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8 September 2017 Financial Analysts Journal Book Review

Aging and the Macroeconomy: Long-Term Implications of an Older Population (a review)

  1. Murad J. Antia, CFA
In 2010, pursuant to a U.S. Congress request, the National Research Council appointed an ad hoc committee to survey the academic literature and create a knowledge base for the ongoing debate on the demographic shift and its effects on Social Security, Medicare, and Medicaid. This book presents the committee’s findings.

The United States and many other countries are in the infancy of significant demographic changes. Over the next four decades, the retiree demographic will constitute an increasingly large percentage of the population. In the United States, the old-age dependency ratio—the ratio of people aged 65 years and over to people aged 20–64 years—will likely increase by 80% by 2050.

In 2010, the U.S. Congress asked the National Research Council (NRC) to prepare a report on the long-run macroeconomic effects of the aging population. The NRC appointed an ad hoc committee to survey the academic literature and create a knowledge base for the ongoing debate on the demographic shift and its effects on Social Security, Medicare, and Medicaid Aging and the Macroeconomy: Long-Term Implications of an Older Population presents the committee’s findings.

Two long-term trends underlie the demographic shift. First, people are living a lot longer: The average life span has risen from 47 years in 1900 to 78 years today, and its rise is expected to continue.1 Older people are also healthier, as evidenced by falling disability rates. Second, the birth rate is declining: From 3.7 births per woman in 1957, it has fallen to less than 2.1 births per woman today. Moreover, a sizable number of people have failed to save enough for retirement, partly because so many look to the government entitlement programs—Social Security, Medicare, and Medicaid—to care for them after they retire. Per capita health care costs have grown substantially faster than per capita income for decades. If this trend continues, it will interact with the aging population to increase health care expenditures exponentially.

Because most people are ill prepared to handle the financial complexities of retirement planning, there is substantial value in boosting the nation’s level of financial literacy. Surprisingly, the report finds that financial firms have been slow to develop and market such tools as long-term care and annuity products to facilitate the transition to retirement. A variety of existing and potential annuity products, however, can fulfill the needs of seniors. One such product that should gain traction is a longevity annuity. By providing an income stream at a late age—say, 85 years—such a product reduces the risk of retirees’ outliving their wealth.

At present, 83% of individuals aged 65 years or over are not working, even though many do not have even minor disabilities. The average retirement age for men and women is about 62 years and 61 years, respectively. Defined benefit plans have encouraged workers to retire early because such plans guarantee an income stream for life. Consequently, the shift to defined contribution plans has been beneficial in that their greater uncertainty regarding income sufficiency has forced people to work longer. Although 65 years is considered the normal retirement age, it is imperative that people work longer because doing so would boost GDP and allow workers to save more. The good news, according to the report, is that longer working lives would not impede employment opportunities for younger workers and that the consequent change in the age composition of the labor force would have a negligible effect on productivity. Phased retirement2 is gaining in popularity among employers and employees, notably in areas that have a shortage of workers, such as the teaching professions.

The committee projects that the aging population will likely have a modest effect on capital market returns. There is substantial variation in the magnitude of the effect. Several studies have identified a strong relationship between demographics and returns on capital assets, but others have found little or no association. Simulation analyses suggest a sell-off of equities that will lead to an increase in the equity risk premium.

The report concludes that although the aging population poses challenges, they can be resolved with little discomfort if rational policies are implemented sooner rather than later. The committee recommends four basic approaches to prepare for the changing demography:

  1. Workers must save more (and consume less) in order to better prepare for retirement.
  2. Current workers must pay higher taxes (thereby consuming less) in order to finance benefits for retirees.
  3. Benefits (and consumption) must be reduced for retirees.
  4. People must work longer and retire later.

With references to about 280 articles, Aging and the Macroeconomy often reads much like the literature surveys of academic papers. The book covers a wide range of topics but omits some that require study and debate. For instance, there is no discussion of why U.S. per capita health care costs are higher than those of other developed countries. Although Medicare, compared with private insurers, has been parsimonious in its reimbursements, could still more be done to reduce costs?

By stating that 65 years is an increasingly obsolete threshold for defining old age and providing benefits, the report implies that the eligibility age needs to be increased. That may be appropriate for white-collar professionals but not for blue-collar workers whose jobs can be physically demanding. If the latter are unemployed at age 65 and without health insurance, who will pay for their health care expenditures? To reduce health care costs, it might make sense to allow retirees to buy into Medicare—say, at age 62—by paying insurance premiums. End-of-life care consumes a disproportionate amount, about 25%, of Medicare spending.3 Discussion of this topic in the political arena often sheds more heat than light (e.g., talk of “death panels”). The committee should have investigated how countries with universal health care cope with this issue. That said, the book presents a fairly comprehensive survey concerning the effects of aging on the economy.


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