The Economist: Demographics: Nonsense nonsense crisis

AMERICA and Europe face a troubling demographic future. Declining birth rates will probably result in an older population and a smaller share of the population working to pay for their retirement. Does this necessary spell doom and gloom?

Megan Mcardle reckons so, but Dean Baker dismisses such arguments as “nonsense”. He shows that if productivity continues to increase (even at a lower rate than we’ve experienced historically) then we can still expect rising levels of prosperity. But which factor will dominate, aging or productivity, is uncertain. History is on Mr Baker’s side. Since industrialisation, each new cohort was more productive than the last. The productivity of labour depends on capital and innovation. There are diminishing returns to capital, so sustainable increases in productivity come from new innovation. Ms McArdle, channeling endogenous growth models, is concerned there will less innovation in the future. Younger workers are more innovative and entrepreneurial; an aging labour force might mean much less or no productivity growth. Future productivity of labour will also depend on capital-intensity. An old population requires more people to work in labour-intensive jobs like elder care, there's not much scope to improve productivity of labour in such sectors—at least not in a humane way.

The unknowns make it hard to speculate what the future will be like. Helpful policy ideas, like more immigration and education reform, could help ensure that young workers are competitive and productive. Mr Baker takes his argument further when he says:

In short, the idea that demographics will impoverish our children and grandchildren is absurd on its face. Readers may rightly note than most workers have not seen the gains of productivity growth over the last three decades, but this just highlights the importance of intra-generational distribution. The impact of battles over distribution of income within generations will dwarf the impact of battles over distribution between generation.

I agree it’s premature to start planning for the decline of western civilisation, but his productivity speculation doesn’t justify the conclusion that intra-generational distribution matters more than inter-generational. Arguments like his remind me of the way that pension managers used to justify under-funding of their pensions: they counted on high stock returns or on productivity growth within the company/municipality sufficient to fund future obligations. Often their hopes didn’t come to fruition. Now we have under-funded pensions; many retirees and soon-to-be retirees face the possibility of benefit cuts. This is happening after it’s too late for them to save more; they face insecurity in retirement and likely declines in their standards of living.

In light of this, we can’t be so dismissive of entitlement reform (though whether or not it belongs in fiscal cliff negotiations is another issue) on the hope we’ll be richer someday. The sooner entitlements are put on a solvent path the lower the cost to future generations. Income from entitlement programs is all many retirees have to live on, and given current saving rates, most of what future retirees will have too.

available at http://www.economist.com/blogs/freeexchange/2012/12/demographics?fsrc=scn/fb/wl/bl/nonsensecrisis