We recommend you grab a copy of George Magnus’s The Age of Aging. Mr. Magnus is a senior economic advisor at UBS, and his new book is probably the best “big picture” analysis on demographic trends that we have seen since Philip Longman’s The Empty Cradle.  Magnus’s work is a fine complement to our own research, and it deserves a place on your bookshelf.
In the pages that follow, we’re going to quote Magnus on various topics and compare his views to those of our own and of other commentators that we follow.

On the History (and Future) of Retirement:
In the preface to the book, Magnus writes,
Many of the premises on which modern welfare programs were established have changed or soon will.  Retirement pensions, for example, were designed to allow people to stop working and enjoy their last few years in relative comfort while making way for new, younger workers.  Today, although pensioner poverty is becoming a growing problem…retirement is for many an extended period of state-supported or company-financed leisure, which was never anticipated….

To address these challenges over the next decade or two, it is probable that the role and influence of the state, and what is demanded of it, will expand.
There is no question that the concept of retirement has fundamentally changed over the years.  Today, it is viewed as a true entitlement, something that is “owed” to retirees who have spent their lives working and paying Social Security taxes or union dues.  But as Magnus points out, it was not always this way.
In the preindustrial economy, “retirement” did not exist at all.  Traditionally, you worked on your farm until you were physically too weak to do so any longer, after which point you either moved in with one of your children or you ‘retired” to a hospital.  You certainly didn’t play golf or take long walks on the beach.

Pensions were a product of the industrial revolution, but they were not originally considered a benefit to the worker.  In fact, they were designed to gracefully remove older, more accident prone workers from dangerous positions that put the company at risk.  For example, railroads considered it unwise to let 70-year-old workers with failing vision handle heavy machinery or man the engine of a locomotive.  The objective was to make room for younger workers, not to reward the elderly for a lifetime of service.

For a variety of reasons, including union activism, the labor shortage during World War II, and the general increase in prosperity in the post-war era, retirement has evolved into what it is today: a period of extended leisure, often lasting 20-30 years or more, that one enjoys after leaving the workforce.

Now that the largest generation in history is ready to enjoy these benefits, the concept of retirement may have to change again, becoming less generous to avoid bankrupting future generations.  In a service and information-based economy, elderly workers are no longer a safety liability, meaning that the original rational for the creation of pensions no longer exists.
But at the same time, the Baby Boomers are right to expect the entitlements that were promised to them decades before.  We expect the political debates in the coming decades to be increasingly dominated by intergenerational conflict.  Unfortunately for the younger generations, older voters tend to have a much higher voter turnout, and the Boomers have numerical superiority.

On Societal Change and Falling Birthrates

Echoing Phillip Longman in The Empty Cradle, Magnus explores some of the sociological features of demographic change in Chapter 2.  Magnus writes,

think how family life has changed over the last 100 years and tended to lower fertility.  With the introduction of social security and insurance systems, the benefit of having many children for support declined, and this would have contributed toward lower fertility.  Compulsory education and a rising tendency for young people to enter university raised the cost of having children and had the same effect on lowering fertility.  Perhaps the biggest social change of the last 50 years, though, has been the opening of employment and income opportunities to women – in which arguably the pill played a role.  With these, the “cost” of having children has also risen in that having children or more children often involves giving up access to a more lucrative career or stream of income.  It is what economists call the “opportunity cost” of children or, put another way, the income or lifestyle we give up to stay at home and look after children.

Longman wrote extensively about the opportunity cost of children in The Empty Cradle, and Mark Stein offered his own somewhat off-color remarks on the subject in America Alone.  In an information-driven economy with increasing returns to education, it takes a lot of money to raise a child and prepare them for career success (close to a quarter million according to US government estimates, which don’t include the cost of university education).  It also takes a lot of time, which along with money, is a scarce commodity.  This brings us to yet another author on the subject, Brick Lindsey, whose Age of Abundance is also a good study on the causes and effects of changing demographics.
In Lindsey’s words, the processes of urbanization and industrialization transformed the family from a unit of production to a unit of consumption.  On a family farm, children provide cheap labor.  But to a machinist or mill worker, a child is an expensive mouth to feed.  This became ever more true in the post-War era of mass affluence in which young people spent longer and longer in formal education.

In The Age of Aging, Magnus informs us that we have a new acronym for these young people, “Kippers,” Kids in Parents’ Pockets Eroding Retirement Savings.  These adult children in question are not necessarily lazy; they are simply a product of the times.  Many simply do not have the means to support themselves through education and early career without taking on crushing levels of debt.  This was particularly true during the years of the real estate bubble, when home prices far exceeded average incomes.
We can see this same process of family transformation from a unit of production to a unit of consumption happening in the developing world, and we’ll return to that theme later.

On Demographics and Economic Growth

So, what do aging demographics mean for economic growth?  Focusing on projected demand, HS Dent reached the conclusion long ago that an aging society implies slowing growth and falling prices. Most other analysts (such as Dr. Jeremy Siegel) have focused on projected supply, using forecasted changes in the working age population to predict output.  It reflects a supply-oriented bias among the neoclassical economists that dominate the profession.  We’ve picked this argument apart at length in other newsletters, but to summarize here, we believe the supply-side argument, which is summarized by Say’s Law (“Supply creates its own demand”) is fundamentally flawed in a post-bubble world of aging demographics and excess supply.  Increasing supply in the face of stagnant demand does nothing more than lower prices.  In other words, it creates more deflation, which is the last thing you could possibly want.

Magnus’s approach is somewhat of a middle ground between the HS Dent demand-focused analysis and the supply-focused analysis favored by academia.  Magnus echoes the HS Dent view than an aging society consumes less, thus suggesting a stagnant economy with falling prices, like that of Japan since the early 1990s.

Magnus does explore the supply side too, however, and some of his comments are quite insightful.  In Chapter 4  Magnus discusses in layman’s terms the production function memorized by every freshman economics major.  We will spell it out here in economistspeak:

Production function: Q = Lx * Ky *A, Where
Q = Total economic output
K = Total stock ofcapital(for example, buildings and machinery) available.
L = Size of thelabor force
A = Productivity, computed from technology and efficiency.  Also called total factor productivity.

So what does this gibberish mean in the real word?  Our GDP is a function of the labor and capital employed, with productivity enhancements providing a turbo charge.  Magnus points out that L, the labor force, will be stagnant or falling in the years to come.  And with savings rates likely to be down, so will K, as there will be less loanable funds to finance capital expenditures.  That leaves A, productivity, which was the primary driver of American growth throughout the 1990s and 2000s.  So, can productivity rise fast enough to compensate for a decline in labor and capital?

We think not. The information revolution made possible by the internet and by wireless communications has transformed our economy, and there will continue to be incremental enhancements going forward.  But much of the “heavy lifting” has already been done.  Laptop computers, mobile phones, and Blackberries are now ubiquitous among traveling professionals.

New gadgets will no doubt add incrementally to productivity, but the next “big” leap is probably years if not decades in the future.  Revolutions don’t happy every day.

On Immigration

Numerous analysts, ourselves included, have pointed to the benefits of immigration.   While we generally support an open immigration policy, we are also realistic.  New migrants typically do not have the earning and spending power of native workers, at least not for several years.  Also, the amount of immigration that would be needed to sustain economic growth at pre-crisis levels would also be functionally and politically impossible and would bring a host of other problems related to assimilating a group that large.  As a solution to America’s aging crisis, immigration is simply not a viable solution.

Magnus largely shares our views, dedicating an entire chapter to immigration issues.  Summarizing his views, he writes,

However, there at least three major problems with the theory.  First, as noted, the scale of immigration required to offset native demographic trends and the loss to economic growth is extremely large and unrealistic – certainly as things stand today politically.  Second, these positive effects of immigration [such as higher birthrates] may be much more short-lived than they are made out to be, so that immigration doesn’t really offer a stable, long-term solution.  Third, sooner or later, high immigration may also involve costs to the host society too, including those of dependency, welfare, social disharmony, and pressure on infrastructure and social facilities.

On Taxes

The subject of taxation will be a hot-button issue once President-elect Obama takes office.  The government is running up mind-boggling debts, and those debts can only be paid one way: taxes.

Magnus summarizes the unfortunate choices facing America’s next Congress and President:
Tax decisions will have to be tackled with great caution.  If you raise taxes to punitive levels on inheritance, wealth, and other forms of capital, the effect is to discourage savings when saving is exactly what you want people to do.  If people do not save enough, there might not be enough investment, and this could put upward pressure on interest rates.  If you raise income or social security taxes to an excessive level, it will discourage companies from hiring people from working, when more labor effort is precisely what you want.   The major alternative is a shift in the tax system from these kinds of taxes to higher or new consumption taxes, such as a value-added tax or a sales tax.  But these are regressive – since everyone pays the same tax, they’re unfair to less well-off people.
There are no easy answers here.  The tax man is coming.  Our advice is to do everything you can to shelter your assets from him.  This means using every tax deferral at your disposal, such as IRAs, 401ks, variable annuities, etc.

On Emerging Markets

Magnus’s comments on India sound as if they could have come out of our own mouths:

India’s demographic advantage is not the only reason for optimism.  Unlike other Asian economies, including China, India’s path to development has had a much more domestic, as opposed to export focus.  If Western economies were to cool down under demographic pressures in the next several years, India would not be as exposed as, say, China [Emphasis HS Dent].  Moreover, India’s more domestic development pattern has emphasized personal consumption, services, and high-tech (as opposed to low-skill) manufacturing.  So, this young, consumer-oriented, and service-based economy looks remarkably  like that of the United States.
Interestingly, Magnus points out that India’s demographics are not uniform.  The “American” economy is concentrated in the more-technologically-advanced southern part of the country, while the north is still dominated by low-productivity agriculture.  Believe it or not, like America, southern India is aging quite rapidly! The large cities of Mumbai and Chennai, for example, have below-replacement fertility rates.  Overall, the fertility rate in the north is about twice as high as that in the south.

Like ourselves, Magnus is much less optimistic about the prospects of other emerging markets such as China and Russia.   China and Russia are quietly chugging along towards a demographic disaster.
The effect of the One Child policy is that China will grow old before it fully has the chance to grow rich.  Even if the Chinese Communist Party reversed the policy today (which they have shown no indication of doing), there is nothing that can be done about the cresting of the Chinese Spending Wave around 2015.
Russia’s situation is even worse.  Due to high emigration out of Russia, rampant alcoholism and poor health, and an abortion rate that is actually higher than that of live births, Russia’s population is practically evaporating.  Magnus describes the desperation of the Russian government, exemplified by Vladimir Putin’s offer of $10,000 to Russian women for bearing children.  When the usually steely-eyed Putin gets on national television to smile and softly praise motherhood and family, the situation must truly be grim.
Concluding Remarks

We are living in unprecedented times.  Never before in human history have we had to face the specter of entire countries growing old and shrinking by lifestyle choice.  As Japan’s experience in the 1990s vividly illustrates, the road ahead will be a hard one.  Understanding the changes coming can help you to better prepare.