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Entitlement Crisis Is Just Beginning As Retiree Ranks Soar

2013: A Look Back And Ahead The fiscal cliff may seem like a big fight over taxes and spending, but it's actually just an early skirmish in the inevitable war between the aging population, the mushrooming welfare state and, ultimately, sustainable economic growth.

The huge number of Baby Boomers in the workforce fueled an economic boom in the 1980s and 1990s, generating sufficient tax revenue to cover a relatively small group of retirees. But a welfare state that seemed like a good deal 50 years ago is rapidly turning unaffordable in the U.S. and other industrialized nations.

Boomers started retiring in large numbers in 2011, marking the beginning of an era when younger workers and retirees will divide a weaker tax base.

Simply put, there are too few workers to support the growing ranks of aging Americans, and government spending can't grow faster than the economy indefinitely.

The share of the U.S. population 65 and older is 13.5% vs. 9% in 1960. It is projected to rise to 16.1% in 2020 and 19.6% in 2030.

People are living longer after reaching retirement age. Life expectancy will be 79.5 years in 2020 vs. just 69.7 in 1960 and 62.9 in 1940.

The worker-to-retiree ratio was 3.2 in 1980 and 3.4 in 2000. But it fell to 2.8 in 2012 and will drop to 2.1 by 2030.

Social Security had a cash-flow surplus of $94.2 billion in 2001 but has been cash-flow negative the past three years. In fiscal 2012, the system took in $47.8 billion less in payroll taxes and noninterest income than it paid out in benefits and administrative expenses. The sluggish economy speeded up the shortfall's arrival. But the underlying cause is demography.

And budget experts agree that Medicare is an even bigger problem. Spending is projected to balloon to $7.7 trillion in the decade to 2022 from more than $4 trillion in the prior decade.

Medicare, Medicaid and Social Security will account for nearly half of all federal spending by 2022, up from 41% in 2011.

Slow Growth Era

Such obligations are swelling as the ability to meet them ebbs. With economic growth slowing from average annual rates above 3% during the 1980s and 1990s, the government can no longer rely on a robust economy to cover bigger spending commitments.

Older populations can lower growth trends worldwide as the share of people who are of working age falls, the Organization for Economic Cooperation and Development has warned.

It sees average U.S. GDP growth slowing to 2.3% from 2011 to 2030 and 2% from 2030 to 2060 vs. the 2.5% average from 1995 to 2011.

While the OECD says productivity improvement will be the main growth driver, there is little room for demographic course corrections anyway.

An improvement in the sagging U.S. birthrate would come too late to support most future retirees. An American born today will enter the work force as the last Baby Boomers retire. The U.S. fertility rate fell to 2.03 births per woman in 2011, below the 2.1 replacement rate, from 3.61 in 1960, according to the Social Security Administration. In the 1990s, when more births were needed to support today's retirees, fertility dipped below 2.

Immigration also is unlikely to provide a quick lift. Net immigration from Mexico has dried up, and historically fertile recent arrivals are having fewer children.

Delaying Retirement

The public's burden should be eased somewhat by the growing number of seniors delaying retirement, a trend that gained steam after the last recession put a dent in many Americans' savings and net worth.

The percentage of men 65-69 in the workforce rose to 36% in 2010 from 26% in 1990, the Social Security Administration says. For women, it climbed to 27% from 17%. Rates for those 70 and older are up too.

"Today's 65-year-old absolutely can be working in a lot of occupations and wants to be working," said Arthur Noonan, a senior partner in Mercer's retirement consultancy.

Certain businesses may even prefer to keep older workers, especially where maintaining client relationships is key, he added. Employers also may want to hang onto older engineers or software workers, given the dearth of young Americans getting those high-skill degrees.

But even with more seniors working, the wave of older Americans will reduce the overall labor force participation rate.

The participation rate, at 30-year lows now due to the weak economy, is expected to fall further to 62.5% in 2020. It was 67.1% in 2000.

America's daunting demographic challenges look better relative to other developed countries.

Government programs fund 40% of consumption by the U.S. elderly, says Andrew Mason, an economics professor at the University of Hawaii. That compares to about 50% in Japan and virtually 100% in Sweden. Birth rates are lower and life expectancies are longer in other rich countries too.

"Our population is not aging nearly as rapidly as Germany, Italy, Greece or Japan," said Mason, who co-authored the recent book "Population Aging and the Generational Economy: A Global Perspective.

A more extreme case of these demographic trends can be seen in Japan, where one company said it sold more adult diapers than baby diapers for the first time last year.

The fertility rate in the world's No. 3 economy has declined to 1.39 in 2010 from 2.05 in 1961, according to the World Bank.

With little immigration, Japan's population is shrinking, and the economy has been in the doldrums for much of the past 20 years. A massive debt load more than double the size of economic output threatens its financial stability too.

Korea's Fertility Crash

South Korea must cope with a worse demographic cliff. Its fertility rate dived to 1.2 in 2010, among the lowest in the world, from 6 in 1961.

Germany's recent history shows rich countries aren't doomed to economic stagnation. Its fertility rate is at 1.39 too and the population has been flat or declining for a decade. But the economy has boomed with help from labor market reforms enacted in the past decade.

Still, Germany will be tested as China buys fewer industrial exports amid more consumer-led growth and as other eurozone countries improve their competitiveness via structural reforms.

Mason sees the full impact of low fertility hitting Germany eventually.

"They're going to experience a lot more aging," he said.

China will have the unique problem of its people growing old be fore getting rich. That could prompt the government to abandon its one-child policy, though Mason doubts that would help much now.

The demographic shift will pressure Beijing to be more reliable in how it delivers services and more transparent on pensions. Financial markets must meet the needs of retired seniors too.

China "may not have the institutions that would be very helpful in an aging society," Mason said.

Industrialized economies face painful choices as they come to grips with the new demography. If the U.S. continues on its current path, big tax hikes to cover soaring entitlement spending will further depress already anemic economic growth.

And the higher overall tax burden would fall on working Americans who will comprise a smaller share of the total population.

The other course is to rein in spending on retirement programs via higher eligibility ages, lower cost-of-living adjustments and means testing. Older, able-bodied Americans also could be encouraged to keep working without slashing benefits for the very old.

Even then, pay-as-you-go models that rely on growing populations will eventually confront demographic realities.

Lawmakers reluctant to resort to French-style top tax rates of 75% may warm to Chilean-style personal savings accounts that were politically toxic when the entitlement crisis was far off in the future.