Thursday, October 20, 2011

Demographic Changes in the U.S. Economy That Will Affect Small Business

In Chapter Eight of Creating Wealth With a Small Business I dealt with the issue of whether the high unemployment that is a distinguishing feature of the post-Great Recession “New Normal” is cyclical and likely to return to more normal levels as the economy resumes growth or structural, that is, likely to remain high even as the economy expands. I come down squarely on the structural side of the issue, arguing that because of the nature of some fundamental changes in the U.S. and global economy, unemployment will remain a major problem for years and perhaps decades to come even if significant growth occurs. On page 472 of Creating Wealth… I summarize the argument as follows:

“The bottom line is that an improving economy, as measured by traditional indicators such as an increase in GDP, growing retail sales, an improved stock market, declining credit card debt, growth in some manufacturing sectors, etc., is not expected to restore normal employment levels any time soon.”

Job growth will not keep pace with overall economic growth even if this growth boosts aggregate demand in the economy. In the past, increase in demand has always led to a corresponding increase in jobs. Not this time.

In the book I discuss four major factors that lead me (and many other economists) to this pessimistic conclusion about employment (see Creating Wealth starting on page 466). But I failed to include an important one – a new and significant demographic shift that is occurring in the U.S. economy. I am referring to the retirement of the “baby boomer” generation which, starting in 2011, will have a major impact on patterns of consumption (demand) in the economy for at least twenty years (the average life expectancy of a U.S. citizen who is retired for all or part of calendar year 2011).

During the period 1946 – 1966 almost 80 million babies were born in the U.S. They are now beginning to retire. This has been one of the most productive working population groups in U.S. history and has also exerted tremendous influence on patterns and levels of consumption over the past several decades made possible by their relatively high aggregate incomes. All of that is about to change. As “boomers” retire they will experience shrinking incomes as wages are replaced by Social Security combined with a drawdown of their retirement savings. The average person over the age of 65 currently receives an average of $14,200 per year in Social Security benefits, less than the wages earned from even a minimum wage job. Unlike wages which can increase as productivity increases, Social Security is fixed income and increases are limited to the rate of inflation. For example, an increase of 3.6% is scheduled to begin in January of 2012 but from 1/4 to 1/3 of that will be absorbed by higher premiums for Medicare Part B (a mandatory government health insurance program) leaving an average increase of about 2.5%. This is the first increase in three years and prospects are not good for large increases in Social Security benefits in upcoming years due to government budget deficits. As for using monies from various retirement funds built up during working years, most retirees opt for caution so as to not outlive their resources. This results in larger inheritances for the next generation but lower spending during the lifetime of the retiree. Overall incomes and expenditures on consumer goods for baby boomers are expected to be far lower during retirement than during their working years. This will reduce overall demand in the economy and this will not be good for economic growth.

There is more. Retirees not only have less money to spend but also make significant changes in what they spend it on. Few retirees purchase a new home and all that goes with it (washers and dryers, lawn mowers, dishes, furniture). On the contrary, sooner or later most retirees usually sell their homes. They also sell other assets (equities, for example) as they convert investments into cash to pay for the costs of aging and retirement. Whereas the young and middle aged save and invest (for retirement, among others things) retirees liquidate their assets and holdings, depressing asset prices and putting a damper on economic growth. Clothing purchases decline as retirees dress more casually (no business suits, for example). Instead, closets full of clothes purchased over the years are used up and not replaced. New car purchases and expenditures on automobile transportation in general decline (less gas consumption, fewer auto parts and repairs as average annual mileage decreases). Even food consumption patterns change resulting to fewer trips to the grocery store. Instead, boomers will be spending more of their income on health-related products (medications) and services, including doctors, clinics and retirement homes. Aggregate demand in the economy will be decreased and also will shift away from what we consider “normal” patterns of consumer purchases as the boomers age.

The demographic shift caused by the aging of the baby boomers will be a major structural change in the economy over the next 20 years. It is not cyclical and subject to return to prior norms (nobody is going to get younger and start spending the way they did in their 30’s and 40’s.) All of this is going to happen whether we want it to or not. No government stimulus or clever private sector advertising program will be able to restore consumption to pre-retirement levels. Demand will shift permanently and the economy will change with it. This may not have the effect of reducing total employment (although it probably will) but it will change employment opportunities throughout the “New Normal” economy.

©Ralph Blanchard 2011

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