Stagnant Economy Kills Retirement

Over the past 20 years our economy has been growing more slowly than it did during the 20th century. We went through two presidential terms under Obama without a single calendar year with three percent growth. In his first term, Trump has presided over a modestly better economy, thanks in no small part to his tax cuts and his deregulation policy, but we still have barely touched three percent.

The source of our slow growth is to be found in the welfare state. This big conglomerate of economic redistribution puts mechanisms to work in the economy that slowly grind it to a halt. I explained those mechanisms in my book Industrial Poverty and I discussed them further in my book The Rise of Big Government.

Slow economic growth claims many casualties. One of them is, of course, the welfare state itself, the entitlement systems of which are slowly starved to the brink of implosion as tax revenue dries up. Europe is painfully aware of what this means; here in America we have seen the first glimpses of this phenomenon in the massive money printing that the Federal Reserve has engaged in from time to time over the past two decades.

Another casualty is our children’s prosperity. As I explain in Industrial Poverty, a country that is brought into economic stagnation by its welfare state will suffer from high, permanent youth unemployment. It will be so high that the young generation is effectively barred from ever obtaining a higher standard of living than the generation of its parents. More than likely, every generation will grow up to be slightly poorer than its parents were.

This economic regress takes many forms. One of the less explored is the slow demise of retirement security. It is well known that Social Security is one of the big casualties of our emerging economic stagnation. As I explained in Ending the Welfare State, we can still save retirement security from the Social Security collapse, and the solution – an algorithm-driven transition into private accounts – could serve as a platform for saving another stagnation casualty.

Private retirement saving.

Americans continue to rely to a large degree on private savings accounts. This is good, because it gives people a certain level of independence from government fiscal excesses, but those savings are not immune to economic stagnation. All other things equal, private retirement savings depend on the long-term growth in personal income. That growth, in turn, is closely tied to the growth rate of Gross Domestic Product.

Pension systems – government or private – are never better than the balance between contributions and benefits. The original pension-system form where retirees relied on defined benefits are the most vulnerable to the long-term slowdown in economic growth, but the alternative, also known as defined-contribution plans, is also vulnerable. The reason is in the difference between the plans:

  • Under a defined-benefit plan the implicit assumption is that discrepancies between benefits and contributions are solved by means of changes to contributions (higher fees, simply);
  • A defined-contribution plan is supposed lower benefits to weather cash-flow crunches.

In reality, the maneuverability of either plan is limited. The defined-benefit plan can only raise its fees within the realm of what people can spare out of their current paychecks. The defined-contribution plan cannot lower its benefits more than what people will tolerate without pulling their money out. Nevertheless, the prospect of fixed fees and some variation in benefits has slowly increased the attractiveness of defined-contribution plans. As Figure 1 reports, over the past decades this plan type has slowly gained ground on the defined-benefit alternative:

Figure 1: Source of retirement benefits by plan type

Source of raw data: Bureau of Economic Analysis

Despite the shift toward defined-contribution plans, our retirement systems are slowly sinking into a cash-flow squeeze. The rise of the defined-contribution alternative has slowed this trend, but it has not stopped it. As Figure 2 reports, those plans are also fighting a losing battle against economic stagnation. The cash flow reported in this figure is simply the margin between, on the one hand, actual employer and household contributions plus the plan’s earnings on assets, and on the other hand benefit payments, withdrawals and administrative expenses. The net, which is the cash flow surplus, is reported as a percentage of total plan revenue:

Figure 2: Pension-plan cash flow

Source of raw data: Bureau of Economic Analysis

In addition to the slow cash-flow decline, the urgent message in Figure 2 is the plunge of defined-benefit plans into negative territory. They pay out more than they take in, simply. This means, plainly and brutally, that we are already in a situation where our retirement system is degrading.

We hear a lot about how our pension-plan problems are allocated to government. This is correct, and as Figure 3 demonstrates, state and local governments are seeing their defined-contribution plans bleed cash. However, what is often overlooked is the precarious situation for the defined-benefit plans in the private sector:

Figure 3: Cash flow balance in defined-benefit plans

Source of raw data: Bureau of Economic Analysis

To some degree the deterioration of defined-benefit plans in the private sector could be the result of withdrawals to invest in defined-contribution plans. As we saw earlier, those have grown in prominence and are now responsible for almost half of all benefits paid out. However, as Figure 2 told us, even that type of plan is in financial decline.

To get another perspective on the problems with the private plans, consider Figure 4 which reports the cash-flow deficit in defined-benefit plans as share of total employee compensation for the private sector. The red columns represent the rise in fees needed each year to avoid the negative cash flow:

Figure 4: Cash Flow and Employee Compensation

Source of raw data: Bureau of Economic Analysis

Over the past ten years, owners of private defined-benefit plans would have had to surrender almost one extra percent of their employee compensation – or about 1.2 percent out of their wages and salaries – to avoid the negative cash flow. This does not sound like much, but it is only to keep the defined-pension plans afloat. We have not even taken into account what we would have to do to stop the deterioration of defined-contribution plans.

Then, of course, we have the state and local government plans, plus Social Security. Adding up all these plans, we as a nation face a retirement-funding crisis that is being exacerbated by our inability to get the economy back to higher rates of growth.

That, in turn, is a problem caused by our ideological commitment to a fiscally unsustainable welfare state.

We as a nation have a lot of work to do.