Updated 11 Jan 00 * Copyright 1999-2000 by Andrew Homer.
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Social Security
Q: Would prolonged economic growth save Social Security?
A: No, Congress will have to face the hard choices of higher taxes or lower benefits sooner or later.
The Washington Times, 10-25-99
A booming stock market during the last eight years has inspired the notion that steady, prolonged
growth of the gross domestic product virtually will save the Social Security trust fund from insolvency by the
year 2034. Skepticism is in order for several reasons. First, it is too early to tell if we are entering a long
period of robust growth. A spell of good weather is not necessarily a permanent climate shift. Should the economy
still be expanding without interruption five years from now, the case for optimism will be stronger. However, nobody
has repealed the business cycle. Recessions do happen. There was much talk of a "new era" of permanent
prosperity in early 1929, too.
Second, it is doubtful that the brisk growth that could help Social Security can be achieved.
Obviously, growth depends heavily on productivity (output per man- hour or per worker). The latest report of Social
Security's Board of Trustees includes an "intermediate" actuarial analysis in which Social Security's
trust fund is exhausted in 2034 and a "low-cost" (optimistic) one in which trust-fund exhaustion is avoided.
The productivity growth assumption underlying the low-cost outcome is 1.6 percent per year. Put another way, this
is roughly the productivity growth needed to avert disaster in Social Security.
Productivity growth for 1958 to 1997 averaged 1.7 percent annually, which makes the optimistic assumption look
plausible. But this seemingly healthy figure masks a steady decline, revealed by disaggregating 1958 to 1997 into
10-year periods: 2.9 percent average annual productivity growth from 1958 to 1967, 2 percent from 1968 to 1977,
1 percent from 1978 to 1987 and just 0.9 percent from 1988 to 1997.
So, for productivity growth to reach 1.6 percent, it has to nearly double from its 1988-1997 level - and to avert
Social Security's ruin, it must stay there long term. But how likely is this to happen? Productivity is determined
primarily by investment, and the seed corn of investment is savings. Our net national savings rate - net private
savings minus federal-budget deficits, i.e., the share of gross domestic product, or GDP, actually available for
investment - has collapsed from an average of 9.2 percent of GDP in the sixties to just 2.6 percent in the period
of 1991 to 1996. Reflecting the scarcity of investable capital, the real interest rate - as measured by the interest
rate on Moody's AAA-rated bonds minus the Consumer Price Index, which gives a measure of the cost of credit for
investment in plant and equipment - has been steadily rising; its 1987-1996 average of 4.8 percent is almost triple
its 1957-1966 level of 1.8 percent. Just where will the money for the investment needed for sustained doubling
of productivity growth -
and robust output growth - come from? Overseas? Don't count on it. The Japanese are struggling out of financial
meltdown. They can't do our saving for us any more.
The productivity growth slump also reflects the shift from manufacturing to services. In 1950, 47.2 percent of
the private nonagricultural labor force was in manufacturing, 52.8 percent in services. In 1995, 24.7 percent was
producing goods, 75.2 percent producing services. And while manufacturing has seen impressive productivity gains,
because its share of total output has fallen, so has its contribution to overall productivity growth, which has
been less than that in manufacturing, implying unimpressive productivity growth in services.
True, measuring productivity in services is difficult, and some observers argue that service-sector productivity
has been soaring since 1995. Perhaps - but again, beware of mistaking possibly only temporary improvement for a
permanent trend; whether substantial productivity improvement sustainable over the long run indeed has occurred
will not be clear for several years yet.
Also, much of the purported productivity surge has been achieved by replacing managerial and clerical employees
with computers. But we must be clear about what is going on here. When a labor-saving device is introduced, productivity
grows while labor savings are being realized - but once all the savings that can be captured have been captured,
productivity, though now at a higher level, stops growing unless further enhanced by some other cause.
Just how much more blood can be wrung from this turnip? Firms have already squeezed their workforces rigorously.
Indeed, today's high labor demand indicates that substitution of computers for labor has been taken about as far
as it can be.
Finally, remember that productivity comes down to how quickly the physical process of producing a good or service
is completed in a unit of time. Productivity growth means that this process is being completed faster. But can
output per man-hour really rise indefinitely? This implies that eventually people will produce almost instantaneously.
Since this is obviously impossible, it follows that there are limits on productivity growth.
Annual productivity growth of 1.6 percent implies that in 2044 output per man-hour will be twice as high as it
is now. Is it seriously possible that in 45 years workers will build cars twice as quickly, barbers will cut twice
as many heads of hair per hour and keyboard operators will perform twice as many keystrokes a minute? Even if we
had the savings to finance the needed investment - which we don't - it is more likely that productivity growth
eventually will taper off, and productivity will stagnate.
Given all this, even the "intermediate" assumption of annual productivity growth of 1.3 percent looks
unlikely.
The dependence of growth on net national savings and productivity growth is borne out by the fact that while these
collapsed, so did average annual real GDP growth, from 4.4 percent in the sixties to 2.8 percent in the eighties
and just 2.2 percent in the booming nineties. And even with the assumed rates of productivity growth, annual GDP
growth for the next 10 years under the actuaries' intermediate assumptions is 2.0 percent, and under optimistic
assumptions, 2.4 percent. Given that annual GDP growth from 1960 to 1998 averaged 3.2 percent, this is underwhelming.
We could try to offset our dismal savings performance and achieve faster economic growth by adding lots of workers
through immigration. But the foregoing unimpressive growth outlooks assume annual immigration levels of 1.15 million
(low cost) and 900,000 (intermediate) - roughly similar to current levels. Pursuing faster growth through immigration
would entail much higher numbers - and spark a political crisis, since immigration already is an explosive issue.
The idea that shuffling information among computers will propel a "new economy" of fabulous growth is
far-fetched. Most production, after all, is and always will be about goods and noninformation services - precisely
where the troubling savings and productivity trends matter.
Yes, sustained brisk growth may occur. But it's unlikely, and pinning our hopes on it is like children in a fairy
tale assuming that a good fairy will appear in time to save them from the big bad wolf. And, if she doesn't?
Third, even if the economic growth occurs that the "new economy" enthusiasts predict, they forget that
the aging of our population will put federal finances under severe pressure from several other sources besides
Social Security.
Under its latest intermediate actuarial assumptions, which factor in recent economic growth, assume steady growth
of 2 percent through 2007 and no recessions, Medicare's Hospital Insurance (HI, or Medicare A) "trust fund"
is projected to run deficits starting in 2007 and be exhausted in 2015. HI spending is projected to soar to $335
billion in 2015 and $908 billion in 2030, with cash deficits for these years of $46 billion and $330 billion, respectively.
And spending for Medicare's Supplementary Medical Insurance (SMI, or Medicare B), which pays for outpatient hospital
care, doctor visits and so on for old and disabled persons, is already growing faster than the economy and is projected
to keep doing so. In calendar-year 1998, SMI spent $77.6 billion, about one percent of GDP. Under SMI's intermediate
assumptions, outlays are projected to more than double by 2008, to $174.2 billion - this even before the baby boomers
start retiring - and reach about 2.5 percent of GDP 30 years from now.
Spending for Medicaid, the health-care program for the poor, will explode, too. Medicaid is the primary source
of public funding for long-term care for the elderly, financing about 31 percent of it. In 1995 Medicaid spent
$28.5 billion on long-term care. While persons age 65 and older are 13 percent of America's population now, they
will be roughly 20 percent of the population in 2030. Moreover, the population of the oldest old (aged 85 and over),
those most likely to need long-term care, will more than double by 2030, from 3.9 million in 1997 to about 8.5
million, and more than double again by 2050, to roughly 18 million. The budgetary implications are obvious.
Meanwhile, as of 1996 the civil-service retirement system had unfunded liabilities of a present value of $1.1 trillion,
the military retirement system had an unfunded liability with present value of more than $713.4 billion and the
veterans' benefits program had an unfunded liability with present value of more than $190 billion - a total charge
on future output of more than $2 trillion.
Given these other simultaneous large fiscal pressures, growth is unlikely to help Social Security. Much of the
revenue from it will be devoured by these other needs.
Finally, the stakes are too high for trusting in uncertain reeds such as economic
growth. Since virtually all Americans participate in Social Security, the political ramifications of a Social Security
crisis are mind-boggling. Outside help such as growth will be nice if we can get it, but the responsible course
is to refuse to lean on luck and to grapple with overhauling the program itself.
Attarian, an economist based in Ann Arbor, Mich., writes frequently on economic issues for the National
Review, Reason and the Detroit News.
