The Future in Focus: Our Demographic Destiny

During this brief lull between crises in Washington, investors might do something the government seems loath to do: consider longer-term fundamentals. One critical matter on this more distant horizon is the increasing average age of the country's population. Because this trend will impose an expanding number of dependent retirees on an ever-more constrained relative number of working-age people, it will have profound financial and economic repercussions. These will not, however, follow the disastrous outlines occasionally outlined in the media's simple extrapolations. On the contrary, the United States will almost certainly change to protect its prosperity, seeking ways to increase worker productivity, for instance, get more of the existing population to participate in the workplace, tap immigrants, and increase levels of trade and globalization. All should help this economy cope with its demographic imperatives. The effort will, however, require some wrenching changes in the structure of industry and in business practice, and these will inevitably create investment opportunities.

This is a big subject, too big for a single weekly website discussion. The plan is to cover various aspects of this matter in a series of weekly pieces, issued as immediate crises and contingencies allow. This first column will set the tone, describing the demographic imperatives facing the country, outlining the dangers they threaten, and indicating where the various responses fit into the picture of the longer-term future. More focused discussions of each response will follow.

This country's demographic problem has two roots. Increases in public health and tremendous advances in medical science have greatly increased life expectancies. On average, a baby born today in the United States can expect to live for almost 80 years. This is up from an expected 74 years in 1980 and an expected 69 years in 1950, effectively an almost 7% extension in life expectancy in the last 30 years and an almost 15% extension in the last 60-some years. At the same time, a drop in fertility rates has slowed the flow of young people into the workforce. In 1950, for example, the average American woman had 3.5 children in her lifetime. By 2010, according to Bureau of Census estimates, that figure had dropped to 2.0, barely enough to sustain the existing population.1

The confluence of these two trends will put the country into a predicament that it has never before faced. The proportion of people of retirement age, according to the Census Bureau, will grow from 12.8% of the population today to about 15% by 2020 and to about 20% by 2030. Meanwhile, because of the constrained flow of younger people into the workforce, the number working will fail to keep pace with this anticipated expansion in the dependent older population. The Census Bureau calculates that the number of working age available to support each retiree will fall from 5.2 today to 3.7 by 2020 and to only 3.0 by 2030. Fewer workers available to support a greater number of dependent retirees cannot help but force change on the economy and its financial markets.

Best known of these strains is the predicament faced by Social Security and Medicare. Contributions from existing workers will fall ever shorter of the growing demands of this enlarging retired population. But the impending insolvency of Social Security and Medicare are only part of the coming financial difficulties. Private savings will likely fall short of the flows needed to support other pension plans, those maintained by state and local governments in particular, but also private pension and retiree medical plans that have retained a defined benefit structure. These plans theoretically avoid the pitfalls of a pay-as-you-go system used by Social Security and Medicare by backing their obligations with pools of invested assets. But even these investment pools will have a harder time sustaining acceptable levels as reduced relative numbers of new workers slow the flow of contributions relative to the growing numbers of retirees drawing on the plan.

There is a third financial problem. As an even larger part of the population retires, they will tend to draw down on their savings and investments instead of adding to them. Such selling pressure could limit or even undermine the basis of long-term market appreciation. To be sure, this particular problem will not develop for some time, as the largest portion of the baby-boom generation is still in its fifties, with an increasing tendency to save and invest for some time to come. But over a longer time frame, as this portion of baby boomers passes into retirement, this financial threat will build.

If the economy could produce enough added wealth, these financial strains would be easily managed, but as it is, the demographic imperative also is likely to hold back the economy. The relative shortage of workers will, all else being equal, limit the economy's productive power, including its ability to provide the consumption and other economic needs of these retirees. It may be hard today, in the face of a huge army of unemployed, to envision a time when such a relative labor shortage exists, but it is important to realize that these are long-term trends, while today’s high unemployment, stubborn as it has been, is fundamentally a cyclical phenomenon. And if, as many suggest, unemployment stays high because of a mismatch between the skills the economy needs and those that exist in the workforce, the financial and economic burden on those reduced relative numbers working will become that much more unsupportable, as these workers will have to produce enough for themselves and their immediate dependents, the country's retirees, and also for those effectively unemployable because they lack needed skills.

A worsening relative shortage of working hands and minds, especially of those with the appropriate skills, will necessarily tend to limit the economy's raw production ability and so also its growth prospects. What is more, the shortage of workers will tend to raise wages, at least for those with certain skill sets, and to that extent, impair growth prospects, some research estimates by 10%.2 While that shortfall might have immediate ramifications in financial markets, more fundamentally it also will tend to deprive business of the wherewithal for capital spending. To that extent, matters will further impair growth prospects by constraining the main means by which business increases its productivity and its overall productive capacity. Some academic research estimates that these and lesser economic effects will tend to slow the economy's real growth rate by one-fifth. Other work suggests that in the absence of remedial efforts, this demographic pressure could reduce the economy's historical growth pace by two-thirds.3

Rather than accept such economic and financial hardship, there is every reason to expect the economy, even without central direction (perhaps especially without central direction) to seek remedies. One would increase productivity. With fewer numbers of workers relative to production needs, an increase in the average hourly output of each worker could cover some of the productive gap left by the demographic reality. Of course, the indicated profits shortfall and other financial strains will make such efforts more difficult. Perhaps a rising wage for skilled labor well provide a counterbalancing incentive for business to make the effort anyway. Along similar lines, the economy could cover some of the relative labor shortfall by increasing the population's participation in the workforce. Older people, for instance, might stay at work for longer. There is also a huge potential to increase women's participation. Even though during recent decades women have flooded back into the paid workforce, still only 70% of working-age women participate in gainful employment, compared with almost 90% of working-age men. The increased participation of either women or elders will necessarily involve greater flexibility on the part of firms, in order to, for example, change rules on hours, child support arrangements, and working conditions. The effort could ultimately alter the entire nature of the workplace.4

The economy also can reach overseas to remedy the labor shortfall implicit in its demographic predicament. Increased immigration is one obvious avenue, but to have the desired effect, the country will have to target those with the skills it needs. Even then, because immigration sufficient to bridge the entire relative labor gap will almost surely cause social tension, it cannot provide the entire answer. More potential lies with increased trade and globalization. By increasing imports, the country can effectively relieve its productive shortfall by tapping foreign labor even as it remains at home. Especially by relinquishing labor-intensive, lower value-added activities to less developed economies while concentrating more on high-value-added, capital-intensive activities at home, trade and globalization can answer just about all the needs of the labor shortfall implicit in the demographic trends. But such a shift will require another considerable revamp in the structure of the economy, more than has taken place already, and also ever greater efforts at training and education in the domestic workforce.

Subsequent pieces in this space will elaborate on the nature of each of those remedies, the alterations they will require in industrial and business practice, and, of course, the investment opportunities that will accompany those changes. Even with a separate discussion dedicated to each, the space allowed here can hardly do the subject full justice. That requires a much longer treatment. Still, it will offer a summary view.

* All the analysis presented here is draw from a new book, Thirty Tomorrows, forthcoming in April 2014 from Thomas Dunne Books.

1 Bureau of the Census, Department of Commerce.

2 David E. Bloom, David Canning, and Gunther Fink, "Population Aging and Economic Growth," working paper 31, Harvard Initiative for Global Health Progress and the Global Demography of Aging, April 2008.

3 Dick Kruger and Alexander Ludwig, "On the Consequences of Demographic Change for Rates of Return to Capital and the distribution of Wealth and Welfare," working paper 12453, National Bureau of Economic Research, August 2006.

4 Milton Ezrati, Thirty Tomorrows (New York: Thomas Dunne Books; forthcoming 2014).

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

© Lord Abbett

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