Pension Ponzi

After I wrote the last post, I wasn't entirely satisfied with it. What it did do was explain why certain types of taxes are essentially the same as borrowing (I'm certainly not the first to point that out). What it didn't do is make this any less abstract. A debt-to-GDP ratio of 400%! Sounds big, but what does it mean? Since countries don't die very often, America could have centuries to pay off that debt. Put that way, it doesn't seem like such a big deal. That assumes that America's creditors would keep rolling over the debt and not want to cash it in, though.

Anyway, all that's abstract, too. So I thought I'd make an extremely simplified model of a pension scheme. We're going to make a pretend company that starts off with 100 workers, none of which are retired, and then see how things progress. Our company could just as easily be an entire economy: It's population can grow, as can its workforce. They can also both shrink. We'll see with examples exactly how birth rates, life expectancy, and retirement ages affect everyone in the system. It requires only a little math, and I'll use easy numbers wherever possible. Oh, and I won't adjust for inflation or anything else. Again, it's not supposed to be reality, just a quick illustration with stick figures, if you like.

OK, so our company has 100 workers. Let's say they all earn the same amount. We introduce a retirement plan. Those who turn 65 get to retire on 2/3 of their salaries. Everyone else will pay from their own salaries to support them. In the first year, two retire. They are replaced by two new hires. We have 100 people supporting 2 people who only receive 2/3 of a salary. That makes 2*2/3=1.33. That means the workers have to pay 1.33% of their salaries into the pension program. Easy, and not much of a burden. The "old age dependency ratio" (the ratio of workers to old people) is 50 to 1.

In each subsequent year, two people also retire and two are hired to replace them (always 100 workers). The number of retired rises by two per year. So there are 4 the second year. The dependency ratio is now 25 to 1. Each worker now has to pay 2.67% of his or her salary to support the pensioners. Still not much of a burden, but it has doubled.

Let's say the average pensioner lives 20 years. We'll take that average and just pretend that they all live exactly 20 years for simplicity's sake. That means the number of pensioners would rise for 20 years. After that, it would stabilize at 40 pensioners for 100 workers. Each worker would now have to pay an eye-watering 26.67% of his or her salary for the pensioners. The dependency ratio is now 2.5 to 1. Let's not forget that these workers also have to support children, so the overall dependency ratio is even worse. These are hard-pressed workers indeed. This, in a nutshell, is what's happening. But it may be even worse. The reason is that the work force in rich countries is actually set to decrease (or is already), even as the number of pensioners rises (due to baby boomers retiring and increased longevity).

For years, the opposite happened: more people entered the workforce each year than retired. That made it seem like pension promises could be kept. If the workforce shrinks, this gets harder. We now add three per year to the pensioners (e.g. as the baby boomers retire), but maybe only one per year to the workers. After 20 years, there are 80 workers supporting 60 pensioners. This would obviously be impossible: Each worker would have to pay 50% of his or her income to support the pensioners.

Of course, the numbers are not that extreme or round, but that is the gist of what's happening. One solution is to raise the retirement age. Let's see what happens. We'll start again with 40 pensioners and 100 workers (the stable numbers we had before, but with a high pension burden). Here's a year-by-year breakdown if we instantly raised the retirement age to 70 but kept replacing workers at the original rate of 2 per year. This used to keep everything constant. Now, the workforce grows again and the number of retired declines.

Workers    Pensioners     Pension payment (%)
100            40                 26.67
102            38                 24.84
104            36                 23.08
106            34                 21.38
108            32                 19.75
110            30                 18.18
110            30                 18.18

With no further increase in life expectancy (which would increase the number of pensioners), birth rates (which would eventually change the number entering the workforce), or immigration (an increase of which would also increase the number of workers), the system would stabilize at a somewhat more affordable level. Each person would work longer, paying into pensions longer, and also be retired a shorter time, thus drawing less money out of the system.

In the case of most rich countries, this change would be gradual and could thus at most hope to slow the rise of pension premiums rather than slash them. It's still the right move. Health care, by the way, is a much more significant problem than pensions in the US, at least, but pensions are easier to illustrate (this is basically how Social Security works, except that it also does have a trust fund--which is being drained).

What about fairness? If you think back to when the system was implemented, those who retired first got a great deal: they paid nothing in and got 20 years of free pension payments (in reality, people didn't live so long in those days, so it wasn't quite so generous).  The people who worked while the system was ramping up also paid in less than those who came later. Those who are stuck paying the most and forced to pay longer (by working longer) and spend less time retired are clearly getting a raw deal. It's a sort of inter-generational transfer of wealth: The young people of today are shifting money back to the old people of the 1930s. That may seem unfair, but that is EXACTLY what debt is: spend now, pay later. With governments, that means this generation spends now, some later one pays. The bill, my friends, is coming due. The music is stopping, and it looks like we're the ones with no chairs to sit on.

The "informational" part of my post ends here. The rest is a bit of a rant, which you may want to skip if you don't want to get revved up. If you do, though, by all means: read on.

Was it past generations' fault? Surely our parents worked hard? No question mark needed. They DID. Our parents and grandparents did, however, benefit heavily from the schemes put in place. It was innocent enough: With growing populations and workforces, the scheme is sustainable. It's also easy to see why, even as demography began to shift, with old people living longer and the workforce growing more slowly, no one wanted to change. The problem had not become a crisis and no one wanted to be the sucker generation that got stuck paying the bill by finally owning up to the emerging problem and dealing with it.

Do we blame politicians? Sure, but we also have to blame those who voted for them. What about the media, which are supposed to inform the electorate and highlight issues? Yes, they are to blame, too. But: we've been hearing about the problem for ages and have failed to act AND people also only get the news media they deserve. If we'd rather watch newscasts with anchors who read Twitter feeds about Kim Kardashian and chat with each other about how they spent their weekend, then that's what the advertisers will pay for and that's what stations will provide us. In the end, this is not about blame. Blame gets us nowhere even if there's plenty to go around. We need to look forward, not back.

What is the solution here? The best of all worlds would be everyone deciding we needed to get to work and fix this stuff. Everyone decides to demand good news coverage and analysis and holds politicians to account. Everyone realized that we all will have to make further sacrifices and that no one can be spared. We all demand discussions rather than bickering, solutions rather than recriminations, and look to the future as a target place we want to get to proactively, rather than something we are trying to pretend we don't see coming in the hope that we won't have to address any of the problems that have been mounting for decades.

Fantasy. Or is it? As the crisis continues, people are being forced to pay more attention to its causes. Britain in the 1970s looked a lot like America today: a deeply divided country with a bickering, rudderless government. The empire was gone, Britain's world standing had faded, its industries were dying, its debts were high. Britain today has the same problems America has today, too. In fact, its debts are even higher. There's one crucial difference, though: Britons seem to be getting on with the work of tackling the issues. There's still plenty of fighting, but there is an acceptance that something must be done and somewhat of a consensus on approximately what that might be.

Consensus has emerged at crucial times in America, too. The country survived the Civil War (barely) as an incredibly divided place. It went on to do great things. In the depths of the Great Depression, a sort of FDR consensus emerged that lasted decades. A Cold War consensus also eventually emerged. Cue the bla bla about crises and opportunity.

Is this time different? The other disturbing question: how bad does it have to get, and how many false paths do we have to follow, taking us how close to ruin, before a new consensus emerges?

That should be the end of the post, but I have one further thing to say: I increasingly wonder if things like good news coverage need to be subsidized. They benefit more than just the people who watch and read them, making them a public good, something that makes economic sense to subsidize. The problem is always deciding what's "good," though, but I think we need to try. "Infotainment" is the abomination word of my generation, I think. There is no such thing. Reality isn't always entertaining and funny. That doesn't mean we can just change the channel. Whatever channel (or website, or blog) you follow, reality is still there, waiting to bite you in the ass if you ignore it too long.


Popular Posts