Saturday, January 29, 2005

The Demographic Deficit

by Tom Bozzo

If the previous posts on Social Security haven't put enough of a spring in your step, then refill your antidepressant prescription and take a look at a new McKinsey Global Institute report* (registration req'd for download) "The Coming Demographic Deficit: How Aging Populations will Reduce Global Savings." From the executive summary:
MGI's new report reveals that the aging of the developed world is creating a demographic deficit that could radically transform the financial wealth of households, and therefore, the capital available to businesses and government.

MGI's key finding is that over the next two decades, absent dramatic changes in saving behavior or returns earned on financial assets, growth in household financial wealth will slow by more than two-thirds, from 4.5 percent historically to 1.3 percent going forward. This slowdown will cause the level of household financial wealth to fall some 36 percent, or approximately $31 trillion, below what it would have been had the higher historical growth rates persisted.

The U.S. will be by far the largest source of the global shortfall ($19 trillion) because of the U.S. dominant share of global financial wealth...

Unfortunately, there are no easy ways to counterbalance the coming decline in wealth. MGI found that no country outside the developed world can generate enough new financial wealth over the next two decades to meaningfully address the projected shortfall... It is unlikely that nations will be able to simply grow their way out of the problem either. Increasing economic growth without changing the relationship between income and spending will not by itself change the amount of savings enough to materially alter the rate of wealth accumulation.

MGI found that achieving higher rates of real financial asset appreciation is the most powerful adjustment... Other changes that could also mitigate the downward demographic pressure on savings to some degree include extending peak earning years ― chiefly by increasing the retirement age, and raising the savings rate of younger generations.

In short, we need to save more, borrow less, and earn higher returns on our saving, not in that order. Obviously, this is bad news for the Bush administration's addiction to public sector borrowing.

As for the solutions, I mostly allowed an initial "well, duh" reaction to the 'improve rates of financial asset appreciation' solution to pass. Some of the potentially effective means for improving rates of return, such as improving the efficiency of financial intermediation or —reading between the lines — eliminating corporate welfare, would be politically painful. (And there would go the Manhattan housing market.) Others, like promoting innovation and protecting intellectual property, can be at cross purposes. Mandatory savings programs that don't lead to the end of Social Security will not go down well with the libertarian think-tanks.

Are we screwed? The conclusion is hard to avoid.

* In the interest of full disclosure, I should note that one of my two best friends from grad school , who has the Google misfortune of sharing his name with an Emory University College Republican, is a coauthor of the report.
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