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A Growth Problem, Not a Pension Crisis
November 15-16, 1996
The Council on Foreign Relations has done a singular service in calling this conference. The challenge of formulating policy to deal with the aging of the population faces many countries-industrial and developing-with widely different economies, governmental structures, familial arrangements and cultural traditions. It is an ideal topic for the sharing of international experience, analysis, insights, and policy options.
It is the job of a keynote speaker to put the problem under consideration in context and even redefine it. So I would like to start by suggesting that it would be an aid to constructive thinking to relabel this conference "Dealing with the Challenges to Aging Societies," rather than, "The Coming Global Pension Crisis." Some of you might not have come to a conference with such a bloodless title. Unfortunately, one needs a "crisis" to attract busy people on a Friday night; but now that you are here, it is important to understand and structure the problem right. So I want to discuss why I am uncomfortable both with the implications of "crisis" and with the emphasis on "pensions."
A "crisis" is a dire event that will have tragic consequences if not averted. The Council on Foreign Relations deals with many terrible crises which are evidence of human failure-war, famine, ethnic hatreds, environmental degradation, and terrorism. In contrast, the challenges we are about to discuss are evidence of enormous success. The challenges to an aging society mainly result from three trends that are indicative of human progress and technological advancement:
People are living longer as a result of higher living standards, better sanitation, healthier life styles, and better medical care. Medical care, including geriatric care, is more effective and more widely sought. Birthrates are falling because of higher living standards, better education, and the higher status of women.
Nobody wants to reverse any of these developments, which means that we need to figure out how to deal with the consequences of this monumental success.
"Crisis" also suggests something temporary--a turning point. The crisis is either resolved or else everything falls apart. The challenge of an aging population is not of that nature. It is neither going to engulf us suddenly and wipe us out--although much of the current rhetoric suggests this--nor is it going to get fixed and go away. The human race will continue to face the challenge of aging societies for the foreseeable future. Our descendants, if they are fortunate, will have to figure out how to deal with even longer life, even more effective medical care, and possibly negative population growth.
My more fundamental uneasiness with the conference title comes from with the focus on pensions. The emphasis on pensions suggests that the essence of the aging problem is how to finance pension programs, especially public pension programs. Funding pensions is an important part of the challenge to an aging society, but it is certainly not the whole question, and the partial focus can lead to policy changes that do more harm than good.
For example, if one listens to the public rhetoric in the United States, one could easily get the impression that the essence of the aging problem is that "Social Security is going broke" and that restoring the Social Security Trust Fund to long-run solvency--either by increasing the inflow or cutting the outflow--would fix the problem. Similarly, restoring solvency to the Medicare Trust Fund would solve the Medicare problem.
In the first place, Social Security is not "going broke" in the sense that many people seem to imagine. Many young and not so young people believe that they are likely to pay into the system over the next 30 years, and then suddenly in 2029 the system will just disappear. A surprisingly large number of people, both informed and less informed, seems to believe that no one will receive any Social Security benefits about 30 years from now. These are the people who tell pollsters that Social Security will not be there for them or their children. This is not true, of course. Even if the reserves were completely exhausted, billions of dollars would still flow into the system to pay benefits on a pay-as-you-go basis, albeit at a reduced level of about 75 percent of the currently estimated benefits. The "going broke" misperception is easily cleared up when one realizes that even if nothing is done until 2029, many people will continue to work and pay into the Social Security system, which will be able to support a reduced, but not insignificant, level of retiree benefits.
It is harder to deal with the related and seemingly more logical misperception--namely, if there are enough reserves to pay all the retiree claims, then there is no problem finding adequate resources for future retirees. The government or whoever is holding the reserves can simply cash in the bonds or sell the stocks and pay the benefits. Indeed, some argue that having those securities is the way to avoid having a zero-sum game played between future retirees and future workers.
Some people figure that this scenario is a misperception because they are uncomfortable with the fund being invested by the Social Security system in government bonds. They rightly perceive that when it comes time to cash in those bonds to pay the retirees, someone else will have to give up something, perhaps through higher taxes or reduced government spending. These people believe that Social Security is a false promise because the reserves do not really exist; instead, the Social Security funds merely represent an iou from the government. This is true, but it would be equally true if the reserves were invested in private securities by the Social Security fund or by the retirees in their own retirement accounts. What is in any fund is a bunch of paper claims against future resources. Somebody else has to give up the resources when retirees cash in their ious, whether public or private, and spend their retirement nest egg.
At any given moment, say 2050, there will be a finite amount of national output to be divided among retirees and workers and their children. What we know with reasonable certainty about 2050 is that there will be a higher proportion of retirees in the population competing for those resources than there are now. In that future year, the division of the resources consumed will be a zero-sum game, more for older people will mean less for younger ones(and vice versa(within whatever total the gdp has reached by then. We can influence the rules by which the total is divided, but we cannot be sure the rules will not be rewritten or the claims devalued by inflation or other means. We cannot stockpile roast beef sandwiches or hip replacement operations or Mediterranean cruises for the use of future retirees(and they cannot do it for themselves. We can only pass on paper claims on that future output that may be handsomely honored or not, depending on the political forces at the time.
What we can do is take steps to make the future output larger by saving more out of the current output and channeling the saving into productive investment. Several options exist for increasing national savings. For example, the government can run a budget surplus and buy back government bonds from the public. Other ways of achieving higher saving could involve mandating private saving in various types of individual savings accounts or increasing tax incentives for private investors, although the latter might have an undesirable offsetting effect on the federal budget deficit.
All these options have differing features and different rationales with respect to redistribution and risk bearing, but they all ought to be judged by one fundamental criterion: how much will this option likely increase national saving and contribute to higher future growth?
Any society facing the consequences of continuing success in lengthening life, improving medical care, and reducing birthrates should ask itself two sets of questions.
The first set focuses on the ious--specifically, what set of paper claims on future resources we want retirees to have in 2050:
The second set of questions--those dealing with savings and growth--are even more important:
The two sets of questions are interrelated to a certain extent. For instance, certain structures for passing out the claims may be more conducive to saving relative to other structures. However, they are not the same question and should not be mixed up. The point is: dealing with an aging population is fundamentally a growth question, not a pension financing question.
In this context, I would like to discuss the United States Social Security system as an example, with apologies to the rest of the world, whose systems I do not know enough about to use as examples. In my view, the basic structure of Social Security, supplemented by private pensions and savings, is a good one. Some relatively minor adjustments to the basic structure, along with additional features that can help increase national saving, could make it even better. Of course, these judgments reflect my own values and may not be universally shared. I value the communitarian universality of Social Security--everyone contributes while they work and everyone is entitled to benefits. I value the redistributive aspect of the system--everyone gets back something, but low earners get relatively more.
Our current structure has been enormously effective in providing basic retirement security for working people and raising the incomes of older people, especially those who must depend on Social Security for the bulk of their income. This success owes much to the lucky accident that we established the Social Security program during the Great Depression era and phased it in over a long period during which the number of retirees claiming benefits was relatively small and both the labor force and wages were increasing rapidly. As revenues poured into the system, it was possible to raise benefits and keep substantial redistribution in the Social Security system. Retirees supported the program--which was not surprising--and wage earners supported it because they saw their parents benefiting and thought that eventually they would benefit too. Both low- and high-wage earners supported Social Security in part because they were getting back more than they put in. Even high earners received a handsome return on their money, albeit not as much as the low earners did.
However, by the early 1980s the country realized that the party was over as it confronted slow wage growth, increased payroll taxes, and higher inflation. Policymakers, as well as the public, became increasingly aware of the demographic pressures arising from longevity, the maturing of the baby boomers, and the prospect of slower labor force growth.
Cynics about the political process should remember that during the Social Security "crisis" of 1983 the political system functioned well. The major parties faced up to the difficult situation and developed a plan to shore up the system, mainly by increasing revenues, reducing benefits, and building up a substantial reserve for the future. The political system--through a bipartisan coalition--made the tough decisions that the analysts said were necessary. It was actually the analysts who failed to predict how the economic and demographic forces would interact in the future. That is not surprising. The world changes, and new projections every few years should be regarded as normal. The problem perceived at present--that surpluses building up in the Social Security Trust Fund will peak before 2020 and be exhausted about 2029--would be far more daunting now if it were not for the earlier actions taken to reduce future benefits.
Should something be done to extend the life of the Social Security Trust Fund by reducing future benefits or increasing revenues? My answer would be "yes," but only if the proposed remedy is likely to increase national saving. Modest benefit cuts probably would achieve this best by reducing the outflow from the fund and enabling the government to borrow less (or repurchase its debt if the government was operating with a budget surplus). Increasing payroll taxes, on the other hand, should be avoided because it could raise the pressure to cut other less onerous taxes. Investing the Social Security funds in the private market, even in index funds, also should be avoided because it does not contribute to national saving and instead forces the government to borrow an offsetting amount from the public. Yet another alternative is mandating private retirement accounts, which may not be a bad idea as long as it requires workers to save more than they are saving under the current structure. Administering private retirement accounts would be more costly than our current Social Security system. We could perhaps reduce the payroll tax by 1 percent and add a mandatory 2 or 3 percent personal saving account. But substituting, rather than adding, mandated private accounts for the current basic Social Security system would destroy the redistributive aspect of the system and would do nothing to increase national saving in total.
These suggestions may be rather boring, but they illustrate my belief that we do not really have a serious pension problem in the United States, let alone a pension crisis. What we do have is a growth challenge. We need to get on a higher growth track because of the aging of the population, among other reasons. Increasing saving can help, and restructuring public and private pension to raise saving will be useful. But increasing public and private saving is only one of the set of tools needed for raising growth. A successful overhaul of the school system that increased skills and basic intellectual competence could do more to benefit the well-being of future retirees than anything we could do with pension systems.
Fortunately, I do not have time to discuss Medicare in detail. But again, the core of the Medicare problem is not how to finance the program but how to restructure the delivery of medical and geriatric care. The Medicare problem is more urgent and difficult to solve than Social Security. The rapid growth in Medicare spending is largely the result of both increased longevity and the increasing cost of efficacious care for older people. In the short term, the rate of spending growth can be reduced by tightening reimbursement rates, increasing incentives for Medicare beneficiaries to move into managed care, and taking aggressive action against fraud and abuse in the system. All these suggestions were part of the budget compromise that came close to passage last year. These options deserve to be considered again in the next round of discussions. The cost reductions combined with modest increases in the Part B premium, including means testing at the top, would lower the budget deficit for a decade or so while we figure out a long-term solution. That is not a cop-out, but a sensible approach to a very difficult problem. We need to act now to address those problems that are somewhat manageable in the short run; but at this time we do not know enough about changes in technology or delivery systems to design Medicare for the next several decades.
Finally, I would like to say a word about politics. Recently, bad-mouthing politicians and the voting public has become quite fashionable. If I were to make a cynical speech about how politicians will not allow changes in Social Security or Medicare and about how they only care about getting reelected and pleasing greedy geezers, you might nod wisely and say, "Isn't she insightful?" But I do not think the evidence supports this cynicism. The American political system created a very solid institution in Social Security and has reviewed it periodically to make useful improvements, which have sometimes even included rescinding benefits. The bipartisan coalition plan in 1983 is the most dramatic example of benefit reduction, but it is not the only one. For instance, the education benefits for Social Security survivors which were an important piece of the original Social Security legislation, disappeared when more general programs, such as Pell grants, were enacted. I do not see any reason to believe that the American political system has suddenly lost its good sense about redesigning Social Security.
The key to political action is to inform and involve the public in serious dialogue about these issues. For example, mandating private savings accounts might force members of the public to increase their knowledge of markets and risks as well as of how public and private pension programs work. Misinformation and scare talk, on the other hand, often result in a lot of harm.
The main message I would like to give tonight is that an aging society is an important problem. It is, however, fundamentally a growth problem, not a pension financing problem. Higher growth can be attained in several ways: increasing national saving and directing the resources to fund productive investment and using other measures, such as education and research, to raise the standard of living and the well-being of the population. Undoubtedly, some tools, such as education, are difficult issues themselves. Nonetheless, we should take advantage of time to use these tools now and prepare ourselves and our children for the challenges that lie ahead.
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