Retirees pay the price for falling innovation

Megan McArdle

Growth-wise, the world seems to be in a little bit of a rut.

Oh, sure, we’re OK. We just do not seem to be going much of anywhere. Global production has recovered somewhat since the catastrophe of the financial crisis, but it did not bounce back entirely. Instead, we’re staggering along at a noticeably lower rate of growth, both abroad and at home.

What’s going on? One theory is that this is simply the aftermath of a financial crisis.

We had a lot of malinvestment, and now we have a lot of fiscal and monetary problems to work out, and as with a bad illness, it’s going to take a little time for us to get back to 100 percent. A more worrying theory is that this may be the new normal because of the developed world’s aging populations. And that was especially bad because when the population is aging, that’s when you need growth the most.

Most developed nations have made enormous promises to their elderly populations – promises that they could continue to live in the style to which they had become accustomed during their working years. Those promises were easy to fulfill when the ratio of workers to retirees was, say, five to one. As that ratio collapses, it gets harder and harder, because each worker has to devote a larger and larger fraction of their income to supporting another nonworking adult.

A simple numerical example may illustrate how important growth rates are to an aging economy.

Let’s say we have 99 workers and one retiree, and we want all of them to enjoy the same standard of living. Now say each worker can produce $100 worth of stuff. If each of our workers donates $1 apiece to the retiree, everyone gets $99 dollars.

But now let’s say nine more people retire over the next nine years. Now we have 90 workers, generating total output of $9,000 a year. Split 100 ways, everyone gets $90 instead of $99. As more people retire, the math gets worse and worse. Eventually, the workers may well say “You non-workers are on your own.”

Of course, this example is a static economy. Make those workers more productive, and things get very different. If the economy is growing by just 2 percent, and people retire at the same rate, we can maintain this system indefinitely with neither workers nor retirees getting poorer.

On the other hand, if growth falls to 1 percent, then over time, incomes start declining. Gross domestic product is going up, but income is falling. That’s obviously undesirable – and it’s also politically unstable. Which is why we need productivity growth now more than ever.

Unfortunately, a new paper suggests that now is when we’re least likely to get it. Economists have long known that economies were likely to slow down as the population aged, simply because the size of the workforce declined.

Economic growth is composed of two components: workforce growth and productivity growth. If those numbers fall, so will the growth rate.

But most commentary on this has focused on the workforce component. Nicole Maestas, Kathleen J. Mullen and David Powell suggest that two-thirds of the reduction in the growth rate actually comes from falling productivity, with the shrinking labor force playing a comparatively minor role.

Why might this be true? If you think about it, it’s not that surprising. Growth comes from innovation, and innovation is risky. If you’re young, you have longer to recover, and longer to enjoy the fruits of a lucky bet, than you are if you’re 55. We should expect aging societies to shift toward a more stable, less innovative, equilibrium.

Unfortunately, thanks to all the promises we’ve made, that equilibrium does not look all that stable. If both workforce growth and productivity growth fall at the same time, most of the world’s developed nations are going to find themselves in deep crisis as they try to stretch a shrinking income to fulfill promises to retirees.

One obvious answer is to import a younger workforce, and thereby shift the demographics of the nation back toward a higher-growth equilibrium capable of meeting those demands. But workers are not undifferentiated blobs of human capital that all produce exactly the same amount when plugged into the economy.

It’s not clear to me that replacing a retiring $100,000-a-year CPA with a young $26,000-a-year roofer is a net benefit to the Social Security system, even if you assume that the roofer boosts economic growth by allowing others to spend more time making money and being productive.

Of course, it’s possible that we’re on the verge of technological breakthroughs that will allow us to replace massive amounts of human labor, making us so rich that we will not have to worry about the health of our retirement systems. But that was been predicted for centuries and has not materialized. In the meantime, when you’ve made promises as big as the ones we have, it’s probably not safe to sit back and hope for the best.

Megan McArdle is a Bloomberg View columnist. © 2016, Bloomberg View