posted on 02 April 2016
from the Atlanta Fed
-- this post authored by Karen Jacobs
While the aging of the population will produce economic and fiscal challenges, the outlook is not uniformly grim. There are reasons for optimism on several fronts, from the labor market to health care costs to the general dynamism of the U.S. economy.
For starters, the nature of retirement as we know it appears to be changing in ways that could lighten the burden on programs like Medicare and Social Security and benefit the macroeconomy. After steadily falling for decades, the average age of retirement in the United States began climbing in the late 1990s.
Nearly three times as many people age 65 and older are employed now as were employed in the late 1980s, according to the U.S. Bureau of Labor Statistics (BLS; see chart 4). The labor force participation rate among older Americans is likely to keep rising, even as the rate for the overall population declines (see chart 5). For example, the participation rate for those 75 and older will reach 10.6 percent in 2024, roughly double the rate in 1994, according to BLS projections.
Why are people retiring later? The answers are not certain, according to Atlanta Fed economists Toni Braun and Karen Kopecky.
"It's not necessarily clear that these higher labor force participation rates later in life reflect that people are feeling poor and need to work longer," Braun says. "It could be that technology is changing in ways such that it's easier for them to transition into retirement, as opposed to abruptly stopping work entirely. That may not be a bad thing."
Smooth labor supply, not abrupt changes, is optimal
Basic economic models say a gradual transition into retirement is optimal for the macroeconomy, and probably for most individuals, too, Kopecky explains.
Even though older people are likely to continue working later in life, overall labor force growth will slow. The BLS projects that the labor force participation rate will continue to decline through 2024. The decline, coupled with comparatively slow growth in the working-age population, will produce labor force growth of just 0.5 percent a year on average through 2040, according to the Congressional Budget Office. That's less than a third of the average annual rate of labor force growth, 1.7 percent, between 1970 and 2007.
Slower labor force growth could pose a challenge to economic growth, says Julie Hotchkiss, an Atlanta Fed research economist and senior policy adviser. Then again, a slower-growing labor force is not necessarily a recipe for lower productivity and stunted economic growth.
It is true that as baby boomers enter old age, they become net consumers and not net producers. On the other hand, some older people amass lots of wealth by saving for many years. So the economy is transitioning from one with an age structure favorable to production - with a bigger share of working-age people - to one more favorable to deepening capital for investment, points out Gretchen Donehower, a demographer at the University of California-Berkeley's Center on the Economics and Demography of Aging.
"If the amount of available labor goes down, you can perhaps compensate by giving each worker more capital to make them more productive," Donehower says. "This would counteract the population aging panic."
The more we save for retirement, the better for us and the macroeconomy
Of course, a surge of investment in human and physical capital won't happen by itself. Various policies and incentives would be required to channel wealth toward capital investment. And it's not certain this will happen. Braun does not subscribe to the theory that wealth accumulated by elderly people will lead to heavy capital investment and thus more productive, if fewer, workers.
He points to research suggesting that while elderly people save throughout their lives, they tend to spend their wealth in retirement. Moreover, shocks during old age - a spouse's death, a major health problem - tend to quickly wipe out wealth, according to research by economist James Poterba of the Massachusetts Institute of Technology.
Clearly, the more that all Americans save, the less difficult will be the demographic shift.
Pegging how much the elderly have saved is no simple matter, though. Many are well off. A 2012 study by Poterba, Steven Venti of Dartmouth College, and David Wise of Harvard University found that between 1993 and 2008, the median wealth of married senior-citizen couples, about a year before they died, exceeded $600,000. Yet they also found that 46 percent of the elderly in the United States had less than $10,000 in financial assets when they died.
The economist Ronald Lee of the UC-Berkeley Center on the Economics and Demography of Aging took wealth into account in constructing an alternative to the standard old-age support ratio. In a paper presented at the Federal Reserve Bank of Kansas City's 2014 Jackson Hole Economic Policy Symposium, Lee noted that the support ratio ignores capital and reflects only labor income in relation to consumption.
He concluded that "the impact of population aging is cut by three-fourths using the general support ratio," his new formulation. Using his general support ratio, he calculated that the growth of output per hypothetical consumer declines by .06 percent a year from 2010 to 2050, instead of .26 percent annually under the ordinary old-age dependency, or support, ratio. The standard support ratio refers to the ratio of elderly people to working-age people.
Another hopeful sign in the battle against the demographic wave: the growth in health care spending has slowed in recent years. Part of the story is that older people today generally are healthier than older people of earlier generations, thus requiring less expensive care, Donehower says. The percentage of people in nursing homes is declining as older people are generally healthier and as programs encourage people to avoid the very costly care nursing homes provide.
Population aging will have many and diverse economic impacts. But that alone is no cause to despair.
"The bottom line is that the nation has many good options for responding to population aging," notes Aging and the Macroeconomy: Long-term Implications of an Older Population, a 2012 report compiled by the National Research Council for the U.S. Congress. "On the whole, America is strong and healthy enough to pay for increased years of consumption through increased years of work, if we so choose. Alternatively, we will be healthy enough to enjoy additional active years of retirement leisure if that is our decision, individually or collectively."
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Staff writer for Economy Matters
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