Promises, Promises

My piece on bank reform will have to delay until Monday evening.  I am still working on it.  Tonight’s piece is on entitlements and pensions globally and locally.

I asked recently if anyone had data on other countries of the world to analyze where other countries were in terms of debt plus unfunded liabilities as a percentage of GDP.  I got a few good suggestions, but then I stumbled across this article in the New York Times that provided the graph to the left.

The article is about Greece, but the graph covers all of Europe and the US.  I am not sure where the author got the 5x GDP estimate for the US, but I have e-mailed him.  My own estimate was 4x GDP.

Either way the US and the EU are more comparable than different by this measure.  They are both in the 4-5x GDP zone.  But the EU contains some real basket cases such as Poland, Greece, Slovakia, Slovenia, and Latvia.  Oddly, Spain looks good on this measure, and Ireland and Italy are better than the EU average.

Now, recognize that these figures are from 2004, so they could be worse by now — they are unlikely to be better.  Here is the original article from Jagadeesh Gokhale, the fellow who calculated the European figures at the Cato Institute.  Quoting from his paper:

No EU government has made the necessary investment. As an alternative, the next-best option is for these countries immediately to gradually but significantly increase saving and investment. In particular, the average EU country could fund its projected budget shortfall through the middle of this century if it put aside 8.3 percent of its GDP each and every year. Despite this adjustment, a budget shortfall is likely to emerge after 2050, requiring additional fiscal reforms.

What will happen if EU countries do not set aside these funds? Unless they reform their health and social welfare programs, they will have tomeet these unfunded obligations by increasing tax burdens as the larger benefit obligations come due. Although spending averages 40 percent of GDP today:

  • By 2020, the average EU country will need to raise the tax rate to 55 percent of national income to pay promised benefits.
  • By 2035, a tax rate of 57 percent will be required.
  • By 2050, the average EU country will need more than 60 percent of its GDP to fulfill its obligations.

Later, he continues:

In comparison, the United States’ shortfall for Social Security and Medicare alone has been somewhat smaller than the EU average, at 6.5 percent of future GDP. But as a result of the expansion of the Medicare program to cover prescription drugs, the U.S. fiscal imbalance is now 8.2 percent of future GDP. Putting this in perspective, to close its fiscal imbalance:

  • The United States would need to save and invest an amount equal to 8.2 percent of its GDP beginning now and continuing every year forever to pay expected future benefits without future tax increases.
  • This could be accomplished by more than doubling the current 15.3 percent payroll tax on employers and employees, immediately and forever.
  • Alternatively, the federal government could immediately stop spending nearly four out of every five dollars on programs other than Social Security and Medicare — eliminating most discretionary spending on such programs as education, national defense, environmental protection and welfare — forever.

Each year that the United States does not take action to reduce the projected shortfall, it grows by more than $1.5 trillion, after adjusting for inflation.

If you are a wonk on these matters, I recommend that you read the paper.  But the article from the New York Times motivated the issue in other ways.  A hairdresser in Greece retires at age 50?  In the US, aside from the military, the only people I know of that retire with a full pension at age 50 are oil wildcatters, and those that similarly punishing hard work.  Also, it is backward for women to retire earlier than men; they live a lot longer.

There is no way that we are going to get governments to run 8% of GDP surpluses per year to deal with these crises.  I hate to say this, but if some of the profligate European governments want to deal with this situation, they will need to change their constitutions or laws that guarantee pension payments at a certain level and age, and extend the age and drop the benefits.  Political suicide, I know.  But do you care if the Eurozone fails?  Do you care if your nation fails?  I’m not saying that one group has to bear pain while another does not, but aside from those that work at physically demanding jobs, there is no reason why everyone can’t work until age 75.  Yes, 75, leaving aside disability.  Retirement should be the last 10 years of life on average, not the last 20, much less 35.

When someone stops working, the rest must pick up the slack.  Is there any way for a culture to work where those who work must support 2+ people excluding themselves?  Many Western governments are staring at cultural failure, and can’t see the forest for the trees.  They see the short run funding difficulty, but do not see the long-term problem that is lurking to begin to bite in the next decade.  The sad thing is — it’s too late.  Aside from cutting benefits, or raising benefit ages, there is no way out.

The Divided States

The Barron’s cover article dealt with high state and municipal pensions.  Though I wrote a piece on this recently, talking about the Pew report study, among other things, this article makes the valid point that the state and municipal discount rates on pension liabilities are likely too high, averaging 8% or so.  The nominal GDP growth rate of the economy of the whole is probably the best estimate of where discount rates should be — what shall we say? 4-5%/year?  In this low rate environment, earning 8% forever is ludicrous.  But at 4-5%/year we are talking about a deficit of ~$3 trillion, not $1 trillion.

As the article points out, workers in the public sector earn more on average than those in the private sector.  The need to have high pensions to attract workers is no longer valid.

Also, the states and municipalities are taking above average risks to try to earn their target rate, even though doing so is highly unlikely.  As it says in the article:

Finance professors Robert Novy-Marx at the University of Chicago and Joshua Rauh of Northwestern University asserted in a recent paper that the funding gap for state pension plans alone might exceed $3 trillion, in part because state funds are using an unrealistic long-term annual investment return of 8% to compute the present value of future payments to retirees, as is permitted in government standards for pension-fund accounting.

This establishes a “false equivalence” between pension liabilities and the likely investment outcomes of state investment portfolios, which are increasingly taking on more risk by beefing up their exposure to stocks, private-equity deals, hedge funds and real estate. Using a much lower expected return — say, one at least partially based on the riskless rate of return on government securities — would both properly and dramatically boost the present value of the pensions’ liabilities while decreasing their likely ability to meet them. The academic pair, using modern portfolio theory, claim that state funds, as currently configured, have only a one-in-20 chance of meeting their obligations 15 years out.

As I said above with countries, so it might be with states.  Some states will have to repeal statutory or constitutional guarantees on pensions in order to survive.  I don’t like saying this, but I don’t think there is any choice eventually.  Do you want your state or municipality to survive or not?  Even Chapter 9 and/or ERISA should be amended to allow for adjustment of pension obligations in municipal bankruptcy.  States also should be able to use Chapter 9, or, a new Chapter of the Bankruptcy code for States.

That is why bond investors are getting skittish over General Obligation bonds, and moving to Revenue bonds, if the revenues are stable enough, and protected for bondholders.  They don’t trust the states and municipalities.

Now, this comes after years of underfunding the pension funds.  Few truly were farsighted, and set aside the assets, rather than having more current spending, or deceasing taxes.

Where does this leave us?  In no good place.  Is there a solution?  Yes, but only that of shared pain.  We have to decide whether we take structured pain now, through benefit cuts and higher taxes, or, take unstructured pain when the riots arrive, time to be determined.  Cultural failure is a real possibility; civilization is more veneer than solid when everyone argues for their self interest, and few argue for the good of the whole.


  • CB says:

    2010 projections have Spain have Spain’s guv debt-gdp the lowest among the eurozone big four plus UK and USA. And 2005 calculations of unfunded liabilities confirm what your chart shows.

    Where Spain might have a problem is via its net foreign debt, which is very high. But seeing as their funding needs are relatively modest, this may wash to some degree.


  • Indy says:

    It’s not exactly that “few argue for the good of the whole”, I’ve talked to dozens of friends who are willing to implement a “shared pain” strategy, one that even is detrimental to their personal financial interests to save the nation. But when I ask them, “Assuming you could even get elected doing so, would you consider running for congress to argue for and implement such a plan?”

    Unanimous: “No, not me. Politics is awful.”

    It is, alas, but it’s also the only way collective decisions are made in our democracy. But we all (myself included!) seem to be lacking in sufficient courage to do anything about it. So, I wonder if I’m in any position to complain…

  • maynardGkeynes says:

    “The United States would need to save and invest an amount equal to 8.2 percent of its GDP beginning now and continuing every year forever to pay expected future benefits without future tax increases.”

    Although outsourced to Cato, this is the typical misleading Peterson Institute statement lumping Social Security in with Medicare. Every informed person knows that if you extrapolate Medicare/Medicaid from the current trend the numbers are astronomical and obviously unsustainable, and that Social Security is a relatively minor issue due to the Reagan-Tip O’Neil reforms of the ’80s. Note how the author gives three possible solutions for addressing the funding shortfall, all of which he knows are in fact impossible, without even mentioning reigning in health care costs via meaningful health care reform, the one solution that is realistic and actually on the table, but which the right wing opposes purely for ideological reasons. This is yet another example of the right wing disinformation campaign that has been polluting our political discourse for 30 years now, and it must not go unchallenged. It is really insidious and I am getting sick of it.

  • sg says:

    Wow, lacking the courage to complain means your children will suffer. Speaking of whom, the very low birthrates of Europe seem to be driven by the fact that the cost of children falls to their families but the benefit of children (their taxed productivity) is socialized even to those who have no children.

    Also healthcare costs seem intractable because the number and percentage of people who do not pay is growing. The poor and elderly do not pay more than a tiny fraction of their healthcare and use more services. When 5-10% of people are indigent or elderly, society can afford to pick up the tab. When 65% are indigent or elderly, we can’t.

  • sg says:


    You said:

    “Some states will have to repeal statutory or constitutional guarantees on pensions in order to survive. I don’t like saying this, but I don’t think there is any choice eventually. Do you want your state or municipality to survive or not?”

    If some states/municipalities raise taxes in an effort to meet their obligations, but the overtaxed residents leave, then what?

  • Rich says:


    I think extending the retirement age would be more palpable if people could get more vacation time to enjoy life. Many often postpone things until retirement but if they were able (assuming they have saved the money) to do so while still working it would make working longer not so bad.

    I’m lucky enough (and of course this could change at any moment) in my mid 40s where I’m at a point that I’d prefer more vacation time instead of raises. I’d gladly give up 10% of my salary for an equivalent time off.

  • Mike C says:

    Speaking of whom, the very low birthrates of Europe seem to be driven by the fact that the cost of children falls to their families but the benefit of children (their taxed productivity) is socialized even to those who have no children.

    I wonder how prevalent this is or will become. I can tell you that I am about 99.9% sure that I will not have children, and the primary reason is the cost. I figure I can redirect that money into accumulating financial assets such as stocks or rental real estate and hopefully assure myself of a comfortable retirement that does last 20-30 years.

    I recognize that in some sense I will be acting as a “free rider” as someone else’s children will have to pay my SS benefits although I doubt I’ll get much if anything at all. But obviously, if too many people thought and acted the same way, the results would be disastrous.

  • AS says:

    Mike, Why would you call yourself a free rider?
    Maybe what you are trying to say you are tending toward self-reliance, and away from social security and other gov’t programs. Nothing wrong with that and no need to be apologetic, imo.

  • sg says:

    “I can tell you that I am about 99.9% sure that I will not have children, and the primary reason is the cost.”

    That is my point. There are plenty of people who might like one or two more children than the 0-2 that they have but can’t afford them. So the ratio of workers to retirees keeps falling and making the system less sustainable.

    “But obviously, if too many people thought and acted the same way, the results would be disastrous.”

    Not if. Every industrialized nation has a birthrate below replacement and so do many poorer countries. Investments of any kind assume a business will grow and make more money. That is a tough proposition with a shrinking customer base who are themselves taxed heavily and therefore have very little disposable income.

  • ts says:

    Work ’til you’re 75?! You’re crazy!! Have you seen how 75 year old people live and what condition most of them are in?! Go work in a retirement community or a hospital that services mostly geriatrics for a while, most of them are in HORRIBLE shape (I work in the medical field FWIW, I’m no expert but I KNOW you’re totally full of it to suggest a general retirement age of 75).

    Look, people certainly do live longer these days, but there is a huge difference between how long they can work and how long they can live. Most people who are 75 are used up many years before hand and have trouble just walking around even if they haven’t broken a hip already or don’t have the beginnings of heart failure. Even if they can do work they’re very delicate, they get sick and they’re out of work for months easy. And if they break a knee or hip?

    They could be out of work for most of a year (rehab is the big time killer here)!! Most don’t EVER recover properly from something like that, they’re effectively permanently disabled. People are living longer these days because of medical advances which keep them alive BUT they don’t necessarily improve their quality of life enough to work.

    We don’t have elixirs of rejuvenation, we’ve got Coumadin and Advair that manage health problems to make life somewhat livable but they don’t cure you!! They don’t make you better!! You’re heart and lungs are still crap and you still can’t work even if you live another 20 or 30 or 40 years and aren’t “disabled”!!

    Look you obviously know your economics but you don’t know diddly about health care if you’re serious about an age requirement of 75 for retirement. You could maaaaybe push it up to 69 or 70, but even most people are limping a long at that point and can barely do their jobs. There is a reason why the WalMart greeters are usually old folks who stand or sit instead of pushing a mop or something else even remotely laborious.

    There outliers too BTW. People who live to be an active 70 or 80 or 90 years of age. However they are rare, very few will be able to pull that off. You can’t point at examples like that and say, “well if they can do it anyone can!”. That is total dishonest BS if you do. That would be like expecting everyone to live to be over 120 just because a few people like Jeanne Calment (who smoked well past the age of 100!!) have done so before. Everyone falls a part in a different way, and many do so depressingly quickly. You wouldn’t believe how many people who are 60 or 50 but look like they’re 70 and aren’t disabled (ie. they can still walk, no broken bones, but their lungs and heart are shot due to obesity, diabetes, or smoking) and sure as hell cannot work.

  • maynardGkeynes says:

    @ts– That’s the most depressing thing I’ve read in a long time. I might as well just jump off the bridge now, but I can’t remember where it is.

  • I agree with ts. You just cannot increase the retirement age, as if it is some number with no meaning behind it. Very few–this may not be true in warmer climates in Southern US and other parts of the world–can function very well past, say, 67.

    I’m not trying to be ageist but the reality is that even if one increases the retirement age to 75, productivity won’t be that high.

    I think the ideal solution is to have some sort of tapered retirement, whereby those who are over, say, 60, are allowed to work part-time. They probably shouldn’t be taxed either (or raise the minimum income threshold so that they have enough incentive to work part-time.) Not everyone will do this but if a small, non-negligible, number of people work part-time, while others don’t (mostly because they are incapable or have enough money to retire without govt support), the burden won’t be that bad.

    I can easily see the elderly working well as part-time workers in libraries, schools, and the like. I think little kids get along better with older folks, and older people tend to like kids, so some jobs in schools/museums/etc can actually be quite productive.

  • SG: “That is my point. There are plenty of people who might like one or two more children than the 0-2 that they have but can’t afford them. So the ratio of workers to retirees keeps falling and making the system less sustainable.”

    Affordability has very little do with the birth rate. This goes for wealthy countries like America; but also is the case in poor countries. If you don’t believe me, try plotting income vs birth rate for almost any country out there. You will generally find that the poor have way more kids than the wealthy. This goes for a poor country vs a wealthy one, but is also true if you look within a country (I’ll bet the lower 30% of the American population have more kids than the top 30% in America.)

    Having kids is almost always a personal (or sometimes a lifestyle) choice and has little to do with income.

    I’m not trying to be rude and call out anyone’s personal decision but I also think it is a weak argument to claim that kids are expensive in America (or Canada or France or Japan or insert-developed-country.) Unless you have financial problems (usually because of health reasons or difficulties maintaining jobs), kids are not that expensive.

    Americans are the richest people on earth. Not everyone, but on average, that’s the case. I’m Canadian and you guys in America are even wealthier (especially if you adjust for taxes.) The median household income in America is somewhere around $50k (don’t quote me since I didn’t look up the latest number.) The lifetime cost of a typical child is around $100k to $200k. This varies depending on your lifestyle, cost of living in your area, etc, but that’s roughly the number for aggregate population. If you have two kids, you are probably looking at around $200k to $400k total.

    If one is living in the wealthiest country on earth and can’t afford children, when are they going to? Many, especially on the right, blame the low birth rate on high taxes, high cost, etc; yet the reality is anything but.

    (NOTE: my comment is about an average American with a typical life. It is not meant to be directed at any specific individual, whose circumstance may difference.)

  • maynardGkeynes says:

    The elderly could also be used as base bags.

  • TS — we at 75 are healthier now than 65 year-olds were when Social Security began. The life expectation is about the same. You may be a doctor, but I am an actuary.

    And yes, MGK, a lot of the difficulties are embedded in Medicare, but how will expenses be changed there? We haven’t shown the ability to cut government expenses in healthcare… and the current proposed bill, if scored properly, would be another budget buster.

    All, one of the great points here, is that the trouble from demographics is a global issue. It is showing up everywhere in nations and lesser governments, and even in corporate plans… wherever long term promises have been made — there have been too many promises made relative to likely future GDP. That is the quiet, powerful, long-lasting part of the crisis that will be with us for a long time, and the canary in the coal mine is Greece.

  • AS says:

    I’ve worked with people over the age of 65 for 25 years. If there is one issue I’d like to see in public discourse it is this: We can change retirement age or benefit levels, adjust taxes until the cows come home and experiment with nationalized health insurance and NONE of the problems will be solved UNTIL we get a true change in mindset regarding health.

    We live in a society that has totally bought into the notion that Old equals Illness. Going to the doctor is an accepted part of life. Too many benefit by the status quo – from the pharma industry to your neighborhood drugstore, not to mention well-paid doctors, pharmacists, advertisers, insurance cos., you name it.
    The social security issue will not be solvable until the bulk of people rethink and truly reflect on their health-related beliefs. Do speak to someone in a country that has government-run health insurance. Continually increasing out-of-pocket payments, less services, and people feeling they need to “get their moneys worth”, seeing their doctors for every little thing. It is just a very sad situation. I do not see improvement on the horizon; quite the opposite.

  • Frank says:

    Mike C. – you are a free rider – you may think you are taking care of yourself by saving and investing in some rental properties – but if others in your cohort don’t have some kids, their won’t be anyone to rent it from you.
    Sivaram – I believe it is a wealth and affordability issue. Of the people I know and know of, the group that tends to have larger families are those that are very wealthy – $200K plus on one income. Even though we in Canada and the US are very wealthy on a world scale, the financial sacrifice of having one parent out of the workforce for an extended period of time and/or the continued hassles of childcare etc. makes having a larger family difficult. I believe that if we believed it was necessary we could effectively motivate people to have larger families – it would require a combination of much greater direct financial assistance than we presently (in Canada) provide, plus subsidized daycare. It would take a huge amount of money – more than any government would be prepared to commit to, but in the long run would turn into the greatest investment.

  • ts says:

    @David M.:

    Yes in general they are healthier at 75 than they used be at 65, but that isn’t the same thing as being healthy enough to work is it?

    Today’s medicine keeps people alive longer but it repairs relatively little to no damage that age brings, it can only at best slow the deterioration down a bit. You try to keep people working until they’re 75 and you’ll watch that life expectancy go down, while per worker productivity barely goes up (or even down, since you’ll have many more “walking wounded” who can’t, simply CAN’T, work properly anymore but are still employed) and you’ll still end up spending a ton of money when these people get into a hospital.

    Which most really can’t afford, even with insurance or even if Obama’s health care bill goes through and starts to go into effect 4-5 years down the road. Health care is really too goddamn expensive, but that is an entirely different issue.

    The economic issues were facing cannot be fixed by having people work ~7 years longer, they’re too severe at this point. Unfortunately I think some combination of default, lifestyle austerity measures, and increased taxes will be our only hope (note: I say hope, because that is all it is, there is no guarantee that it’ll work…) to avoid some sort of major crisis. But then, I’m not an economist or an actuary so that is just my opinion.

  • People at age 65 worked 80 years ago, they can work to age 75 now. My father worked in a high impact profession to age 62, and then worked in a low impact profession to age 75. And, he liked it.

    My father-in-law worked with distinction half time from his late 60s until age 77 when he retired. He may have accomplished more after age 65 because of his wisdom that younger people could not have. If you go to a hospital and have a PET scan, you can be grateful he did not retire at 65.

    There are jobs for the elderly. Perhaps not what they expected, but occasionally, what they like, because it is really boring to retire.

    TS — I totally disagree with you. Yes, elderly people can’t do the same things as younger people, but they can still contribute to society in meaningful ways. Even bagging groceries is something, particularly if one refused to save when he was younger.

    Anyone can learn the phrase, “You want fries with that?” No one deserves a work-free retirement for 20+ years if he did not save for it, or work in a profession that requires it (e.g. oil wildcatter).

  • Frank: “I believe it is a wealth and affordability issue. “

    I disagree. You might want to check out the so-called ‘demographic-economic paradox':

    The link above deals with the world (rich vs poor) but a similar relationship holds within a country, say within USA (did a quick Google search and didn’t find anything but maybe someone who is into social science can provide some numbers for the breakdown within USA.)

    The data, over long periods of time, across many countries, clearly indicates that the fertility rate appears to be inversely related to wealth. There are a whole hoard of hypotheses for this (increased life expectency in wealthier countries/population; women entering the labour force; increased leisure time for wealthier countries/population; decline of religion; etc) but the reality is that wealthy people tend to have less kids.

    Frank: “Of the people I know and know of, the group that tends to have larger families are those that are very wealthy – $200K plus on one income.”

    Anecdotal evidence can be misleading in situations like this. Things like religous adherence and lifestyle can have a bigger impact than income. Your observation in your neighbourhood may be true but it probably isn’t driven by income.

    Frank: “…it would require a combination of much greater direct financial assistance than we presently (in Canada) provide, plus subsidized daycare.”

    If what I’m saying were true (i.e. birth rate not correlated much to income,) your proposed strategy won’t have much impact. Sure, it will increase the birth rate a bit but probably not by much.

    What you are suggesting (i.e. greater govt support for children) is already happening in one province, at great cost. In Quebec, the govt provides many incentives, including very cheap daycare, and the results are questionable. Quebec tends to have a slightly higher birth rate than the Canadian average, likely due to these policies, but it isn’t a whole lot higher.

    So, policies can boost births but I doubt it will have enough of a meaningful impact (i.e. it probably isn’t easy to raise the birth rate above 2.1, which is required for stable population (ignoring immigration/emigration.)) I’m a liberal and am generally ok with government spending in these areas but such a policy would likely not be supported by conservative types (unless you throw in some religious benefit of some sort.)

  • ts says:


    Yes I already brought that up. Your holding up the outliers as the norm. A few will still be able to do the work they used to at 70 or 80 or even 90, but they’re unusual.

    And yes, anyone can in theory can say “you want fries with that” or bag stuff in a grocery, unless you’ve got some issues like senility or chronic arthritis in your hands/knees/hips. More subtle but socially embarrassing issues like having to wear a colostomy bag (usually makes the wearer smell bad…) or being near totally deaf in both ears or near totally blind are probably far more difficult to work with then you’re considering. Yes there are hearing aides and glasses/contacts and such, but they often don’t work well. There are of course corrective surgeries and such, but for that age group it is a big risk, and the surgeries often don’t work as well as intended.

    None of these issues are unusual for that age group. You may not see so many of these people walking around day to day because most of them don’t go out much in the first place. They have a hard time functioning in the “real world” even if in theory they should be able to get by just fine. Most are not like your father was.