No Words Wasted Sale

Times Literary Supplement
Sunday, June 13th, 2004


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 Toffler's Future 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 website.

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.

Howard Davies is Director of the London School of Economics

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