennsylvania PETER J. DONALDSON, Population Council, New York KATHLEEN HARRIS, Carolina Population Center, University of North Carolina, Chapel Hill MARK HAYWARD, Population Research Center, University of Texas, Austin CHARLES HIRSCHMAN, Department of Sociology, University of Washington WOLFGANG LUTZ, World Population Program, International Institute for Applied Systems Analysis, Laxenburg, Austria ROBERT MARE, Department of Sociology, University of California, Los Angeles SARA McLANAHAN, Center for Research on Child Wellbeing, Princeton University BARBARA B. TORREY, Independent Consultant, Washington, D.C. MAXINE WEINSTEIN, Center for Population and Health, Georgetown University DAVID WEIR, Survey Research Center, Institute for Social Research, University of Michigan JOHN R. WILMOTH, Department of Demography, University of California, Berkeley Staff BARNEY COHEN, Director vii

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Foreword The shifting balance between young and old--in particular, between working-age people and retirees--is forcing governments around the world to rethink or revamp policies and programs that affect many aspects of peoples' lives. In the United States and elsewhere, this has given rise to an increasingly contentious debate about how to address current and loom- ing fiscal deficits associated with various age-related entitlement programs. The fiscal problems facing our society are daunting. At the same time, it is important to recognize that population aging also will have important effects on the broader economy. We need to better understand how macro- economic factors--such as savings rates, stock market exposure, productiv- ity, consumption patterns, and global capital flows--react to demographic shifts. These factors must be inputs to any analysis of fiscal health and of the solvency of entitlement programs. At the request of Congress and with support from the Department of the Treasury and the National Institute on Aging, the National Research Council undertook a study of the long-term macroeconomic challenge fac- ing the United States because of these shifts in demographics. The NRC organized an expert committee spanning a diversity of disciplines in order to enhance the basis for policy decisions and to offer its professional judg- ment about the key issues for our economic future. The committee worked diligently to forge a consensus under the leadership of its co-chairs, Ronald Lee and Roger Ferguson, Jr. We thank the co-chairs for their leadership and the entire committee for its efforts. We hope the insights in this report will be widely used to support seri- ix

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xFOREWORD ous discussion of the urgent aging-related issues confronting our society and of appropriate policy options to ensure the adequacy of retirement income. Peter Blair Robert Hauser Executive Director Executive Director NRC Division on Engineering NRC Division of Behavioral and and Physical Sciences Social Sciences and Education

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Preface In 2010, Congress asked the National Research Council (NRC), the operating arm of the National Academies, to prepare a report on the long- run macroeconomic effects of the aging U.S. population. In response, the NRC appointed an ad hoc committee, the Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population, under the auspices of its Board on Mathematical Sciences and their Applications and its Com- mittee on Population. The committee was charged with distilling a large body of academic research and providing a factual foundation for the so- cial and political debates about population aging and its macroeconomic impacts and about appropriate policies regarding public entitlements such as Medicare and Social Security. Given the breadth of the report's focus, it was clear from the outset that the committee did not have the full empirical underpinning needed to address this complex topic. Hence we are grateful to the Division of Behavioral and Social Research, National Institute on Aging, for providing additional project funding to identify key research needs and develop research recommendations. No committee could perform a task such as this without the assistance and close cooperation of a great many people. We would like to thank, first and foremost, our fellow committee members. Despite having many other responsibilities, members of the committee generously donated their time and expertise to the project. The committee met six times over the course of the project. Members contributed to the study by providing background readings, leading discussions, making presentations, drafting and revising chapters, and critically commenting on the various report drafts. The per- xi

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xiiPREFACE spectives that members brought to the table were instrumental in synthesiz- ing ideas throughout the committee process. Drafting the report was a collaborative enterprise. The committee divided itself into five working groups corresponding to the major substan- tive content areas--demographic and health trends; labor force participa- tion, productivity, and retirement; saving and retirement security; capital markets and rates of return; and fiscal concerns. Each committee member made significant contributions to the report in at least one of these areas, and many people were involved in a crosscutting manner. We are grateful to a number of people who were not on the committee, including David H. Rehkopf (Department of Medicine, Stanford University) and Nancy E. Adler (Department of Psychiatry, University of California, San Fran- cisco), who worked with committee member John W. Rowe to produce the commissioned paper "Socioeconomic, Racial/Ethnic and Functional Status Impacts on the Future U.S. Workforce," which helped to inform the discussions in Chapters 4 and 5. Special thanks go to Robert Pool (Digital Pens, LLC), who drafted initial versions of several report chapters as well as the Summary. We also are grateful to David P. Richardson (senior econo- mist, TIAA-CREF Institute), who shared his extensive knowledge of public and private pension plans, household financial security, and retirement preparedness throughout the committee deliberations. We likewise extend heartfelt thanks to Gretchen S. Donehower and Carl Boe (Center on the Economics and Demography of Aging, University of California, Berkeley), who generated population projections, analyses, and graphs used in this report, facilitated the transfer of data between committee members, and prepared the documentation in the report Appendix. This report has been reviewed in draft form by individuals chosen for their diverse perspectives and technical expertise, in accordance with procedures approved by the NRC Report Review Committee. The purpose of this independent review is to provide candid and critical comments that will assist the institution in making its published report as sound as possible and to ensure that the report meets institutional standards for objectivity, evidence, and responsiveness to the study charge. The review comments and draft manuscript remain confidential to protect the integrity of the deliberative process. We thank the following individuals for their review of this report: Henry J. Aaron, The Brookings Institution; Peter A. Diamond, Massachusetts Institute of Technology; Arie Kapteyn, RAND Corporation; Jonathan N. Katz, California Institute of Technology; Alicia H. Munnell, Boston College; J.B. Silvers, Case Western Reserve University; Barbara Boyle Torrey, Independent Consultant; and David R. Weir, University of Michigan. We also thank Kirsten Sampson-Snyder of the NRC Division of Behavioral and Social Sciences and Education and Elizabeth Panos of the

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PREFACE xiii NRC Division on Engineering and Physical Sciences for their coordination of the review process. Although the reviewers listed above have provided many constructive comments and suggestions, they were not asked to endorse the committee's findings or research recommendations nor did they see the final draft of the report before its release. The review of this report was overseen by Charles F. Manski, Northwestern University, and V. Joseph Hotz, Duke University. Appointed by the National Research Council, they were responsible for making certain that an independent examination of this report was carried out in accordance with institutional procedures and that all review com- ments were carefully considered. Responsibility for the final content rests entirely with the authoring committee and the institution. Lastly, we must acknowledge the efforts of several individuals as well as staff of the National Research Council. We thank Lisa Calandra and Loretta Sophocleous of TIAA-CREF, who helped with many tasks involving meet- ing planning, meeting arrangements, and facilitating communication among committee members. Amanda Volbert (Department of Public Administra- tion and Policy, University of Georgia) and Michael Wodka (Department of Economics, Cornell University) assisted with research and writing for several report topics during NRC internships undertaken in conjunction with the National Academy of Social Insurance. Within the NRC, we are indebted to Danielle Johnson for providing the essential infrastructure for this project. Danielle skillfully and cheerfully handled a plethora of matters during the panel's tenure, with assistance from Jacqui Sovde and Barbara Boyd. Elizabeth Fikre edited the volume and made numerous suggestions for its improvement. Kevin Kinsella, the NRC study director, managed the overall work of the committee, along with Scott Weidman, Director of the Board on Mathematical Sciences and their Applications, and Barney Cohen, Director of the Committee on Population. Ronald D. Lee, Co-chair Roger W. Ferguson, Jr., Co-chair Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population

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Contents SUMMARY1 1 INTRODUCTION 5 2 OVERVIEW 12 3 DEMOGRAPHIC TRENDS 32 4 HEALTH AND DISABILITY IN THE WORKING-AGE 62 AND ELDERLY POPULATIONS 5 LABOR FORCE PARTICIPATION AND RETIREMENT 75 6 AGING, PRODUCTIVITY, AND INNOVATION 106 7 SAVING AND RETIREMENT SECURITY 122 8 CAPITAL MARKETS AND RATES OF RETURN 153 9 THE OUTLOOK FOR FISCAL POLICY 174 10 RESEARCH RECOMMENDATIONS 194 REFERENCES201 xv

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xviCONTENTS APPENDIXES A Population and Related Projections Made by the Committee 219 B Biographical Sketches of Committee Members 232