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Should We Increase the National Savings Rate? --No…

By Elizabeth Gamson

The United States is experiencing a rapid aging of its population. As a rising number of the elderly retire, they increasingly rely on their savings, their children and their government to support them. The aging of the large baby-boom population, along with the improvements in longevity, are expected to put increasing strains on the nation’s health and pension systems over the next half century (McFalls, 29). Economists are now exploring whether or not this will be a serious burden on the future United States economy. They pose an important question as they analyze this situation: Should we increase the national savings rate? In this paper, I will focus on the findings of David Cutler et al. to show that although there are many reasons for arguing that the United States currently saves too little, anticipated demographic change is not one of them and thus, there is no need to increase the national savings rate on account of these changes.

David Cutler’s analysis consists of five key steps. First, he assesses the future dependency burden caused by the aging of the population. One of the largest problems brought about by the aging of the population is the heightened dependency burden in the coming years. For example, by the year 2025, the ratio of retirees to workers will have risen by almost two-thirds (Cutler, 1). Cutler measures the dependency burden by studying the support ratio, a ratio of the effective labor force in relation to the effective number of consumers (Cutler, 8). When presenting his results, Cutler focuses on the results of the short run and the long run separately. There is a long-run decline in the support ratio-- a rise in economic dependency-- on account that the labor force will grow slower than the population during the next seventy years, and because the numbers of elderly will rise substantially during the period of 2010 to 2035. But, in the short-run, the next few decades, there is actually a rise in the support ratio-- a decline in economic dependency. This short-run rise in the support ratio can be explained by the declining number of dependent children which more than offsets the rising number of dependent elderly. Between 1990 and 2010, when the baby boom generation is part of the labor force and relatively small birth cohorts are retiring, the labor force will grow more rapidly than the dependent population. Thus, there will be an improvement in the support ratio by 2010 (Cutler, 13).

Relating these results to per capita incomes, Cutler finds that dependency burden changes unaccompanied by changes in capital intensity would reduce per capita incomes by between seven percent and twelve percent over the next sixty years, but would increase incomes over the next twenty years. Therefore, Cutler concludes that a decline in living standards, caused by increased dependency, will not be substantial. The decline in living standards can be fully reversed, for example, by a quite possible 0.15 percent a year increase in productivity growth. An increase in the national savings rate is thus unnecessary, as increased dependency can be offset by an increase in productivity (Cutler, 3).

Secondly, Cutler considers the consequences of the slower labor force growth with respect to the increase in the retired share of the population. From 1950 to 1990, the labor force grew at a slow pace of 1.5 percent annually. From 2010 to 2060, however, the labor force is expected to slightly decline. Slower labor force growth will allow a smaller share of national output to be devoted to investment in plant, equipment, and housing. This slowing in labor force growth therefore reduces investment requirements. This future decline in labor force growth will allow for a three to four percent reduction in investment while maintaining the same amount of capital.

The consumption benefits from these reduced investment requirements are considerable. During the next two decades, the benefits of slower labor force growth will be about a 1.0 to 3.5 percent increase in per capita consumption, using the 1990 base. By 2050, the benefits of slower labor force growth will be between 2.1 percent and 3.7 percent of per capita consumption. As is evident, demographic shifts during the next fifty years optimally raise present consumption (Cutler, 17).

Reduced investment requirements also intensify the short-run effect of rising support ratios. Reduced dependency and slowing labor force growth both increase consumption possibilities so that by 2010, society will be between 3.4 percent and 6.3 percent richer. Only after 2020 does the increase in dependency outweigh the decline in investment needs and reduce consumption below it 1990 level (Cutler, 19). By working through mathematical models, Cutler shows that for an economy choosing its consumption path in accord with a standard optimal growth model, the right response to the upcoming demographic change in the United States is an increase in consumption and a reduction in national saving. For all the possible combinations of parameter values of his results, the effects of the reduced labor force and reductions in the number of children exceed the effects of increases in long-run dependency. Thus, slower labor force growth reduces investment requirements, increasing consumption per capita and therefore reducing the need for saving (Cutler, 25).

Thirdly, Cutler considers the implications of integrated world capital markets for his analysis. The changes upon the integrated market will bring much benefit for the United States. Cutler argues that demographic changes justify a reduction in optimal saving, which is reinforced when we take into account international capital flows. This is so because demographic changes are less pronounced in the United States than in the other countries comprising the Organization for Economic Cooperation and Development. The degree and speed of population aging in these other major industrialized countries is much more dramatic than that in the United States. For example, by 2050, even with a nineteen-percentage point increase in the elderly dependency ratio from 1950, the United States’ elderly dependency ratio will be approximately five-percentage points lower than will those of the other countries. As a result, the United States will be better off for the next two decades than it is now, while the other countries’ experience declines in the support ratio beginning in 1990 (Cutler, 25).

Cutler predicts that the increase in dependency abroad will coincide with a deceleration in labor force growth rates. The capital per labor ratio is too high in Europe, for example, since the labor force is decreasing in size. Therefore, the return on capital for the Europeans is low. Since the United States has a larger labor force, and the capital in European countries is not needed as much due to the lack of work force, Europe will thus export their capital to the United States. The United States’ investment will be absorbed through European savings, not through United States’ savings. Cutler suggests that Americans should therefore let Europeans worry about saving and also maximize the benefits received from Europe exporting its’ capital to the United States. Along an optimal path, therefore, the European countries will borrow on the international market, buy goods from the United States and in exchange export capital to the United States. This process increases United States’ consumption and also decreases the saving rate necessary to maintain this lending (Cutler, 3).

In his fourth step of analysis, Cutler explores whether the coming demographic changes are likely to affect the rate of technical change. With slower labor force growth, labor is scarce. However, scarcity actually may spur more rapid technical change (Cutler, 3). Increases in productivity enable a country to go beyond the constraints that a higher dependency burden could impose. Cutler investigates this idea further by using international cross-section time series data for the period of 1960 to 1985 (Cutler, 29). In his results, he has found some evidence that nations with slower labor force growth actually experience more rapid productivity growth than those countries with higher labor force growth. For example, most European nations, which are slower-growing countries, exhibit above-average productivity growth, while more rapidly growing countries such as Canada and Australia have lower productivity growth. Cutler’s estimates suggest that the reduction in labor force growth projected for the next forty years may raise productivity growth enough to fully offset the consequences of increased dependence in the United States (Cutler, 3). Cutler here presents yet another reason why decreased fertility may not harm the future economy substantially and why an increase in the national savings rate is unnecessary.

Finally, Cutler considers the implications of demographic changes for fiscal policy. The implications for fiscal policy depend upon how the private saving rate responds to demographic changes. Since population aging does not cause high reductions in private savings, there is no argument for reducing the budget deficit. Tax collection, however, presents an immense problem. To keep up services for the elderly, government spending must increase from the current thirty-two percent of the Gross Domestic Product to thirty-seven percent of the Gross Domestic Product.

Cutler addresses whether taxes should now be raised in anticipation of higher burdens of government expenditures as the population ages. He compares the benefits of a "tax-smoothing strategy," in which taxes would be increased now, before dependency ratios increase, and of a "pay-as-you-go" policy of raising taxes later and concludes that the required increase in tax rates under a pay-as-you-go policy will be substantial- amounting to approximately 4.5 percent of Gross National Product. An advantage of tax smoothing over pay-as-you-go is the lower deadweight burdens from taxation. In the absence of tax smoothing, future generations will have to pay a significantly higher portion of their income for social security and medicare benefits. Cutler therefore supports a tax smoothing policy for it is more efficient than a pay-as-you-go policy.

In summary, Cutler’s study suggests that changes in the economy caused by population aging do not warrant the need for an increased national savings rate. His study mitigates many of the concerns associated with the aging population; demographic changes will not worsen the economic growth of the United States. In the short run, the aging of the population will actually be very much beneficial. However, in the long run, this change in the dependency burden will cause a seven to twelve decrease in per capita incomes. The principal explanations behind this economic change include the increase in the proportion of the working population and the slowing of the labor force, which lowers the level of capital necessary to plant, equipment, and housing. Also, the proportion of the population that is working will increase. The increase in the scarcity of labor and the influx of foreign capital may also directly benefit the economy. Overall, population aging will increase income in the short run, attract foreign capital, and decrease the return on savings. All of these economic conditions do not necessitate a higher level of support through an increased national savings rate.

 

References:

D. M. Cutler, James M. Poterba, Louise M. Scheiner and Lawrence H. Summers, "An Aging Society: Opportunity or Challenge?", Brookings Papers on Economic Activity, Vol. 1, 1990, pp. 1-56.

Population: A Lively Introduction, Joseph A. Mc Falls Jr., Population Reference Bureau, Population Bulletin, Vol. 53, No. 3, 1999.