Demography is destiny

The much-discussed Washington Post op-ed column on Social Security is not my favorite--it makes much of the meaningless actuarial solvency of the social security system, rather than the relevant changes to the inflows and outflows of tax revenue. But it does make one good point:

Social Security isn't a big deal because the trustees' projections are based on unduly pessimistic assumptions, including anticipated economic growth that is slower than has been the case for the past several decades.

The projected slowdown in economic growth is based largely on the slower growth of the workforce, which is inevitable unless fertility rates or immigration soar beyond all predictions. Better-than-expected growth cuts both ways: It increases the amount of payroll taxes coming into the system but also the amount of benefits owed. Even if the economy were to grow significantly faster than predicted, that growth would push insolvency back by only six years. Weighing in the opposite direction: The trustees' projections on life expectancy may be too low -- good news overall, bad for Social Security.

Yes, the trustees' optimistic scenario shows Social Security solvent for more than 75 years, but that is so unlikely (fertility would have to return to pre-1970s levels, for one) that Social Security puts the chances at less than 2.5 percent.

Furthermore, Social Security's intermediate projections are in line with those of other experts. "There is a greater than 99 percent probability that total outlays over 100 years will exceed total revenues," the Congressional Budget Office found last year.

This is a pretty frequent theme among the more sophisticated opponents of social security reform, and it's wrong. First of all, because the changes in the SSA's predictions are only very partly based on economic growth; they're mostly based on things like longevity and birthrates. Demographic change is not a fast-moving disaster; aside from a few million immigrants, we now have pretty much all of the workers we're going to have in 2020. Indeed, it is much more likely that the SSA is being too conservative in forecasting future lifespans than that it is being too pessimistic about future fertility--which means that the pension forecasts are more likely to be too optimistic than too pessimistic.

Meanwhile, the current birth dearth means the labor force is going to grow a lot less slowly. And since economic growth is a function of labor force growth and productivity growth, that means that unless productivity takes off, the economy is going to grow more slowly in the future than in the past.

In addition, ceteris paribus, the retirement of the boomers means that national savings will fall. We currently have a very big generation in their peak savings years, and a much smaller generation drawing down retirement savings. When the boomers retire, this happy circumstance will reverse itself. So it's hard to see where this amazing productivity revolution is going to come from--especially since we're currently bearish on trade, which is one major place we'd look for productivity enhancements.

Then there are the higher taxes which will be needed to pay for social security and healthcare; they are very likely to be a drag on growth.

Finally, to the extent that we mitigate the labor force problem by either keeping seniors in longer, or importing more immigrants, we will be putting downward pressure on productivity. Immigrants are much more productive here than they are in their home countries; but they are less productive than the average American worker. Likewise, the dislocations of dealing with an elderly workforce will be a drag on productivity. At the same time, the elderly will be consuming a lot more low-productivity services such as home health care aides.

The upshot is, we are very, very unlikely to grow our way out of our demographic problem.