-
Ben S Bernanke: The coming demographic transition will we treat future
generations fairly?
Remarks by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal Reserve
System, before the Washington Economic Club, Washington DC, 4 October 2006.
* * *
In coming decades, many forces will shape our economy and our society, but in all likelihood no single
factor will have as pervasive an effect as the aging of our population. In 2008, as the first members of
the baby-boom generation reach the minimum age for receiving Social Security benefits, there will be
about five working-age people (between the ages of twenty and sixty-four) in the United States for
each person aged sixty-five and older, and those sixty-five and older will make up about 12 percent of
the U.S. population. Those statistics are set to change rapidly, at least relative to the speed with which
one thinks of demographic changes as usually taking place. For example, according to the
intermediate projections of the Social Security Trustees, by 2030 - by which time most of the baby
boomers will have retired - the ratio of those of working age to those sixty-five and older will have
fallen from five to about three. By that time, older Americans will constitute about 19 percent of the
U.S. population, a greater share than of the population of Florida today.
This coming demographic transition is the result both of the reduction in fertility that followed the
postWorld War II baby boom and of ongoing increases in life expectancy. Although demographers expect
U.S. fertility rates to remain close to current levels for the foreseeable future, life expectancy is
projected to continue rising. As a consequence, the anticipated increase in the share of the population
aged sixty-five or older is not simply the result of the retirement of the baby boomers; the "pig in a
python" image often used to describe the effects of that generation on U.S. demographics is
misleading. Instead, over the next few decades the U.S. population is expected to become
progressively older and remain so, even as the baby-boom generation passes from the scene. As you
may know, population aging is also occurring in many other countries. Indeed, many of these countries
are further along than the United States in this process and have already begun to experience more
fully some of its social and economic implications.
Even a practitioner of the dismal science like me would find it difficult to describe increasing life
expectancy as bad news. Longer, healthier lives will provide many benefits for individuals, families,
and society as a whole. However, an aging population also creates some important economic
challenges. For example, many observers have noted the difficult choices that aging will create for
fiscal policy makers in the years to come, and I will briefly note some of those budgetary issues today.
But the implications of demographic change can also be viewed from a broader economic perspective.
As I will discuss, the broader perspective shows clearly that adequate preparation for the coming
demographic transition may well involve significant adjustments in our patterns of consumption, work
effort, and saving. Ultimately, the extent of these adjustments depends on how we choose - either
explicitly or implicitly - to distribute the economic burdens of the aging of our population across
generations. Inherent in that choice are questions of intergenerational equity and economic efficiency,
questions that are difficult to answer definitively but are nevertheless among the most critical that we
face as a nation.
Demographic change and the federal budget
As I have already mentioned, the coming demographic transition will have a major impact on the
federal budget, beginning not so very far in the future and continuing for many decades. Although
demographic change will affect many aspects of the government's budget, the most dramatic effects
will be seen in the Social Security and Medicare programs, which provide income support and medical
care for retirees and which have until now been funded largely on a pay-as-you-go basis. Under
current law, spending on these two programs alone will increase from about 7 percent of the U.S.
gross domestic product (GDP) today to almost 13 percent of GDP by 2030 and to more than 15
percent of the nation's output by 2050. The outlook for Medicare is particularly sobering because it
reflects not only an increasing number of retirees but also the expectation that Medicare expenditures
per beneficiary will continue to rise faster than per capita GDP. For example, the Medicare trustees'
intermediate projections have Medicare spending growing from about 3 percent of GDP today to about
9 percent in 2050 - a larger share of national output than is currently devoted to Social Security and
Medicare together.
The fiscal consequences of these trends are large and unavoidable. As the population ages, the
nation will have to choose among higher taxes, less non-entitlement spending, a reduction in outlays
for entitlement programs, a sharply higher budget deficit, or some combination thereof. To get a sense
of the magnitudes involved, suppose that we tried to finance projected entitlement spending entirely by
revenue increases. In that case, the taxes collected by the federal government would have to rise from
about 18 percent of GDP today to about 24 percent of GDP in 2030, an increase of one-third in the tax
burden over the next twenty-five years, with more increases to follow. (This calculation ignores the
possible effects of higher tax rates on economic activity, an issue to which I will return later.)
Alternatively, financing the projected increase in entitlement spending entirely by reducing outlays in
other areas would require that spending for programs other than Medicare and Social Security be cut
by about half, relative to GDP, from its current value of 12 percent of GDP today to about 6 percent of
GDP by 2030. In today's terms, this action would be equivalent to a budget cut of approximately $700
billion in non-entitlement spending.
Besides tax increases, spending cuts, or reform of the major entitlement programs, the fourth possible
fiscal response to population aging is to accommodate a portion of rising entitlement obligations
through increases in the federal budget deficit. The economic costs and risks posed by large deficits
have been frequently discussed and I will not repeat those points today. Instead, I will only observe
that, among the possible effects, increases in the deficit (and, as a result, in the national debt) would
shift the burden of paying for government spending from the present to the future. Consequently, the
choices that fiscal policy makers make with respect to these programs will be a crucial determinant of
the way the economic burden of an aging population is distributed between the current generation and
the generations that will follow.
A broader economic and generational perspective
Indeed, framing the issue in generational terms highlights the fact that the economic implications of the
coming demographic transition go well beyond standard considerations of fiscal policy and
government finance, important as those are. For reasons that I will explain in a moment, the aging of
the population is likely to lead to lower average living standards than those that would have been
experienced without this demographic change. How that burden of lower living standards is divided
between the present and the future has important implications for both intergenerational fairness and
economic efficiency.
Why will the coming demographic transition carry a cost in terms of long-run living standards?
Assuming it unfolds as expected, the projected aging of the population implies a decline over time in
the share of the overall population that is of working age and thus, presumably, in the share of the
per worker
population that is employed. For any given level of output that might be attained at some
future date, this decline in the share of people working implies that the level of output per person must
be lower than it otherwise would have been. In a sense, each worker's output will have to be shared
among more people. Thus, all else being the same, the expected decline in labor force participation
will reduce per capita real GDP and thus per capita consumption relative to what they would have
been without population aging. These reductions in output and consumption per person represent an
economic burden created by the demographic transition.
Although some adverse effect of population aging on future per capita output and consumption is
probably inevitable, actions that we take today, in both the public and the private spheres, have the
potential to mitigate those effects. One such action would be to find ways to increase our national
saving rate. If the extra savings were used to increase the nation's capital stock - the quantity of plant
and equipment available for use by workers - then future workers would be more productive,
ameliorating the anticipated effects on per capita output and consumption. Alternatively, using extra
saving to acquire financial assets abroad (or to reduce foreign obligations) would also increase the
resources available in the future.
By saving more today, we can reduce the future burden of demographic change. However, as any
economist will tell you, there is no such thing as a free lunch. Saving more requires that we consume
less (to free up the needed resources) or work more (to increase the amount of output available to
dedicate to such activities). Either case entails some sacrifice on the part of the current generation.
Consequently, a tradeoff exists: We can mitigate the adverse effect of the aging population on future
generations but only by foregoing consumption or leisure today. This analysis is simple, but it shows
why the coming demographic transition has economic implications that go well beyond the effect of
aging on the federal budget.
In recent work, economists at the Board of Governors have used a stylized model to get a rough
estimate of the magnitudes of the intergenerational tradeoffs that we face.1 Their analysis takes as a
starting point a baseline scenario in which U.S. demographics remain (hypothetically) the same in the
future as they are today. In this counterfactual scenario, the ratio of workers to the overall population is
assumed to remain at its current level over time and per capita consumption grows with productivity.
Now in reality, as I have noted, an aging population will reduce labor force participation, so the likely
future trajectory of per capita consumption over time lies below that implied by the baseline scenario
that assumes away the demographic change. The shape of the actual consumption trajectory
depends, however, on the saving behavior of the current generation. If today's saving rate is low, then
the current generation can enjoy consumption close to what it would have been if the aging issue did
not exist. However, in this case, the burden on future generations will be relatively great. Alternatively,
the current generation could consume less and save more, which would allow the consumption of
future generations to be closer to what it would have been in the absence of population aging.
How big are these effects? To assess magnitudes, the Board economists first examined the case in
which the nation saves at its current rate for the next twenty years, thereby largely insulating the
babyboom generation from the effects of the coming demographic transition. After that, they assumed,
consumption falls and saving rates rise, with all future generations experiencing the same percentage
reduction in consumption relative to the baseline in which no population aging occurs. Their rough
calculations suggest that, in this case, the per capita consumption of future generations would be
about 14 percent less than what it would have been in the absence of demographic change.
For comparison, they next considered the case in which the burden of demographic change is shared
more equally among current and future generations. They considered a case in which the national
saving rate, instead of staying at its current level for the next twenty years, rises immediately. Further,
they asked by how much today's saving rate would have to increase to lead to equal burden-sharing
among current and future generations. ("Equal burden-sharing" is interpreted to mean that the current
generation and all future generations experience the same percentage reduction in per capita
consumption relative to the baseline scenario without population aging.) They found that equal
burden-sharing across generations could be achieved by an immediate reduction in per capita
consumption on the order of 4 percent (or, since consumption is about two-thirds of output, by an
increase in national saving of about 3 percentage points.) This case obviously involves greater
sacrifice by the current generation, but the payoff is that all future generations enjoy per capita
consumption that is only 4 percent, rather than 14 percent, below what it would have been in the
absence of population aging. The large improvement in the estimated living standards of future
generations arises because of the extra capital bequeathed to them by virtue of the current
generation's assumed higher rate of saving.
These numbers shouldn't be taken literally but the basic lesson is surely right - that the decisions that
we make over the next few decades will matter greatly for the living standards of our children and
grandchildren. If we don't begin soon to provide for the coming demographic transition, the relative
burden on future generations may be significantly greater than it otherwise could have been.2
At the heart of the choices our elected representatives will have to make regarding the distribution of
these costs across generations will be an issue of fairness: What responsibility do we, who are alive
today, have to future generations? What will constitute ethical and fair treatment of those generations,
who are not present today to speak for themselves? If current trends continue, the typical U.S. worker
will be considerably more productive several decades from now. Thus, one might argue that letting
future generations bear the burden of population aging is appropriate, as they will likely be richer than
we are even taking that burden into account. On the other hand, I suspect that many people would
agree that a fair outcome should involve the current generation shouldering at least some of that
burden, especially in light of the sacrifices that previous generations made to give us the prosperity we
enjoy today.
The choice of which generations should bear the burden of population aging has consequences for
economic efficiency as well as for intergenerational equity. If we decide to pass the burden on to future
generations - that is, if we neither increase saving now nor reduce the benefits to be paid in the future
by Social Security and Medicare - then the children and grandchildren of the baby boomers are likely
to face much higher tax rates. A large increase in tax rates would surely have adverse effects on a
wide range of economic incentives, including the incentives to work and save, which would hamper
economic performance. Alternatively, to avoid large tax increases, the government could decide to
sharply reduce non-entitlement spending in the future. However, such actions might also have
important social costs that need to be taken into consideration.
Sharing the burden of population aging
If, as a nation, we were to accept the premise that the baby-boom generation should share at least
some of the burden of population aging, what policy steps might be implied? As I have already noted,
from a broad economic perspective, the most useful actions are likely to be those that promote
national saving. Perhaps the most straightforward way to raise national saving - although not a
politically easy one - is to reduce the government's current and projected budget deficits. To the extent
that reduced government borrowing allows more private saving to be used for capital formation or to
acquire foreign assets, future U.S. output and income will be enhanced and the future burdens
associated with demographic change will be smaller.
Increasing private saving, which is the saving of both the corporate sector and the household sector, is
likewise desirable. Corporate saving, in the form of retained earnings, is currently at relatively high
levels, but household saving rates are exceptionally low.3 A broad-based increase in household
saving would benefit both the economy and the millions of American families who currently hold very
little wealth.
Unfortunately, many years of concentrated attention on this issue by policymakers and economists
have failed to uncover a silver bullet for increasing household saving. One promising area that
deserves more attention is financial education. The Federal Reserve has actively supported such
efforts, which may be useful in helping people understand the importance of saving and to learn about
alternative saving vehicles. Psychologists have also studied how the framing of alternatives affects
people's saving decisions. For example, studies suggest that employees are much more likely to
participate in 401(k) retirement plans at work if they are enrolled automatically - with a choice to opt
out - rather than being required to actively choose to join. The pension bill recently passed by
Congress and signed by the President included provisions to increase employers' incentives to adopt
such opt-out rules; it will be interesting to see whether such rules are adopted and, if so, how effective
they are in promoting employee saving.
Other steps can also help increase the future productive capacity of the economy and thereby reduce
the adverse effects of demographic change. For example, devoting resources to improving our K-12
education system, expanding access to community colleges, increasing on-the-job training, and
stimulating basic research could augment the nation's capital in the broadest sense of the term and
might have desirable distributional effects as well.
Another response to population aging is to adopt measures that encourage participation in the labor
force, particularly among older workers. In the near term, increases in labor force participation would
raise income; some of this income would be saved and would thus be available to augment the capital
stock. In the long run, higher rates of labor force participation, particularly by those who would
otherwise be in retirement, could help to offset the negative effect of population aging on the share of
the population that is working.
To some extent, increased labor force participation by older workers may happen naturally. Increased
longevity and health will encourage greater numbers of older people to remain longer in the workforce.
And slower growth in the labor force will motivate employers to retain or attract older workers - for
example through higher wages, more flexibility in work schedules, increased training directed toward
older workers, and changes in the retirement incentives provided by pension plans.
Reform of our unsustainable entitlement programs should also be a priority. The nature and timing of
those reforms will be determined, of course, by our elected representatives. However, the
intergenerational perspective does provide a few insights that might be helpful to policymakers as they
undertake the needed reforms. First, restructuring the finances of our entitlement programs to
minimize their reliance on deficit spending will enhance national saving and reduce the burden on
future generations. Second, changes in the structure of entitlement programs should preserve or
enhance the incentives to work and to save; for example, we should take care that benefits rules do
not penalize those who may wish to work part-time after retirement. Finally, the imperative to
undertake reform earlier rather than later is great. As illustrated by the simulation I discussed earlier,
the longer the delay in putting our entitlement programs on a sound fiscal footing, the heavier the
burden that will be passed on to future generations. Moreover, the sooner any restructuring of
entitlement programs takes place, the easier it will be for people now in their working years to prepare,
for example, by saving more today. However, if reform is delayed and fiscal exigencies ultimately force
changes in these programs with little notice to potential retirees, their ability to adjust their behavior
appropriately could be much reduced.
Conclusion
Over the next few decades, the U.S. population will grow significantly older, a development that will
affect our society and our economy in many ways. In particular, the coming demographic transition will
create severe fiscal challenges, as the cost of entitlement programs rises sharply. I hope to have
persuaded you today, however, that the economic implications of this transition go well beyond fiscal
policy. From a broader economic perspective, the question is how the burden of an aging population is
to be shared between our generation and the generations that will follow us. A failure on our part to
prepare for demographic change will have substantial adverse effects on the economic welfare of our
children and grandchildren and on the long-run productive potential of the U.S. economy.
References
Auerbach, Alan J., Jagadeesh Gokhale, and Laurence J. Kotlikoff (1991). "Generational Accounts: A
Tax Policy and the
Meaningful Alternative to Deficit Accounting," in David Bradford, ed., Economy, vol.
5, National Bureau of Economic Research. Cambridge, Mass.: MIT Press, pp. 55-110.
Elmendorf, Douglas, and Louise Sheiner (2000). "Should America Save for Its Old Age? Fiscal Policy,
Population Aging, and National Saving" Journal of Economic Perspectives, vol. 14 (Summer), pp.
5774.
Gokhale, Jagadeesh, and Laurence J. Kotlikoff (2001). "Is War Between Generations Inevitable?"
Report no. 246, National Center for Policy Analysis. Dallas, November.
Sheiner, Louise, Daniel Sichel, and Lawrence Slifman (2006). "A Primer on the Macroeconomic
Consequences of Population Aging," unpublished working paper, Board of Governors of the Federal
Reserve System, Division of Research and Statistics, September.