The Coming Generational Storm: What You Need to Know about America's Economic Future
by Laurence Kotlikoff
It doesn't add up
A review by Howard Davies
Outrageous predictions sell books. Publishers, at least, think they do. From Alvin
Shock onwards, authors forecasting demographic, technological or financial
booms and busts have been massed in dump bins in airport bookstores. The form
of the predictions varies. In the run up to the millennium we saw excitable forecasts
that the Dow Jones index would soon hit 30,000. Anyone unfortunate enough not
to have more than all their net worth in the equity market would be condemned
to ever-lasting penury. More recently, with the Dow Jones hovering around 10,000,
the prophets of doom have had their day. In the post-dotcom world, the cult of
the equity is over, for now at least. Furthermore, the financial position of governments,
and the US administration in particular, is fundamentally unsound, with fiscal
Armageddon just around the corner.
Laurence J. Kotlikoff and Scott Burns are firmly in this latter category. They
are positively Spenglerian in their outlook. They believe that, as America's
baby boomers approach retirement, fundamental instabilities in the US economic
environment will begin to assert themselves. The dependency ratio is set to
rise sharply. The numbers of over-eighties, and even centenarians, are escalating
rapidly, and the costs they impose on health and benefit systems are astronomical.
The Medicare and Medicaid programmes in the US are demand-led and open-ended,
with no discipline in the system to promote cost-effective treatment. At the
same time, successive administrations have weakened the tax base. The net result
is that "if our government continues on the course it has set, we will
see sky rocketing tax rates, drastically lower retirement and health benefits,
high inflation, a rapidly depreciating dollar, unemployment, and political instability".
Apart from that, the future looks rosy.
Fortunately, there is help at hand. Our heroes have worked out solutions both
for government and for individuals. All you need to do is put down your $27.95,
and read on. Reading on is, however, not as easy as it might be. That is not
because The Coming Generational Storm is larded with equations; far from
it. There are some helpful tables of numbers, and a little of the paraphernalia
of the academic manuscript. But Kotlikoff and Burns are not a run-of-the-mill
academic quadruped. Kotlikoff is a professor of economics at Boston University,
and an associate at the National Bureau of Economic Research. Burns is a Universal
Press syndicated columnist, who writes about personal finance for the Dallas
Morning News. It could be a winning combination, with a journalistic approach,
and a focus on the financial circumstances of individuals, allied to academic
rigour. Unfortunately, the combination has produced a mule, rather than a stallion.
The tone is relentlessly conversational, and the language determinedly demotic.
They cannot refer to the Clinton Administration without describing the President
as "slick Willy" or, a paragraph or two later, "the come-back
kid". When the authors refer to Kotlikoff's own academic work, he becomes,
archly, "an economist we know". When they ask, rhetorically, whether
companies' defined benefit pension plans are in good shape, the answer is "nope,
nicht, nada, nyet, non". For those who enjoy this little conceit, they
repeat it a few pages later.
But if one can fight one's way through the undergrowth of cliche, and avoid
hyperbole above, there is a powerful line of argument running through the middle
of this book. First of all, the authors have a point. The combination of increasing
longevity, highly generous benefit entitlements and politically driven tax reductions
is a dangerous one. The budget arithmetic which results does not add up. The
authors focus almost exclusively on the position in the US, but the thesis they
advance is certainly relevant elsewhere, too. It is a little less forcefully
applicable in the United Kingdom, given our relatively higher birth rate and
relatively less generous benefits than in continental Europe, but the position
is worrying here, nonetheless.
Kotlikoff and Burns claim that the concealed US deficit, on its social security
and medical account, is now $45 trillion. Deficit is a rather loose term in
this context and perhaps their favoured "black hole" is not an unreasonable
description. They maintain that this calculation can be sourced to a piece of
analysis prepared in the US Treasury on the instructions of the previous Secretary
to the Treasury, Paul O'Neill. The intention was to publish the basis of the
calculation at the time of last year's budget, but just before the budget emerged
O'Neill was summarily dismissed, and the figures have not officially seen the
light of day.
They go on to argue that the principal remedies often cited as cures for this
fiscal crisis are unlikely to be successful. There are those who argue, for
example, that if we could be induced to lengthen our working lives by just a
year or two, that would have a major impact on the calculation. The authors
say that this would have only a modest impact. What are the beneficial effects
of immigration, as younger people are added to the workforce? In theory, this
could do the trick. But they point out that to maintain the ratio of workers
to dependants at the current level, in other words using immigration fully to
offset the ageing of the population, would require the US to admit between 4
and 6.5 million immigrants every year for the next two decades.
What of the benefits side of the equation? Is it possible, as conservatives
typically argue, to cut out fraud and waste in the public sector on a massive
scale and solve the problem that way? Correctly, Kotlikoff and Burns argue that
even a pessimistic view of the efficiency of the public sector at present is
hardly likely to generate savings on any scale which would make a dent in the
$45 trillion target.
It may be, however, that they are too dismissive in each case. Surely, in combination,
some increase in working lives, a modest uplift in immigration and a resolute
attack on the inefficiency of the state sector could begin to make an impact?
Perhaps, but it becomes clear that Kotlikoff and Burns are not interested in
minor improvements, because they reveal that they have themselves devised "the
only system that could possibly make sense".
This silver bullet is the heart of the book, though it is relatively briefly
described. Essentially, it amounts to a significant cut in benefits for future
(not current) retirees, the introduction of a new federal retail sales tax to
fund accrued benefits, and a new system of personal security accounts, invested
in a single market-weighted, global-indexed fund, which is gradually transformed
into inflation-protected pensions -- but though these accounts are supposedly
individual, any surplus balances in them are used to pay off deficits in the
fund when an individual dies.
It is an artful construction, which recognizes one of the key political imperatives
in protecting the benefits of the existing retired population, and those for
whom retirement is an early prospect. The rest of the population loses. If Kotlikoff
and Burns are correct, they stand to lose anyway, and perhaps even more if the
political instability of which they speak materializes.
Having sorted out the global position, they turn to the plight of individual
savers. How can individuals protect themselves against the coming generational
storm? Here they begin with an indictment of the structure, and value for money,
offered by today's financial services companies. This is a trenchant critique,
with which it is hard to find fault. Expensive savings packages, offering bogus
certainty and illusory diversification, have lulled many savers into a false
sense of security. The critique applies as forcibly in the United Kingdom as
in the United States, as many holders of life insurance policies would certainly
attest. But what is the answer? Well, as luck would have it, Kotlikoff has produced
a brand new software program which will give you a personal answer, called ESPlanner
(short for Economic Security Planner). As the authors tell us, "Our goal
here is not to sell you ESPlanner (although it's a good idea to buy it), but
to convince you that taking traditional financial planning advice can be highly
dangerous to your financial health". After this decorous disclaimer, perhaps
driven by SEC requirements on financial promotions, they go on to make some
rather obvious points about international diversification, the property market,
and -- more controversially -- the value of gold as an inflation hedge. But
the details, sadly, are not available unless you subscribe on the ESPlanner
The Coming Generational Storm is, nonetheless, a serious contribution
to the debate on future fiscal policy, pensions and saving, though its impact
will be reduced by the packaging. And for a non-American reader the astonishing
ignorance displayed about other countries is also off-putting. The authors'
apparent belief that the UK is not a member of the European Union may possibly
be a slip. But their views on Brazil and Japan are bizarre, and their understanding
of what is happening in Argentina -- which figures quite largely as a cautionary
tale -- is seriously questionable. They say, for example, that three years after
the debt crisis "the economy is in ruins" and "inflation is raging".
In fact, the Argentinian economy grew by over l0 per cent last year and inflation
currently runs at 2.3 per cent. The Argentinians may not be paying their debts
to international lenders, but that is a rather different matter. One can only
hope that the assumptions built into Laurence Kotlikoff's magic software package
are more accurate.
is Director of the London School of Economics