Fed Chairman Alan Greenspan has unwittingly provided perhaps the most compelling argument of all for congressional passage of the Bush administration’s pro-investment tax plan — namely, the need for dramatic improvement in labor productivity in anticipation of baby boomer retirement.
“Because the baby boomers have not yet started to retire in force and accordingly the ratio of retirees to workers is still relatively low, we are in the midst of a demographic lull,” Greenspan recently told Senate and House committee members. “But short of an outsized acceleration of productivity to well beyond the average pace of the past seven years or a major expansion of immigration, the aging of the population now in train will end this state of relative budget tranquility in about a decade’s time.”
The first baby boomers (born 1946-64) will turn 65 in just eight years. The number of Americans age 65 and older will rise from about 35 million in 2000 to nearly 40 million in 2010 and then jump to almost 54 million in 2020 and to more than 70 million by 2030. Thus, the number of seniors will double over a period of just 30 years.
This wouldn’t be a significant economic problem if baby boomers had procreated at the same rate as prior generations, but they didn’t. Boomers tended to marry later in life and also had fewer children, meaning this post-World War II generation procreated at a less-than-replacement rate. And this is why the worker-retiree ratio (i.e., the number of persons of working age 18 to 64 years versus those 65 and older) is due to drop sharply over the next three decades.
The worker-retiree ratio was 7.5 to 1 in 1950 and slipped to 5.3 to 1 by 1980. In 2000, the ratio stood at 5.0 to 1 and is expected to be at 4.7 to 1 in 2010. After the first boomers turn 65 in 2011, however, the picture will changed markedly. By 2020, the worker-retiree ratio will dip to 3.6 to 1, and come 2030, it will be down to 2.8 to 1 (barring any unexpected change in immigration). From 2040 to 2100, the ratio is projected to range from 2.8 to 2.4 to 1, according to Census Bureau data.
The worker-retiree ratio, though, is not the only looming demographic factor weighing on the economy. There are children to consider, too. When persons under 18 and those over 64 are combined, you get what’s known as the “dependency ratio.” And that also is projected to change dramatically in coming years.
In 2000, there were 61.6 youngsters and seniors for every 100 Americans of working age. The number is expected to rise to 67.5 by 2020 and 77.7 in 2030. The dependency ratio is then due to climb from 78.7 in 2040 to 84.2 in 2100.
All of which means, of course, that America’s workers will be hard-pressed to provide for the needs of these dependents, young and old. Besides the provision of real goods and services, there also will be fiscal consequences, affecting both tax receipts and government outlays — notably for medical services and long-term care for the elderly. These fiscal difficulties will be compounded by the fact that Americans on the whole are healthier and thus can be expected to live longer than ever before.
Which is why Greenspan said last week that “it would be wise to address this significant pending adjustment sooner rather than later. As the President’s just-released budget put it, ‘The longer the delay in enacting reforms, the greater the danger, and the more drastic the remedies will have to be.’”
Greenspan, alas, wasn’t particularly optimistic. “To assume that productivity can continue to accelerate to rates well above the current underlying pace would be a stretch, even for our very dynamic economy,” he said. “In fact, we will need some further acceleration of productivity just to offset the inevitable decline in net labor force, and associated overall economic growth as the baby boomers retire.”
Pro-investment tax policies, such as those Bush is offering, are exactly the way to deal with the issue. To raise labor productivity, the ratio of financial capital to labor capital must increase. And leaving more post-tax money in people’s hands is the only surefire way of making more financial capital available to underwrite investment in new technologies and equipment, which in turn boosts productivity, incomes, and living standards — as well as tax revenue.
The record of the 1990s is a prime example. U.S. economic growth was propelled by a record rise in capital spending per worker. Following the recession of 1991, fixed private nonresidential investment, in real terms, averaged $5,114 per civilian worker in the first quarter of 1992, up less than 14% from $4,503 in the first quarter of 1983. However, by the third quarter of 2000, the figure reached a high of $9,802, a gain of nearly 92% from the start of 1992. (In the fourth quarter of last year, it was at $8,652.)
The vast bulk of this spending was on information technology. Real IT spending per non-farm worker nearly quadrupled from just $1,189 at the end of 1989 to a high of $4,491 in the third quarter of 2000. (In the fourth quarter of last year, it was $4,436.)
The “real” numbers for IT investment correct not only for inflation but also adjust for the quality of the technology, which is why real IT spending can actually be higher than nominal spending (i.e., $1,000 spent on IT today buys a lot more than it did 10 years ago). Thus, the U.S. has benefited from an increase in cash spending on IT and also a tremendous improvement in IT capability, both of which have redounded positively in terms of higher labor productivity.
The capital spending data indeed expose the fallaciousness of Clintonite claims that the 1993 tax hike energized the economy. The Clintonites have been committing a notorious fallacy of logic known as post hoc ergo propter hoc (“after this, therefore because of this”). It was merely coincidental that strong economic growth followed the 1993 tax increase, the largest in U.S. history. The real reason for the economic boom was not stiffer taxes but enhanced capital investment, sparked by the IT revolution.
Boomer retirement puts the foolhardy 1993 tax increase into starker relief. At the very time that Washington should have been encouraging even more capital investment in labor-saving technology in anticipation of boomer retirement, the Clinton administration insisted on taking more money out of the private sector. The 1993 tax increase therefore was not just bad economics; it also was shortsighted demographically.
When the jolt of boomer retirement hits, Americans are going to look back and wonder why so little had been done to prepare the economy. It’s as if we knew decades in advance that a killer asteroid was hurtling toward Earth but waited until the last minute to act.
Still, it’s better to act late than never. Bush should be commended for being the first president to see the actuarial handwriting on the wall and to propose pro-investment tax cuts to address the problem. Now let’s see if Congress is as farsighted.
— William P. Kucewicz is editor of GeoInvestor.com and a former editorial board member of the Wall Street Journal.