Transcript of an IMF Economic Forum - Who Will Pay The Bill?
November 13, 2003Transcript of an Economic Forum
Who Will Pay The Bill?
Friday, November 13, 2003
(View a webcast of this Economic Forum using Windows Media Player.)
Peter Heller (Moderator), Deputy Director, Fiscal Affairs Department, IMF
John Hamre, President & CEO, Center for Strategic & International Studies
Maya MacGuineas, Fellow, New America Foundation
Frank Eich, Economic Advisor, HM Treasury, London, U.K.
Peter Schwartz, Chairman, Global Business Network
MR. HELLER: Without further ado, let me start and welcome you all here. It's a great privilege and an honor for me to chair this panel of very distinguished experts.
The purpose of this forum is to focus on the impact and the relevance of issues that are likely to confront governments and society, not in the normal few years that we in the IMF are used to dealing with, but more in terms of events, trends, and structural developments that we can reasonably anticipate over the next several decades: demographic issues, climate change, growing national security threats, intensified globalization, and rapid technological change. These are very big trends, and they're readily anticipatable. They're not totally certain. There are obvious and important uncertainties associated with them. Some of them have very obvious effects on the fiscal position, as is well recognized with respect to the issue of populations. But other such events have possible upside and downside effects that are more complex but still important to be considered.
Most of these events are going to occur over the same time frame, over the next several decades. In many cases there are linkages between these individual events. Also, the fact that these events are going to happen during similar time frames means that they may have joint effects that will have to be taken into account.
An important question that should be asked in this institution and others, is whether these kinds of looming issues should be of concern to fiscal policy planners, not only in this country but in other countries, whether they should be incorporated, taken into account in the fiscal framework. I would note that this event coincides with the publication of a book which I've just written on this issue called "Who Will Pay?"
But I'm not going to talk very much at this session because I've assembled a group of four people who I think provide very interesting perspectives on these issues.
On my right is John Hamre, who is the President and the CEO of the Center for Strategic & International Studies, which is involved in a number of areas, with special attention directed toward CSIS' Global Aging Project, which has been exploring the economic and the political ramifications of demographic change--not only aging but other aspects of demographic change. CSIS has played an extraordinarily important role in terms of promoting the issue of demographic change and its implications--financial, economic, and political. John comes to the Presidency of CSIS with an extraordinarily distinguished background, being a senior official in the Defense Department during the Clinton years.
MR. HAMRE: Also congressional, Capitol Hill.
MR. HELLER: And Capitol Hill as well.
To my left is Maya MacGuineas, who's going to give us a hard perspective on the U.S. fiscal position. Maya has just been appointed Executive Director of the Committee for a Responsible Federal Budget. She's also the co-director of the Retirement Security Program at the New America Foundation and has thought deeply about pension issues and the U.S. fiscal position. Whereas John is going to give a picture of the global demographic perspective and some of the issues that arise beyond simply the aging industrial countries, Maya is going to take us back to the United States and look at the evolving fiscal position and the concerns that we should have if you take a longer-term view.
Frank Eich, who is to her left, is an economic advisor in the U.K. Treasury. He is also a member of the Working Group on Aging Populations of the European Community. Importantly, he is the principal author of the Long-Term Public Finance Report of the United Kingdom, which came out about a year and a half ago. I should note that there are only really two governments that have actively put out long-term fiscal reports--Australia and the U.K. So I thought that having actually prepared one of these things, Frank would give a very useful perspective on what needs to be done in terms of the budget process and thinking long term.
And, finally, on John's right is Peter Schwartz. Peter Schwartz is the co-founder and the chairman of what's called the Global Business Network. He's a partner in some joint venture capital firms, but, interestingly enough, he's also the author of some very interesting books, one, "The Art of the Long View," which I recommend to you, and "Planning for the Future in an Uncertain World."
This summer, I was reading the Financial Times, and I read about a book which he wrote called "Inevitable Surprises: Thinking Ahead in a Time of Turbulence," and I thought, I almost picked that title for my book. So it seems to me quite relevant for Peter to be here, and Peter is going to address some of the fundamental surprises that may upset the trends that I may have been thinking about or you may have been thinking about when we look ahead to the long term.
So I think we have a fairly diversified panel, and without further ado, let me turn to John Hamre.
MR. HAMRE: When I first learned about Peter's work, and he was talking about this event, I really was quite anxious to have a chance to participate because, you know, frankly, it's typical of Washington, but I dare say it's probably typical of almost all capitals, that politics today has made us just very short term-focused. There's no real long-term thinking going on in political circles. And, tragically, politics is becoming very transactional, especially in Washington, but I think it's probably so around the world.
And so who is it that's going to look out to the more fundamental strategic directions? And I really commend Peter for advancing that debate here in Washington. And I'm really very pleased that you all could be here.
I think, frankly, it's the role for think tanks. I mean, we're about the few that have the luxury of being able to do it now, and our frustration is figuring out how to plug in.
I'll try to very briefly say a few words about work we've done on demography, how we got started, and then I'd like to--I'm not an expert. I'm not a demographer or a population economist. So I have to be pretty humble about what I can say.
About six years ago, CSIS did a study called "Strengthening America," and one of our featured elements was we had to tackle the unfunded liabilities associated with our pension system. We produced what was at the time a truly bipartisan game plan. It's now been radicalized because it was embraced by President Bush in his campaign, and, of course, politics, you know, generates bodies and antibodies, and that has now created opposition to what at the time was, I think, a sensible set of recommendations.
That led us then into looking into the larger issue of the aging picture, especially in the Northern Hemisphere. This is largely a Northern Hemisphere kind of problem, and we've done a lot of work on global aging.
I would like to try to take what few insights that I have gained through this process and apply them in a larger sense to the geostrategic picture we're looking at, because in some ways the greatest uncertainty now is in the area of America's role in the world and our willingness to work with allies and the perception of allies that we're willing to work with them, and do we all understand the problems the same way. I'd like to take a few minutes to talk about that from this perspective.
From a geostrategic sense, I think the theory that links population size and national power is fairly limited and brittle. You know that larger countries are more powerful than smaller countries. Okay? Not terribly important. A couple of exceptions, like Israel, you know, stand out, but--and the other basic theory is in the area of population change. Rapid increases in youth in society tend to create revolutionary conditions, for example--or declining, rapidly declining populations--like we're seeing in Russia, tend to create decay. So there's a general theory, though I think it's very important not to try to extrapolate too strongly from this.
But I think if we were to step back and look, I think there are a couple of very large trends that are important to be objective about. First, let's talk about Africa and the Muslim-Arab world. Here what we see is a startling picture, a picture of quite explosive population growth. In the Arab-Muslim world, the populations have doubled in the last 18 years. The average age throughout the region is 18 years now. The average Palestinian is 16 years old. The average Yemeni is 15 years old.
Back in 1950, the population of Saudi Arabia was three million, and if we project out to the year 2050, 100 years later, the population is projected to be 120 million. I mean, you just get these startling statistics. And, unfortunately, this huge population growth is occurring in countries that, frankly, don't generate enough jobs. So you get--the average mother gives birth to five kids, and only two of them are going to get jobs. This is a huge, huge problem.
There are then millions of unemployed men between the ages of 18 and 35 in the countries that surround Iraq. You get a sense of the dimension of the problem that we're dealing with. And finding a solution to expanding populations and anemic economic performance is, I would argue, the great strategic security challenge of the next 30 years. No question that this is going to be by far the biggest problem. Reducing this problem to glib characterizations, you know, dead or alive and all that kind of stuff, is not helpful. We've got a much bigger, much more complicated problem on our hands.
Now, I contrast that with--let's look at the situation in Europe. Everyone knows, of course, that Europe is aging. It's not a dramatic decline. The only place you see really precipitous declines are in places like Russia, which is really startling. But, nonetheless, you see birth rates well below replacement rates throughout most of Europe.
Now, from my perspective, what's interesting about this is what this suggests about the nature of national power over the next 20 to 25 years. To be candid, Europe today can't field much military power. All of Europe together has a military establishment that's about 30 percent bigger than the United States. But all of Europe combined can't put as much combat capability in the field as the United States Marine Corps alone. Okay, so there's not much hard military power.
And if you look at the demographic trends, there's going to be a sharp shift. Thirty percent of the population pyramid is going to shift out of the age category that you draw military forces from into mature and aging parts of society. So the capacity to maintain significant military power in Europe will diminish for two reasons: there aren't enough young men, and you can't afford to have them in the military because the opportunity cost is too high when you need them in productive society to be working in order to sustain aging populations.
So one is drawn to a very difficult conclusion, and that is that the gap that separates the United States and Europe on fundamental military power is going to widen over the next 25 years. It's not going to narrow. It's going to widen.
Now, I think our European friends often say, rightly, that we're too prone to reach for the gun, and I think they're probably right. But I also say to my European friends, you know, you don't have any tools, and so that's why you always talk about diplomacy. It goes both ways. We're too trigger-happy, and you guys are too talk-happy. And this difference between Europe and America is, if anything, likely to widen. I just hate to say it. What it suggests to me is that the tensions between the so-called transatlantic community are probably going to get sharper over the next 20 years, in no small measure because of these demographic forces. And I think that's very problematic when we look at our shared problem, and I say shared problem, in the greater Middle East with the demographic--reverse demographic problem that we have there. So I think we can safely forecast, unhappily, 25 years of very difficult times ahead.
Now, third, the other thing that's startling is to look at the demographic trends around the world, how much they have changed in the last ten years. Amazing, really. Mexico is aging. Over a period of 20 years, Mexico is aging at the same rate it took the United States 120 years to age. Very interesting to see what's happening.
China is aging sharply, of course, the by-product of the one-child policy, but China in 20 years is going to have the age profile of Florida, where about 20 percent of the population is over the age of 65. And, of course, this is a society that has a retirement system that's funded by a lottery. There's just nothing there on the national level.
If you look out 20 years from now, India is going to have the same age profile as the United States. Now, this is very interesting. These countries around the world, the demographic shifts are startling.
Now, again, this is where I want to get to a slightly more positive note, but I have to be pretty humble. I don't know much about this, and so I'd have to point you to other experts, and there are some that are more expert here in the room than me.
I think that we should think about this as an opportunity. You know, when you get declining populations in the Northern Hemisphere, that has very interesting economic implications because your base of consumption is shrinking, and consumption right now drives so much of economic growth. You now have to get disproportionate emphasis on productivity advances and on returns for invested capital if you're going to make--if you're going to swing this problem. In other words, rich Northern Hemisphere has got to find ways to invest in the poorer Southern Hemisphere to get stronger returns on capital so it can afford its own retirement.
Now, it's a pretty jarring thing to say to an American politician that the only way we're going to get out of this fix we're in is to find ways to invest in China. I mean, you get a feel for how hard the politics of this is going to be, but it's true. And I say China metaphorically--China, India, wherever. We clearly are going to have to invest substantially--we're going to have to both boost our savings rates, you know, in this country, which is one issue, and then invest those resources in places where you can get higher rates of return. You're not likely going to get higher rates of return in societies that have shrinking population bases.
If you were to try to maintain the rates of growth we've had over the last 25 years in Europe with the projected shrinkage of population in Europe over the next 25 years, productivity would have to increase 150 percent. You can see how hard this is going to be. So, clearly, we're going to have to export saved capital into developing countries, and that then puts a high premium on us being invested in the success of the development agenda of these countries.
So I think our future, ironically, is far more connected now toward a constructive agenda of human development and good government, good governance, than at any other time in history as a direct result of these demographic forces.
Let me stop here. Thank you.
MR. HELLER: You gave me a fright when you mentioned that China might have the age profile of Florida! Maya, let me turn to you.
[See Ms. MacGuineas' presentation (120 KB PDF file)]
MS. MacGUINEAS: Thank you. It's really interesting to think about the interplay between security policy and economic policy. I am going to talk about the focus of fiscal policy just in the U.S. For me, this represents a career where the most interesting travel I do is to Baltimore, Maryland, where the Social Security Administration is headquartered. So it pales in comparison to the excitement my panelists see.
Thank you, Peter, for bringing this panel together. That Social Security is going to face tremendous challenges in the upcoming decades is, I'm sure, not a surprise to anybody in this room. The root of the problem lies in a number of factors, the first being the upcoming retirement of the large baby-boom generation. Beyond that, there's growing life expectancies in this country without a corresponding increase in the retirement age; declining birth rates; the maturation of the pay-as-you-go system where the earliest generations received huge financial windfalls, which leaves the rest of the system with large legacy costs to pay off; and, finally, the fact that the government trust funds are not effective in pre-funding Social Security in a way that will help pay off these obligations in the future.
Or, put another way, population, which was once pyramid-shaped, is no longer. And so the system that we have, which is a partially government pre-funded, partially pay-as-you-go system, isn't structured to deal with the ensuing problems. And this is even more depressing, no matter how strong the economy gets, because Social Security benefits are indexed for wage growth. So we can't simply grow our way out of the problem. So I just want to touch on a few numbers to fill in the picture.
The key dates of this problem are starting in 2008. At that time, the U.S. system of Social Security surpluses will contribute less and less to the budget. By 2018, we'll be running deficits, and we'll have paper assets to pay benefits between 2018 and 2041. However, in order to pay off those paper assets, we have to raise taxes, reduce government spending, or borrow, which are, in fact, the same options we'll have once the trust funds that hold the assets are completely exhausted.
The cash flow deficits are large. They'll grow from $60 billion in the year 2020 to $720 billion in the year 2070, continuing to grow thereafter. It's not just because of the baby boom. They'll grow indefinitely.
The present value of the amount we would need to put aside today, if we wanted to make the system solvent for the 75-year actuarial period, is $3.5 trillion. If we wanted to make the system structurally sound, it would require $10.5 trillion, which is, in fact, the size of the U.S. economy. And then, also, if you look at our major medical program, Medicare, and you wanted to pre-fund that in a similar way, the total amount of money put aside today in order to do that for Social Security and Medicare would be $44 trillion. So I think that conveys the magnitude of the problem.
The programmatic changes, if you were just thinking about reducing benefits or raising taxes to fill in the deficit, by the end of the actuarial period you'd have to reduce benefits by a third or increase taxes by roughly one-half. And then the number I think is most helpful is Social Security as a share of GDP. It's going to grow from 4.4 percent up to 7 percent over that 75-year period. And if you also include our major health care programs in the government--Medicare and Medicaid--those numbers are actually much higher. They are 7.6 percent today, doubling by the year 2040, up to 15.5 percent.
And I think you have to keep in mind that in the U.S., the Federal Government has rarely exceeded 20 percent of GDP. So staying this course either means a dramatic shift in the size and shape of our government or draconian cuts in all the rest of government.
This is just a picture that portrays both the income and the cost rates as a share of covered payroll. So you can see that where the slope is the highest--the costs grow the most quickly while the baby boom is retiring, but they continue to grow thereafter, so the problem does not go away.
For the sake of time, I'm actually going to skip over my next points, but just briefly, there's a three-legged stool here in the U.S. for retirement. It's Social Security, private pensions, and saving. We're not doing well on any of them because in the pension system, no more than half of the population, the working population, is covered at any one time. And our benefits, which are subsidized through the Tax Code, bestow the greatest benefits on the most well off.
Our saving rate is anemically low. No matter what policies we implement, we don't seem to be able to boost it. Many people believe that the presence of Social Security, which promises benefits, actually decreases personal saving. And then we now have the re-emergence of structural budget deficits, making our national savings problem even worse.
So while experts across the board pretty much agree that this problem exists, that we're going to have to do something, there's a bit less agreement here in the political arena. And people who want to have reforms that are implemented in advance of the problem, usually through individual accounts, tend to exaggerate how bad Social Security's problems are; whereas, people who prefer incremental reforms tend to downplay the whole problem. I would say pretty much any economic expert is going to tell you we have to make changes. The sooner we do so, the better. We can't continue to ignore this demographic boulder that's rolling towards us.
And it's also important to point out that, relative to Medicare, Social Security is not in bad shape. The unfunded liabilities in our medical system are five times as large as those in our retirement system. Likewise, we're not in as bad shape as many countries around the world.
However, both of those statements make me feel worse, not better, for the fact is that we're going to have a double demand on our resources in this country to fix both Social Security and Medicare. And as we continue to delay, future generations are really going to get hit with the brunt of this delay. And then at the same time as other nations struggle to deal with their own demographic problems, we're going to be less able to have the capital inflows we've become so dependent on, which could create another economic challenge here just when we're dealing with this initial problem.
So I quickly just want to talk about a number of the objectives, often competing, that there are in reforming Social Security.
First, you'd want to make the system structurally sound, which doesn't just mean delaying when cash deficits emerge, but changing the structure of the system so that it balances out these changes in declining birth rates, growing life expectancies, and it has more diversity in the kinds of risks that it faces.
Second, you want to think about it not just as a compartmentalized budgetary program, but within the budget as a whole. And so, just for example, right now in the U.S. we spend $8 per senior for every one that we spend for children at the federal level. And this is going to grow larger. And I would argue that this kind of focus on consumption-based transfers rather than public investments does not bode well for the economy, nor does it leave us the amount of flexibility we would want to have in a budget.
Providing adequate benefits is certainly a goal. In a country as wealthy as the U.S., there's no reason for any person who worked for their full life not to be able to retire above the poverty line. This doesn't mean that benefit cuts are off the table, but it should mean that we look carefully at how we structure those reductions.
Then it's very important that we strengthen the economy through Social Security reform, and this really comes in the form of increasing national saving.
There are two approaches to doing this through Social Security, those being either to use the surpluses in the system to reduce government dis-saving, or to increase personal saving. However, both are vulnerable to structural weaknesses. The first is that Social Security surpluses for the government, instead of leading to lower deficits or paying off of the government debt, will merely lead to more spending and greater levels of tax cuts, something I would argue we've been seeing recently since surpluses did emerge. And, likewise, if you have private saving as a consequence of Social Security surpluses being returned to individuals, this can lead to mere substitution of one kind of saving for another. So the real goal here is how to make sure you're increasing net saving.
Finally, an objective that I think is important is to spread the costs fairly between individuals and generations. And while we talk here in the U.S. a lot about how we should protect current retirees and those close to retirement, just as important will be to protect those who rely on the system. So hopefully it's going to be an intergenerational battle. But there is a risk that in some ways, this is looming around the corner.
I have a chart that shows where the division of resources stands today. As a share of both direct spending and tax expenditures, which is how we do much of our budgeting in the U.S. these days, a full 25 percent goes to retirement benefits. That number is going to grow and health care numbers are going to grow.
So I want to discuss the major areas of disagreement in the U.S. about creating reforms. The first is whether to reduce benefits or increase taxes, and this disagreement breaks down pretty neatly along ideological lines. Republicans tend to favor benefit reductions, usually in the form of changing from wage indexing, as we have now, to price indexing. Democrats tend to favor revenue increases, oftentimes in the form of lifting the Social Security payroll tax cap, which currently stands at $97,000 a year.
The second argument is by those who prefer defined benefit systems. They are very worried that in the private sector much of our pension plans are moving from defined benefit to defined contribution plans, and that if we were to do the same thing or create a hybrid system within Social Security, that that the participants would end up preferring this individualized-based account system and this would lead to the unraveling of the present system.
Then there's disagreement about whether we should pre-fund or continue the pay-as-you-go system. Those people who think the problem is large generally believe pre-funding is necessary; however, there are people who make the argument that a pay-as-you-go system is appropriate with raising taxes over time to fill in the hole because future generations will have a higher standard of living. And on this point, I'd actually direct you to Peter's book, which I think does a good job of explaining why that argument--where that argument falls short.
Then there's a second level of debate. If we do pre-fund the system, where would that money go? Would it be held by the government or individuals? And, again, this goes back to one of the biggest debates here in the U.S. Have the Social Security trust funds been effective as a storage of saving? So does the presence of the surplus leave budgeters just to think they have more money to spend? We have greater spending, we have larger tax cuts, which makes future generations no better off for having run those surpluses in the first place, and I would argue it makes them worse off because they also have new spending obligations with fewer revenues to pay for them along with their Social Security and Medicare obligations.
Or should we insulate that money by having the government trust funds invested in the stock market? That's a proposal that's been floated here. There is certainly concern about the political risks of that as well as the fact that there could be liquidity problems from such a large source of revenues being invested centrally.
Then there's the possibility of having individuals do the pre-funding themselves, which again means creating private accounts. The important part here is that if you're going to do this, you need to effectively insulate it from government so that it won't be spent or given away in tax cuts. But can you effectively insulate it from other savings so that you don't move your saving vehicle here over to a new Social Security account? And one of the ways I think to do this actually is to focus on low-income people who are already constrained in terms of saving and focus on building up saving where there isn't currently any. That's probably the best way to avoid the substitution risks.
If we have individual accounts, there are three issues there. How will we pay for them? Pre-funding the system, whether through individual accounts or something else, requires changes. And, unfortunately, right now in the U.S., we're moving away from whether we should reduce benefits or raise taxes to where we are simply borrowing to pay for it. And this, of course, undermines the very economic purpose of using accounts to increase saving. If you borrow here to save there, on a net basis you're no better off.
So one thing that will be interesting is to watch in the upcoming year whether the current administration, which is going to talk about Social Security, thinks we should borrow to create accounts or is willing to put on the table more specific ways to pay for it.
Second, generally in a defined contribution system, which the accounts would be, one would assume that the individual would bear more of the risk. However, again, for political reasons here in the U.S., the trend has become to provide government guarantees. The result of this, if you say to somebody, you are now guaranteed a benefit that's as large as Social Security would have paid you anyhow, unfunded liabilities in the system are merely switched to contingent liabilities. If we make this move, we need to ensure that our accounting system tracks these changes.
And then, finally, there's the issue of regulation. If accounts are, say, voluntary and supplemental, there's not that good a case for regulating the accounts very strongly. However, if they're used to replace part of the current safety net that Social Security serves, there's going to be a lot of reasons that you want to have them mirror existing benefits, say by prohibiting pre-retirement withdrawals and requiring annuitization with inflation protections built in.
So I just want to conclude now with three points. I think a big question is where the impetus for reform is going to come. Unfortunately, it's not in the interest of politicians to make tough choices in the short term that they can delay. However, I think the unpleasant reality is that sooner or later these numbers will be priced into financial markets. And, in fact, one of the things I think that's most important is to make these problems more transparent through better accounting, and by this I mean either accrual accounting in our budget, tracking and limiting unfunded liabilities, it certainly means extending the window with which we look at our budget from five or ten years into the 75-year period, or even perpetuity. This kind of transparency is actually something that could hasten this financial market meltdown. So we need to be careful as we implement it. But it's not a reason not to make those changes.
Secondly, the country's going to have to grapple with the question of the difference between social insurance and universal benefits. We have always talked about this program as social insurance. It would ensure that no person lives in poverty in retirement. However, to build broad-based middle-class support, what we've done is cemented the claim on universal benefits, which in the end in practice means that many workers are giving away 10 percent of their earnings to retirees who are far more affluent than they are. So you get a guaranteed benefit above poverty level, regardless of need. And if we continue to do that, again, the size and shape of government is going to be very dramatically different than it's ever been in the past.
Then, finally, my concern is that the issue that's really been lost here is that of generational equity. We've known about these problems for decades, and we've chosen not to make the choices to start to spread the costs fairly-to transition into these changes gradually. This would be both more fair and less disruptive to the economy. And we're going to have a number of problems that potentially come crashing down on us all at once. Certainly we know with Social Security and Medicare we will. And the longer we continue to delay and postpone this change and grandfather groups of people from being part of it, the starker the costs are going to be on younger workers, future generations, and, I fear, the economy. So I'm going to end on a gloomy note, whereas you, John, ended on a happier note.
[See Mr. Eich's presentation (233 KB PDF file)]
MR. EICH: Good morning. I will talk about the U.K.'s case. The purpose of my presentation is to tell you what we have done in the U.K. and what we've also done on the European level, because we're obviously facing the same challenges and some of them are probably much bigger than in the U.S.
I will talk a bit about the technical work we've done. Obviously, I don't want to go into too much detail. You can have a look at it--I have the reference at the end of the slide show. If you want to look at it, you can look up the report the U.K. has presented on its Internet site. And I will also lay out some questions for the future and present some ideas as to how we can move forward.
The overall context has been mentioned already. European member states are aging. They're actually aging much more rapidly, I think, than the U.S. That is, I think, mainly due to much lower fertility rates at the moment than in the U.S. Also, we don't have a lot of net in-migration. I think that is another reason why the U.S. is growing and also has a younger population.
The trend is obviously similar in other developed countries. But as my slides show, the main message is that the old-age dependency ratio in all these countries is going to rise. The old-age dependency ratio is just one way to think about aging, that is, the number of people above working age relative to the number of working age.
And, interestingly, but it has been mentioned already, I added China. But you could have added a number of other countries, and, interestingly for us as well in the European context is that the Central and Eastern European countries, many of them which will be joining the European Union next year, also face similar challenges.
So that's just the overall context. The U.S.is aging less rapidly, at least based on the old-age dependency ratio, at least relative to the European average. Japan is also aging rapidly and is facing major challenges.
So why should finance ministers really care? There are important intergenerational questions we need to think about. There are long-term trends which could really affect the economy in general, and also the sustainability of public finances.
These trends will have distributional effects, and we should really care about generational and fairness aspects between generations--within generations and also between generations. And governments really ought to know about what's going on in order to make the right decisions now. Many decisions take many years to have an impact, so they have to be made now. In other words, we have this window of opportunity to make changes, and we really ought to know what the future challenges are. Otherwise, we might wait too long, and then the cost of adjustment might be just too high.
I will now talk about the U.K. case because I think we have done a lot of work, and probably more than many other countries. In 1998, the government introduced a code for fiscal stability. It also put into place a framework which requires the government to clearly state its fiscal objectives, as well as the fiscal rules, with which it wants to implement these fiscal objectives. Based on the code for fiscal stability, it also required the government to publish long-term illustrative projections. Although they were required to cover only ten years; in practice, they cover 30 years.
Fiscal policy today should be seen as having short-term, medium-term, and long term objectives. And for the long term, this means ensuring that spending and taxes impact fairly within and between generations. Fiscal policy should also help to promote economic growth.
Looking at the public finance position--and that's what our report really is all about--I think it is important to know the starting position. We have these fiscal objectives, and one of them is called the sustainable investment rule, that the public sector's net debt as a proportion of GDP should remain at stable and prudent levels. We also have quite low debt levels as a share of GDP compared to other G-7 countries. We are coming from a position of quite low debt levels, and obviously the higher the debt level, the bigger the challenge will be.
And we also have a population which is aging, but not as rapidly as in many other EU member states. That is partly because we have a higher fertility rate. But it's still below the population replacement rate, if quite a bit higher than in many other countries.
So the code for fiscal stability really requires the government to publish illustrative long-term projections, but they really are only illustrative. They are published once a year as part of the budget, and I think there are some other countries that do similar things. They're based on the medium-term forecast. They're based on current policies. And they're very, very simple. They just assume that the fiscal rules hold, especially the first rule, which is called the "golden rule," and which means that current spending will be equal to tax revenue.
Then if that is true, then how would net debt develop, and how much money will we have for current expenditure in the future? So you can project that forward for 30 years. Net debt will grow since net debt by assumption will be driven by changes in investment.
This is illustrative. It also helps us to bring these kind of issues, this kind of time horizon, into the budget document. But when you really think about it, what we really should worry about are the underlying cost drivers, demand drivers for spending, and not like a top-down approach to say we assume that there's enough money around.
So we decided last year to do a long-term public finance report, and as Peter said, I think only Australia has done something as comprehensive. The motivation there was to really have a comprehensive picture of the sustainability of public finances and also to provide some kind of indication of generational fairness. I think that is even more difficult than to look at the sustainability here because so many different definitions can be used.
Another objective was to give much more information to policymakers because they really need that information to make the right decisions, and also to have to generate, some kind of public debate, because that is still lacking. It's probably coming, but I think there's a role for government to really contribute to that as well.
The report focused on demographic changes and not on, I say here as an example, global warming. I have to admit that is not something we have looked at yet. Surely it will--in the future we will expand our horizon and look at other issues as well.
So the report really is based on a comprehensive set of revenue and spending projections, and we can do projections which tell us about the share of pension spending as a share of GDP, health spending as a share of GDP, education as a share of GDP, etc. We can then use all these projections to calculate synthetic indicators for sustainability. I don't want to talk about them in detail. And we can also look at generational fairness aspects, and that is using something called generational accounting, but it has to be said that this is only one way of thinking about generational fairness, and future work should probably be more comprehensive.
The first report concluded (and I think it really depends on the starting position we have) that our public finances are in a pretty good position. They are sustainable in the long run, compared to many other countries. And generational accounting also suggests that we have quite a high degree of generational fairness.
Obviously, this all depends on the assumptions you make, but I think as long as you state these clearly, at least you generate a debate, and then people can challenge you on that, and that is a good starting point for discussion.
What difference does it make to do these projections? What they do is provide a bigger picture in which policy decisions have to be made. For example, pension policy has to be done in the context of the overall sustainability of public finances. If you can't ensure that, then you have a bad policy.
They also give us a coherent approach to thinking about these issues. That's something we didn't really have in the past. So for the first time, really, we have a document which other government departments can use, they can look at, they can talk to me or my colleagues, and you can really talk about these issues.
They also address some of the major issues which are important but generally are not considered to be urgent. Short-term stories always seem more important, which obviously is not true, and could crowd out less urgent issues.
We would like to encourage other countries to do some similar work so that we can have a better debate about these challenges.
From the vantage point of the finance ministry, what are some key issues? First of all, it was a major exercise which cannot really be done quite quickly. It takes a lot of time, and it requires senior management to really buy into the approach and to push it along. Because there's obviously quite a lot of--not opposition, per se., but rather questions as to the need for such an exercise. But we do need it. So you need to have the support from senior management.
It's also something which is actually very time-consuming because talking to different ministries takes a lot of time. You need to agree on the assumptions. And it's just not done very quickly. I mean, when you talk about pension projections, you need to talk to the people who do the population projections. You need to talk to the people who do the technical pension projections. And it's all work which takes a lot of time.
And, when you talk to other people, you find that most of your colleagues really don't think in terms of long term time horizons. As we heard before, they might think two years ahead, maybe five. But when you say what's the policy implication in 2020 or 2050, most people have no idea. So that has made a difference.
A key point here, I think, is really what's the target audience. I mean, we want to generate a public debate. We also want to be good enough to be read by academics. I have to say we ended up on the jokes pages of the Times of London because we had equations in our report, and they thought equations shouldn't be part of a budget-related document, and they made fun of us. So, you see, they were not the target audience. But we need to keep on going and get journalists to be more interested in this type of work.
I will talk about the second part of our work stream, and that is really in the context of our relations with the European Union. We have a mandate from European finance ministers to assess the impact of aging on the public finances. Our work started in 2000, and it took us until now to complete it. And the EcoFin Council, the Council of the European Finance Ministers, two weeks ago basically signed off on our first comprehensive report.
The main value-added there is that for the first time I think ever, European member states have agreed to use commonly agreed assumptions and a common methodology. I mean, obviously, there has been work done before, for example, by the OECD, but they always were based on many different assumptions and modeling techniques. This was the first time that countries really agreed to follow the same procedures, and that is a major advance.
And the projections cover public pensions, health, long-term care, education, unemployment, but once again, not global warming, something which we might have to do in the future.
What we find is that in these countries, spending--age-related spending--is projected to go up based on current policies and then on the demographic assumptions we have. It goes up by, I think, an average of 4 percent of GDP for pensions. Health and long-term care go up much less, but we do ignore non-demographic factors there, and the latter might actually be the key cost drivers.
Going back, as a result, I think the conclusion on the European level is that we do have budgetary imbalances, and they're probably bigger than in the U.S. in some countries, and many countries will face major challenges over the next 30 or 40 years.
What difference does it make? Pensions and health care reforms are now at the top of the agenda in many European countries, and the working group has provided a lot of the technical background to that. So I think we are making progress.
Have we made enough progress? Probably not. And finance ministers have asked us to do another round of projections refining what we've done before, also for the first time covering the ten new countries which will join us next year. So by 2005, we are supposed to--or we will provide another set of projections.
My personal view of this exercise is that it is a very interesting experience, especially with 15 other or 14 other countries, and soon 24 other countries. The issues are complex and differ from country to country, so one policy response doesn't really work.
I just want to give one example, the one of long-term care. In Southern Europe, that normally takes place at home; whereas, in Northern Europe, it is much more institutionalized.
Now Southern European countries also at the same time want to raise employment rates, especially for females, so how is that going to work, raising employment rates for females, while at the same time keeping long-term care at home? It's not clear that these approaches are mutually consistent. And so the answers differ from country to country. We also want to improve the projections themselves.
So where next? I think another question for a finance ministry is really not to only look at the public finances, but really on the impact of aging on the economy overall, for example, on trend growth. And I think not a lot of work has been done in that area, and my feeling is that most people are just guessing at the moment.
I think another interesting work stream would be to find out what the optimal investment portfolio would be in order to provide the right kind of capital stock for a future population, because at the moment I think investment is always quite backward-looking. It's always, oh, we have underinvestment here, we need to spend more. Maybe the portfolio of capital stock needs to change as the structure of the population changes. And once again we haven't really done much work on that, but I think that would be really interesting.
So thank you very much.
MR. SCHWARTZ: What I'm going to talk about is what are some of the major surprises that are going to perhaps upset some of the trends just discussed. There is a history to my involvement in this kind of exercise. In the late 1970s we developed two scenarios involving the future of the Soviet Union. One we called the greening of Russia, the end of the Soviet Union and the movement toward markets and democracy; the other scenario we labeled the new Stalinism, a new right wing in Russia that would take hold. In some sense, maybe we've had a bit of both.
But, in any event, we had the collapse of the Soviet Union. When I presented that at the CIA in the 1980s, the Deputy Director of the CIA said, well, that scenario can't happen in your lifetime or your children's. And it was already underway. Gorbachev had already come to power, and you could already see it coming.
Another example: demography. In 1980, the population projections for the State of California population growth came to approximately five million for the next decade. As a result, we started closing schools. We had a huge wave of school consolidation because we weren't going to have any kids in the schools. You know, we had the birth dearth of the 1970s; hence, no children in the 1980s.
Unfortunately, what we didn't think about was conflict in Southeast Asia and Central America that was going to drive a great wave of immigration to California and lead us to a fertility rate of 3.7 as compared to 2.1 for the rest of the country, and lead us to have to open a classroom a day starting in 1992 until today to keep up with the birth rate of California: in other words, we've gone from approximately 10 percent of the U.S. population to close to 20 percent in the last two decades. And we miss-estimated the demography of California by five million over one decade, and the cost, the social cost, i.e., of this was enormous.
And a personal example of the kind of other surprises. A good friend of mine is an American villain by the name of Ken Lay, who only a few years ago, of course, was an American hero. He was running one of the great companies; now it is seen as one of the worst companies and dead companies. But I asked Ken a few years ago, you know, about the future of his company, and he said there's no really big surprises out there. And he said, you know, look, everything--we've got all these wonderful financial instruments, and they're all pegged to our stock prices, and that can't possibly go below $60. And, of course, it went well below $60. All the financial instruments blew up and the company collapsed, and he became the villain.
The world is filled with surprises. I was born in 1946. I'm 57 years old. I can remember the Soviet H-bomb, the Sputnik, the fall of Cuba, the Kennedy assassinations, the 1960s, the first oil shock, the second oil shock--we can just keep going down the list. And yet we planned the future as if it were continuous. Yet all of our experience is that it is discontinuous, that it is full of surprises. We regularly encounter surprises.
So part of what I try to do is to help people see what the surprises are likely to be, because you can see them coming even today. You can see the big surprises.
Now, I want to set the surprises in a context of sort of three generic scenarios for the future. That's what I do, think about scenarios. And one of them is the kind of optimistic scenario of integration and growth of an increasingly integrated global economy and relatively sustained growth. And that's sort of what we were experiencing over the last decade.
The second scenario is fragmentation and deflation. One might argue that maybe some of what we're experiencing right now--a fragmentation around the world, weak demand and so on, and a slowing of growth on a global scale.
And then, finally, a much worse scenario, conflict and real turbulence, real global conflict, real continuous disruption. Think roughly 1914 to 1945: that was the kind of world we lived in for several decades. And who knows? We could end up there again. But we have to recognize that the fundamental context can change deeply as well as the events themselves.
So now let's talk about some of the surprises that are likely to come from geopolitics that I think are really quite significant, and we are in a fundamentally new geopolitical reality. And whatever one may think about the current administration and its rhetoric, the underlying realities of U.S. economic and military dominance relative to everyone else is a structural phenomenon. It was true in the Clinton administration and it's true today. And some of the problems that we've encountered with stress with allies around the world were true before, and it just is the fact that nobody likes being dominated by the biggest gorilla on the block, even if it's benign, forward-looking, thoughtful, and its rhetoric is pleasant. If its rhetoric gets worse, of course, they like it less, and that's where we are today. But the reality was true five years ago, the reality's true today, and the reality will be true 20 years from now. No matter what the rhetoric is, the relative position of the U.S. economically and militarily will be so dominant that it will make it very hard for everybody else.
Now, this is leading us to a set of events that I think are really quite important and a set of phenomena that are going to change the world.
First of all, the U.S. will be seen as a rogue superpower, uncontrollable, not having to play by the rules, no matter what we do. That Europe itself is transforming itself and that there is a new Europe being born, and it is qualitatively different than the old Europe. This is a Europe that we in America have to understand is not about economics but war and peace.
I was at a meeting not too many years ago talking about the future of Europe, and a Brit was there talking and whining about the European Union and all they ever do is talk, talk, talk, talk, talk, and pass regulations on the shape of sausages and chocolate.
When the French delegate said, no, you misunderstand, that's not what the European Union is about. It's about war and peace. It's about keeping us from killing each other.
The European Union is the fruit of World War II. The Europeans have shown remarkable skill at slaughtering each other in vast numbers, and they've done a pretty good job in recent years in Bosnia, Kosovo, Serbia, and places like that, and needed our intervention again to prevent them from killing each other.
So the European Union is not about economic efficiency. That's the rationale. What it's really about is war and peace. And one of the big surprises, of course, is that it has created an institution that's remarkably adept at integrating highly diverse people, of dealing with the various cultures, various institutions, and building a framework of governance for diversity. And, indeed, one of the big surprises is going to be when Russia joins the European Union in less than a decade's time, and Europe will then go from Dublin to Vladivostok. It will be a truly great Europe, Eurasian in scope, with abundant resources, land, and so on, with huge markets, and it will bear both the burdens and the advantages of Russia. And it will be transformed as a result. But Europe will be a very different animal as a result.
Now, I will say this: I don't think Europe will be a significant geopolitical player because it will be focused inward for a very long time. The integration process that it has set in motion will take at least a half a century to be fulfilled.
Another major surprise will be the re-emergence of the state. Beginning with Ronald Reagan and Margaret Thatcher, we saw a wholesale swing away from state power and toward the market. Privatization and deregulation became the dominant themes around the world. And what we're now seeing is very powerful examples of successful state power in a market economy. The small-scale example obviously is Singapore. Singapore went from Third World to First in a single generation, from a per capita income of $1,500 to a per capita income of $30,000 in one generation. No one has ever done that before. And it did it without oil, without resources of any sort, without land. It did it by educating its people and being very smart about its policies and how it developed. And anybody who's been to Singapore knows what life is like there, and it's very pleasant indeed. Remarkable achievement.
China is in some ways today, on a much larger scale, emulating Singapore, and I don't mean it too literally, but I mean in terms of its potential. Think about it as a hundred Singapore's or 20 Koreas, if you like. But there we have now 150 million people living in the middle class, soon to be 800 million. China has brought electricity to 700 million people in the last 15 years-equivalent to a demand for a thousand megawatts a month of new electric capacity in China. During that same time, by the way, India ended up with 200 million more people without electricity.
And so you see the power of very powerful states to improve the standard of living in a relatively open society, and I say relatively. But it presents an alternative model.
So what we're seeing is some challenges to some of the, I think, geopolitical realities of recent years. Let's move on.
Globalization. I think there's no doubt in my mind that globalization has been the most positive force for prosperity on the planet. More and more people are beginning to enjoy a reasonable standard of living around the world. We have probably brought something on the order of a billion to two billion people into a reasonable standard of living over the last 20 years, and we will do so again over the next 20 years. So that roughly by 2020 we will see something on the order of four billion in the global middle class. We'll still have two to three billion people who will be very poor, but we are transforming both the economies and the demands of the world as a result of that movement.
However, of course, there's a lot of pushback against globalization. We've seen the demonstrations and so on. But almost all of those come from relatively wealthy people in the rich world. What they're really pushing against is the power of corporations, and the real issue here is not globalization but corporatization. And the real pushback is against Coca-Cola and Hewlett-Packard and IBM and so on. And so what I think is very much at issue, is the role of global companies, not the role of globalization as such.
Now, another big surprise that is underway is, of course, the increase in mass migration. In the United States, the current wrinkle is very large numbers of men from China coming to the United States. Migration is still continuing to America. It's always been a positive force, and will continue to be. I'm an immigrant. I'm a Hungarian immigrant, one that came after World War II. And we've been the big drivers of growth for America. We'll continue to be. Now it's young Chinese men because there aren't enough young Chinese women in China, and they're coming to the United States in large numbers right now.
But the big one, the big surprise is Europe. Europe is already beginning to experience the first of a large wave of migration from North Africa, Middle East, South Asia, and Central Asia. It is dominantly Moslem and dominantly non-white, and that's the problem because Europe is Christian and white, and it doesn't want the Moslem immigrants. It will be the single biggest issue in Europe over the next decade. It will be the source of great friction because today, if you come in through Italy or Spain, you can go anywhere in the European Union. And this issue is going to be the greatest source of internal friction that Europe faces. And it may be the rock upon which they founder, and it's a really critical issue from a European perspective.
The other big surprise, of course, is that now that ideology in some sense is past as a source of conflict, markets and democracy have basically won. Communism and fascism are history, but that doesn't mean we're now in a world without conflict because now, of course, it is about religion, it is about conflicts between religions and between religious and secular societies.
The U.S.-European alliance is probably over, and it's not just because of a conflict of interest, it is because of a conflict of values. America is becoming more religious. Europe is becoming more secular. In Europe, the average person--14 percent of the population--goes to some form of worship every week. In the United States, the comparable figure is 72 percent. In the United States, 28 percent of the population believe in the theory of evolution; in Europe, it's 85 percent, and so on.
What we can say is that America is becoming vastly more religious. And, of course, we have tensions between the Christian and Moslem worlds. The extremists in both worlds are pushing us toward conflict, and that conflict will persist for a very long time. And these are intractable conflicts. These are not ones open to compromise. There's only one way you can change that: you either believe or you die. And that's where, unfortunately, we are, in a world of believe or die.
So we're going to see many, many conflicts. We see them here in the United States with the Christian right and the secular societies. We see them in Europe between the Christians and the Moslems. And we see them in India, between the Moslems and the Hindus and so on. So religious conflict will be the dominant source of conflict over the next century.
Now, relevant to the IMF, if you think back to every decade, we've had financial crises: the '87 financial crisis that came out of the stock market; we saw the '97 financial crisis in Southeast Asia. There will be financial crises in this decade.
Now, the interesting one is the one that hasn't happened, which is Japan. Japan is the country that needs a financial crisis and hasn't had one. And, you know, the only way that Japan changes is through crisis, and we all know its banking system is bankrupt, and the government has basically been covering it up, managing that--avoiding the crisis. Restructuring the Japanese economy is the only thing that will get it going again, and they've been avoiding it. And as a result, Japan is in a semi-permanent depression because it doesn't want to pay the price of financial restructuring.
But at the top of the list of the likely crises is China, and it's obvious. And when do we get a financial crisis? It's when you get essentially financial innovation getting out ahead of financial regulation. That's what's happened every time. And China is changing its financial system all the time. It's gone from an old state-driven system to a semi-private system that is very complex and unclear and essentially unregulated. It is absolutely vulnerable to a crisis. Unfortunately, U.S. policy today is pushing it toward that crisis, and if they were to strengthen their currency too rapidly, it's very clear what will happen. They'll face a major banking crisis in China as well, as all of the state-owned enterprise loans go bad.
Not far behind that is India, Russia, and, of course, everyone always talks about the financial crisis that will happen in the U.S. because of our current account deficits, our major federal deficits, et cetera. Of course, we have one big advantage--the dollar. And somehow or another, we've managed to avoid the worst crises here.
And then the extreme case would be the breakdown of the euro, which is unlikely.
Energy. Energy has not been at the center of our thinking for a number of years, not since the 1970s and early 1980s. But, in fact, it will be again fairly soon, for a combination of reasons: price and environment. And we have failed to invest in adequate supplies, distribution systems, natural gas systems, nuclear power, et cetera, around the world. Demand has kept on growing. We've kept prices artificially low. And so as a result, we have very tight margins, and we're very vulnerable to big increases in price, and that will keep happening. It's already underway in natural gas. There will be price spikes in oil. We've seen big price spikes in electricity. It will keep happening. We are not building nearly fast enough to keep up with demand.
And there's some other big potential surprises out there: the gradual shift toward hydrogen as an energy carrier, and the really big surprise is the return of nuclear power for environmental reasons. We're going to become rapidly concerned about hydrocarbons and their impact on global climate change, and one of the really big surprises is a decade from now when Greenpeace is out there campaigning for nuclear power as an alternative to oil.
Now, to make that happen, we have to cut the cost of nuclear power quite substantially. It's still 50 percent more expensive than its competitors, but the ways to do that seem plausible. So one of the big surprises will be the return of nuclear power as the green fuel, the green energy, of the next decade.
And then there are some really big things coming out of the sciences that are going to change the world, change the world of demography, change our view of climate change, and change our view of reality itself.
First of all, climate change. While most of the world has been concerned about global warming, that isn't what's happening. Indeed, global warming is trivial. We have lived in a period of global warming. This is basically 70,000 years of world history, all of modern human history, the last 10,000 years. We settled down and lived in relatively stable places and developed agriculture when the world warmed. And, indeed, we've had several incidents of cooling, one about 8,200 years ago and a little Ice Age about 800 years ago, which have been highly disruptive.
What tends to happen is that the world's climate changes abruptly, not slowly, and, in fact, warming leads to cooling. And the most likely scenario is not global warming but "abrupt climate change," a period of relatively rapid warming over the next decade, followed by rapid cooling thereafter. And the places that will be hit hardest will be Northern Europe, parts of North America, and big parts of China, India, and Southeast Asia. The big effect will be that it will get much colder and much dryer and much windier. Mega-droughts on a global scale. That's what we need to worry about, not global warming.
And, by the way, of course, none of this had to do with automobiles and factories, of course. These are likely to amplify the effects, but none are the underlying causal agents.
We're seeing across the sciences some really quite fundamental changes, and the one that I think is going to have a big effect on demography is regenerative medicine, fundamental change in the paradigm of medicine. Today we basically fix people by either cutting something out of them or pouring nasty chemicals into them. Yet the human body regenerates itself all the time. We get a cut and our skin grows back.
What we're now learning how to do biologically is to do what nature does already, regenerate tissue. The next effect of this is that fairly soon the basic paradigm of medicine is going to change; that when you need a new heart, we'll grow one for you out of your own tissue; when you need a new kidney, when you need a new knee, etc. And it's already beginning to happen. We're already beginning--for skin, for example, for burn victims, we're already growing skin from an individual's own skin to replace it rather than taking skin grafts. We're producing blood for people who need blood for reasons of surgery and so on from their own blood and so on. It's already beginning to happen.
And within a few years, we're also going to begin to actually have therapies for aging itself. So the implication of this is quite fundamental for several of the presentations we've heard so far. One is that we will, first of all, live healthier longer, and we will live--that is, we will retire much later, and it's already begun to happen in the United States. Retirement age went up two years ago, and it's beginning to happen, and the retirement age is going to get pushed further and further and further back because people will stay healthier longer, will want to work longer, will want to be contributing longer. And, by the way, they will need to work longer because they're going to live longer. Their pensions will have to last longer. All the infirmities of aging are going to go away. Whether it's sight, hair, skin, memory, all of those things will begin to be reversed, and then aging itself.
I have the possibility of living to be 150. I'm 57. I would guess that that's about how long I will live if I don't kill myself before then by accident. But my son, who is 13, probably has a chance of living even longer. I only say that because I don't know what lies beyond that. In other words, all the demographic assumptions we're making are fundamentally wrong. Fundamentally wrong. What?
And then, finally, we're seeing big advances in science and technology--in computing, quantum computing (we'll break Moore's law), and even in physics, where we're seeing a fundamental revolution in our basic model of the universe, much like we saw at the beginning of the 20th century with Einstein and Bohr, quantum theory, and relativity.
In other words, our fundamental science is changing fundamentally as well, and the potentials created by that are enormous. So I think the likelihood of many of the environmental issues being solved, our energy issues being solved, many of the health care issues being solved, human suffering being reduced, and the ability to support an enormous number of people, say eight to nine billion people on this planet in an environmentally benign way, are all essentially almost in hand. And I think those are the big surprises to come.
MR. HELLER: Thank you, Peter. I knew you'd be provocative!
Let me just sort of briefly put all this in context. I think what's interesting about this is, on the one hand, we've clearly heard about some of the structural imbalances that are going to be difficult to deal with looking ahead 20, 30 years.
On the other hand, we've heard about global imbalances, and I think John's presentation illustrated very much that what's going on in the industrial countries is matched by equally difficult problems of a different nature in other parts of the world that are going to have to be taken into account.
And then I think what Peter Schwartz laid out is that there is a tremendous potential for surprises. There are non-demographic factors which have to be taken into account. They have plus sides, they have negative sides, and there's a lot we don't know. But these uncertainties have to be factored in.
And I think from the perspective of the IMF, the real question is how should we approach thinking about the long term? Do we maintain our focus of looking ahead for only three or four years? Or do we try and anticipate some of these longer-term trends that we can see and try and get ahead of the curve? Because ten years is not that far in the future.
And we can already anticipate some of the national economic problems that countries are going to confront ten years from now, and these may be different than the problems we face today. We can also see that these national economic problems are going to be mirrored by global imbalances, which are going to have ramifications in terms of key macro variables in the world economy, be it the level of economic growth, interest rates, or exchange rates. And there are going to be imbalances and tensions that are going to have to be resolved across regions.
And we may have a more difficult time confronting these imbalances ten years from now than if we were to start to encourage countries, in the present, to start addressing these foreseeable imbalances.
Let me open the floor for questions.
QUESTION: Looking ahead at the expected imbalance in the Social Security system I wonder if the panel could comment on the solution proposed by [Martin] Feldstein, to divert several percentage points in the payroll tax to individual accounts-which seem to be portrayed as a no-pain, no-cost solution, with no one seeming to lose. The increase in saving that's necessary to finance all this is generated by starving the trust fund as opposed to reducing government expenditure.
MS. MacGUINEAS: In terms of increasing working lives, clearly that's what we want to get towards and we have to get towards. Particularly if you're living to be 400, you probably have to work beyond age 62.
But, in fact, in the U.S. where we've started to increase the normal retirement age by a few months a year-- just to catch up for all the time we didn't increase it-- the early retirement age is remaining the same and people are still retiring early.
One of the questions that's out there is if you have individual accounts, will people work longer because they can, therefore, build up their accounts? Or will they retire earlier because they look at their accounts and they think that they have enough to retire on?
So actually one of the issues, in terms of encouraging if not mandating people to work longer, is the importance of making more transparent those financial resources individuals will need in retirement. I think it's very difficult, if somebody has $50,000 or $500,000 or $1 million, to know what that does for them in retirement. And our annuities markets here in the U.S. are very poor. There's very low demand for it. The overhead cost and adverse selection problems make them too expensive. So I'm hoping we'll see the development of a private annuities market which helps to translate private saving into regular annuity streams and, therefore, makes it easier for people to find out how much longer they will need to need to work. That's clearly part of the solution.
In terms of the free lunch plans, of which there are many, I am a huge opponent of it. I'm kind of a gloom-and-doom person when it comes to reform because I really believe if you're not talking about the pain, you're not making any sense at all. We have to raise taxes. We have to cut benefits. And these plans out there for individual accounts appear disingenuous. They're all about ownership and wealth building, but they ignore that these things will replace an existing revenue stream which people depend on. You need to compare how much your account will provide versus how much the Social Security benefit provides, and the political risk of the current system versus the financial risk of an individual accounts system.
But, clearly, in order to increase national saving, which is the whole purpose (and something that Feldstein takes credit for in his plans--he believes that a lot of the additional revenues we'll get will be from higher corporate profits, from the higher revenue stream from saving)--you need to lower your consumption in order to save more, and very few of these plans are willing to talk about how we lower our consumption in this country, and that I think is the key.
QUESTION: I want to address a question to Mr. Schwartz, and on the issue of climate change, I think I represent my two children more than the general public. I think you have underestimated the potential for feedback to the climate. As the tundra warms, it's going to yield methane and carbon dioxide, something that we haven't even begun to factor in. As that may cause global cooling--and I agree with you on that--I think it's Nelly, bar the door.
I also believe that it's our children's option to decide on nuclear power, and I think Ralph Nader has done a terrible damage to future generations, and I think he ought to answer for that.
Thank you for calling this together.
MR. SCHWARTZ: You know, I think this issue--the feedback mechanisms--are a good example of the things we don't really understand. I actually built the first global climate models back in 1977 for ERDA, before there was a DOE, when the issue was global cooling. Then it began to warm. And the dynamics of the climate are very complex. My background is fluid mechanics. I'm literally a rocket scientist. I worked on Apollo. And we don't know a lot. But we know a lot of history, and the history we know is that the climate is relatively unstable and that, in fact, the real risk of hydrocarbons is that we trigger early and more extreme changes than would happen naturally.
I think we are in the period of relatively rapid change, and increasing the energy absorption of the atmosphere is likely to increase and accelerate the change. And that's the big risk. And, in fact, therefore, the issue of reducing hydrocarbons may be more urgent than we think if we have just simply, you know, a two-century gradual warming in mind.
MR. HELLER: I would refer to a very interesting report from the National Academy of Sciences in early 2002 (which is on their website) on the subject of abrupt climate change. They indicate that the consequences would be quite significant. But the probabilities are very, very small-on the order of 1 percent. One percent is not a trivial probability when you think about something of this nature.
So these are potentially very serious shocks.
QUESTION: I had some questions mostly for people concentrating on the policy issues. I was wondering in your research if you've seen or come across countries or maybe in the European Union where there have been dramatic policy changes to address the lack of funds in the future, or if the brunt of the work has been mostly done on projections.
MR. HELLER: Let me jump in. Read the newspapers and you'll see that in Germany and France, the issue of pension reform has been extraordinarily alive-in Italy as well. And there have been some significant changes in the pension systems of Sweden and Italy in the last decade, and they're moving in the same direction in France and Germany. And the inevitable message is that there's going to be a pushing back of the retirement age, but even more importantly, significant cutbacks in benefits. It's not very transparent, I would think, but that's clearly the way in which the systems are being restructured. This will automaticity lead to cutbacks in benefits as life span increases and interest rates change.
MR. EICH: I think you've said it all. Clearly, some countries--I'm now thinking about Sweden, they've done their work, or at least have addressed some of the issues several years ago, and it seems to be working. Their projections say what we've done, is this okay? Maybe it's not enough. But obviously, as Peter just said, in Germany and France they have started. Obviously it's just the beginning. But it is top of the policy agenda, and it's every single day when you read the newspaper, it's top of the stories. You watch TV, the news, it's top of the headlines. So just gradually thinking then on what is obviously absolutely crucial is that society also recognizes the need for change, and I think that is gradually happening in many of these countries. They are becoming more and more aware that the status quo cannot be defended and actually shouldn't be defended, because there are also some benefits from change. But it's a slow process. There are risks-upside and downside risks. It might just accelerate, and then you will see reforms which in a few years' time have addressed the issue, or actually it might slow down again.
Also, coming to the short term again, some of these reforms are driven by a short-term shortage of funding at the moment; if the economies pick up again in Europe, then maybe there will be a little less pressure to reform, and then maybe reforms will slow down again. I don't know.
MR. HELLER: Frank, there's one other wrinkle in all this, which is about the sustainability of systems that have low benefits-meaning the sustainability of the U.K.'s pension system, where benefits are so meager in many ways.
MR. EICH: In the case of the U.K., the basic pension is indexed to prices. So what you see over time obviously is that the share of outlays on this basic pension is coming down as a share of GDP. But there is also another part, which is means-tested, which tries to put more money, more pensions, into the hands of the people who need it most.
Is it sustainable? I don't know. I mean, it is current policy, and current policy at least is at the moment sustainable. So at least we are coming from a relative position of strength. We have the resources if there is political or social demand for change, I think we would be in the position to spend more; whereas, in many other countries, the current policy framework is just not sustainable. I mean, I didn't show that. I just showed the average. I think in the case of Spain, projections show that pension spending will go up to 17 percent of GDP or something. I'm sure this is not going to happen.
I also know when you read the newspapers that many countries are now saying the role of the state ought to be to provide a basic pension, and that is what I think the U.K. is doing. So the challenge for the U.K. really is to develop further--I mean, it already exists in a quite good state, but to develop further the combination of state provision and private provision. And I think that is the challenge for the U.K.--to make that really work really well.
MS. MacGUINEAS: Also, if I could quickly add to that, I think you can also look to Latin America for a number of examples of countries that have made the transition, and there are various models that you can look at, such as employer-based and individualized account system, and they're centrally managed. And one of the most interesting questions is how these different countries--somewhere between 20 and 40 have already reformed their pension systems-have financed the transition. This is really the biggest challenge.
And then, Peter, your question just made me think, you know, are low benefits sustainable? If you look here in the U.S., the baby boom hasn't even retired yet, but already you have a larger population that votes more than younger people looking out for their interests. And what are we doing? We're expanding our Medicare program with prescription drugs, which faces huge problems, larger than those in Social Security. So my projection would be that the political economy realities are that these programs will probably expand before they're properly reformed.
MR. HAMRE: We at CSIS have just released our 2003 Aging Vulnerability Index, which shows exactly what Frank was saying. The U.K. is number two out of 12 in terms of being least vulnerable. The U.S. is number three. Spain is number 12. And it's a real serious problem. If anybody wants copies, let us know. www.csis.org.
QUESTION: Globalization has been mentioned-the problem has been identified as the global corporation rather than globalization per se. I see a substantial level of ignorance concerning the difference in cultures. The immediate example is the current administration in the United States has gone into the Middle East with hardly any understanding of the local culture, which may [in turn] explain the consequences of how these wars are developing. Had there been more awareness as to what the Middle East was, specifically what Iraq was, in terms of U.S. understanding, we might have avoided quite a lot of problems the U.S. is now facing and possibly future complications that are forthcoming.
QUESTION: Are there ways in which we can systematically integrate some of the innovations and productivity gains likely in the future into our thinking, with regard to financial security, pensions, et. cetera?
MR. SCHWARTZ: I think one of the really big surprises of the 1990s was the dramatic increase in productivity. And, interestingly enough, I was recently debating Joseph Stiglitz in San Francisco on the economic future, and as you know, he's been fairly pessimistic, particularly looking backwards. But the interesting thing that came out of the debate was when we started talking about productivity and its economic consequences, and particularly in light of the most recent numbers that came out here in the United States, which showed productivity growth at 8 percent, which is unusual, a weird twist, because growth was only 7 percent, so that indicated actually a decline in the number of working hours during that period of time. Higher output with fewer hours, much more productive. But 8 percent isn't sustainable, but 4 percent might be. Four percent with a 1-percent labor force growth implies a 5-percent GDP growth rate.
There's nothing that suggests that's going to stop anywhere soon--that the spread of the innovations that are generating those gains have barely begun. These are the first waves--it began in roughly 1995, the fruits of the network economy, of IT distributed throughout particularly the industrialized world, which are now spreading throughout the rest of the world fairly rapidly. And so the potential of that wave of productivity gains has barely begun. And the underlying technologies, as I tried to suggest, are still continuing to advance. And then when you add other industries and other technologies in life sciences, in energy, in transportation coming after that, I don't see any reason why we should see productivity growth slow down over the next 20 to 30 years on a global basis, let alone in the U.S.
So the underlying growth potential of the world is probably much higher than I think the pessimists have suggested.
MR. HELLER: We ended on an optimistic note. Thank you, colleagues.