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Welcome to retirement. Now back to work

Will the district’s aging population affect its labor supply and will our economy suffer?

March 1, 2004


Douglas Clement Editor, The Region
Welcome to retirement. Now back to work

There's a lot of speculation about just when Alan Greenspan, chairman of the Federal Reserve, will retire. He turns 78 in March, and like the rest of us, he's probably thinking about the right time to pack up his desk and stop punching the clock.

In just seven years, the leading edge of the baby boom generation (those born between 1946 and 1964) will face Greenspan's predicament. They'll be 65, the customary retirement age in the United States. If they haven't already quit the daily grind, they may well be forced out by their employer's retirement policy. And many analysts predict that when the boomers do begin to retire, the nation will face a major labor shortage because succeeding generations are markedly smaller.

Between 2008 and 2030, according to the General Accounting Office, roughly 76 million baby boomers will leave the workforce, some of them retiring well before they reach 65. But only 48 million workers in Generation X will be available to replace them. Generation Y, the echo generation, is larger, but its numbers, when they join the workforce, still won't match those of the baby boom.

As a result, growth in labor supply is likely to fall significantly in coming decades. According to the Bureau of Labor Statistics, the nation's labor force grew at an average annual rate of 1.6 percent between 1950 and 2000 but is projected to grow at just 0.6 percent per year over the next 50 years. The annual labor growth rate (as high as 2.6 percent during the 1970s) will plummet to about 0.2 percent from 2015 to 2025 as the boomers begin retiring.

The macroeconomic implications are powerful. Other things equal, lower growth in labor supply means less economic growth and lower standards of living. Because of our advanced demographics, this phenomenon may hit the Ninth District sooner than it will other parts of the nation. But other factors suggest that work and retirement could well be different for baby boomers than it was for their parents. And the aging of the population may influence economic growth in ways that could mitigate the impact of lower labor supply growth.

Out of work

In mid-January, Bev Gehrke, regional labor market analyst with the Wisconsin Department of Workforce Development, had just finished cranking out workforce profiles for 19 counties in the northwest and west-central part of the state. She had good and bad news. Several counties in her region—St. Croix, Pierce and Eau Claire, for example—are likely to grow substantially in the coming years because of migration from the Twin Cities metro area; their populations will remain fairly young and they should have sufficient labor supply to attract and sustain economic growth. But in many counties, such as Iron, Sawyer and Washburn, the population is getting older rapidly. For those counties, labor will be a problem.

Chart: Labor Force Participation Rates, By age, 2000

"I'm looking at [data] here for northwestern Wisconsin, and the labor force is projected to increase maybe 2 percent or 3 percent overall in the next 20 years, compared to 25 percent from 1980 to 2000," Gehrke observed. Labor shortages shouldn't be too critical in the next decade, she said, "but in most cases it's somewhere around 2015, 2018 that the train wreck is going to happen." The problem, she explained, is that "it's the older age groups that are increasing in size. And when people reach the age of 55, the rate at which they participate in the labor force begins to decline."

In Iron County, for instance, 94 percent of males age 25 to 34 are part of the labor force, but that rate drops to 59 percent for men age 55 to 61 and 19 percent for men age 62 to 69. (Similar though somewhat lower rates apply to females in the county.) Since the share of county residents 55 and over is projected to increase from 43 percent to 57 percent, the overall labor force in the county is expected to stagnate.

Even in relatively young counties like Eau Claire, where the labor force age population (residents 16 years and older) is projected to increase substantially over the next 20 years, aging will have an impact. According to Gehrke, those over 55 will increase from 25 percent to 36 percent of the population, and lower participation rates from this group will create a strain on available labor. From 1980 to 2000, the labor force grew 35 percent, but from 2000 to 2020, Gehrke projects just 9 percent labor force growth.

The situation is similar in the Upper Peninsula of Michigan, according to Kathy Salow, regional analyst for the Michigan Department of Labor and Economic Growth. "All the U.P. counties but one have a median age well above the state as a whole," she noted. Ontonagon County, for example, has a median age of 45.9, a decade over the state median of 35.5 years. "We have fewer young people, more old people and therefore we have an aging labor force—an acceleratingly aging labor force, if that's the right word," she said. "And you just do not have the group behind them to replace the older workers."

In Minnesota, labor force analysts see comparable trends. The labor force is likely to grow at around 16 percent in the current decade, similar to the rates in the 1980s and 1990s, according to the State Demographic Center's latest labor projections. That rate is expected to fall sharply to 6 percent between 2010 and 2020 and only 3 percent the following decade.

Some sectors of the economy are especially vulnerable. Tom Gillaspy, the state demographer, points out that substantial numbers of government employees are in their 50s now, so they'll be ready to retire in a decade or so, and public schools will need to replace retiring teachers soon. The Center for School Change has estimated that between 1998 and 2008, about 20,000 teachers, more than one-third of the state's current teacher workforce, will retire, including 46 percent of Minnesota's math teachers, 60 percent of its chemistry teachers and 53 percent of its physics teachers.

Working late

At the same time, demographers and labor economists point out that participation rates for the elderly are not fixed in stone. Indeed, in calculating labor force projections for 2030 for Minnesota, Martha McMurray of the State Demographic Center assumed a slightly higher participation rate for older workers.

"That goes a little bit against the conventional wisdom and the long-term trend on participation," acknowledged McMurray, but several factors argue for a higher rate. Minnesota has experienced "a little bit" of an increase in labor force participation in recent years, and employers may be more eager to employ older workers if they recognize that the younger labor force isn't growing quickly. Combined with better health among older people and less physically taxing work, older Minnesotans may be able to work and interested in working more than in years past.

Richard Rathge of North Dakota's State Data Center agreed. "We're starting to see a great proportion of seniors entering the labor force," said Rathge. "And I think most people probably recognize that when they go to the fast-food service places you'll start seeing more and more seniors. Society is starting to accept the whole idea that maybe we shouldn't be encouraging folks to retire, certainly not young, and even at 65."

Show me the money

A key factor that may lead to increased labor force participation by seniors is financial uncertainty. "It used to be that people retired at age 60, or they would try to retire as early as possible and then either get into a volunteer work or leisure time," said LaRhae Knatterud, planning director of Minnesota's Project 2030 Aging Initiative. "But now it's radically changed, and the boomers are going to change it even more. Some of them are going to have to work because they need the money, because they haven't saved enough."

Indeed, a survey published in September 2003 by AARP, the advocacy group for older Americans, suggests that because of the stock-market downturn, low interest rates on conservative investments, cutbacks in retiree health benefits and reduced expectations about inheritance wealth, 45 percent of Americans 50 and over now expect to work well into their 70s.

A November 2003 study by the Employee Benefit Research Institute strongly supports the idea that American workers need to earn and save much more if they are to cover basic expenses during retirement. "The aggregate deficit in retiree income during the decade ending 2030 will be at least $400 billion," concluded the study, "including at least $45 billion in 2030 alone." The EBRI analysis calculated this deficit as the difference between basic living expenses including costs of long-term care and resources available from government assistance programs and private retirement accounts. Most at risk are single women in the lowest income quartile.

The Congressional Budget Office also released a report in November on the retirement prospects of Americans. It reviewed a decade's worth of economic research and reached a more optimistic conclusion. Baby boomers are generally in better financial shape than their predecessors were at the same age, said the CBO research review, and less likely to live in poverty than current retirees. About half of boomer households are on track to accumulate enough retirement wealth to maintain their current standards of living post-retirement, and many—though not all—in the other half could do so if they were to work a few additional years.

But the CBO points out that most of these studies assume that Social Security and other government benefits will remain unchanged. If boomers are counting on that consistency, "that expectation may induce them to save less than they would otherwise," said the report. "Conversely, to the extent that they recognize the looming difficulties in funding those programs, they may increase their saving or retire at a later age than they had originally planned."

It's what economists call rational expectations. People will rationally base their savings behavior, in part, on the policies that lawmakers adopt. But that makes prediction difficult if policies are altered. So it's hard to know just how boomers might react if Congress modifies Social Security. And it's hard for baby boomers to know what the smart retirement move might be given a constantly changing fiscal and political environment.

Motive and means, but opportunity?

Still, the desire and ability to work more may not cut it. Many employers maintain pension and retirement policies that gently—or not so gently—encourage older workers to leave. In the past year, in efforts to cut costs by trimming their workforces, major Twin Cities employers like 3M and the University of Minnesota, and FedEx and Verizon nationally, have been offering workers lucrative early-retirement packages that are hard to refuse.

But when companies need to hire again, say labor analysts, they may find that tax and pension laws and age discrimination rules will make it difficult to rehire older workers, even if they're available. Minnesota's McMurray, among others, observed that at this point most employers seem unaware of the impending workforce shortage. "A lot of organizations now have a really aging workforce, and I'm not sure how many of them are really doing much in the way of planning for how to deal with that," she said.

A recent report by the Society for Human Resource Management indicated that nearly 80 percent of employers surveyed said they were doing little if anything to prepare for an impending wave of baby boomer retirements. And a 2001 GAO report reached similar conclusions. "Employers have taken little action so far to prepare for this demographic transition," said the report. "We identified few employers with well established, formalized programs to encourage older employers to work longer."

The reason, at least since the recent recession began, seems clear enough. Employers focused on near-term survival have been trimming workforces, not developing strategies to retain senior employees. "Part of this inaction may be because these demographic changes, while inevitable, remain largely on the horizon," concluded the GAO. "Most employers are not yet facing labor shortages or other economic pressures requiring them to consider phased retirement or related programs."

Eventually, though, increased labor force participation by older workers seems probable, as employers feel the shortage and workers need the money. "It's a message that we've been talking about for almost 10 years," said Wisconsin's Gehrke. "As soon as jobs start to open up again and employers are looking for people, they'll be listening." Nonetheless, more work by older people is unlikely to eliminate the labor gap entirely. According to Boston Fed estimates, reasonable increases in participation "could make a modest dent" but won't completely solve the problem.

Outside help

There is another time-honored solution to major labor shortages, of course: immigration. And that may indeed be at least part of the solution at both the district and national levels. At a national level, President Bush has recently announced new immigration policies that he suggests could relieve labor shortages.

Minnesota had major net migration gains during the late 20th century, adding substantially to its labor force by bringing in workers from other states and nations. State demographers assume that in-migration will continue at a moderate though lesser extent over the next several decades. But that assumption, they acknowledge, is critical to their projections and to the state economy. "Minnesota's future labor force growth will depend on attracting new residents from other states or from foreign countries," said the state demographer's most recent report. "If there is no in-migration, the workforce will start to decline after about 2015, when the baby boomers begin to retire in large numbers."

Wisconsin also benefited from substantial in-migration and might again. "In the 1990s, half of our population growth was in net migration," noted David Egan-Robertson of Wisconsin's Demographic Service Center. "Our projection series are saying net migration can't stay that high. ... But then again, maybe it will. There are those unforeseen things that you just can't get a complete grasp on. In-migration could continue at a pretty hefty clip."

Other district states had lower levels of in-migration in the past decade, but they would undoubtedly benefit from an influx of outsiders as their local population ages. If nothing else, the high proportion of foreign-born attendants in many nursing homes provides a striking metaphor for the idea that our nation's oldest citizens will likely be cared for by an immigrant labor force.

Another possibility

But immigration and increased work by the elderly aren't the only potential solutions to a labor shortage due to the impending demographic transition. If you can't get more hours of work, you need to get more work out of the hours you do have. One way to do this is to invest in more machinery so that an employer can increase production with the same amount of labor—what economists call "capital deepening."

A complicating factor here is that at the macroeconomic level, increased investment ultimately requires higher saving. But an aging population could well deplete national savings as retirees spend their retirement funds, while also garnering high transfer payments in the form of Medicare, Medicaid and Social Security. On the other hand, an older population also implies less government expenditure toward public education, since children are a smaller fraction of the population. A further complication: If savings rates in Europe and Japan decline as their populations age, global capital flows to the United States could decline and capital deepening would suffer.

Economists who have used macroeconomic models to analyze these many factors are not entirely pessimistic. "Demographic trends will have adverse effects on economic growth after 2010, due in large part to the slowdown in the growth of the workforce and the increase in spending on age-related government transfers," wrote economists Diane Lim Rogers, Eric Toder and Landon Jones in an Urban Institute/Brookings Institution analysis of the economic consequences of an aging population. "But the effects do not appear to be catastrophic." The economy will grow, if more slowly than before, according to their analysis. And though national saving rates will decline, they say, capital deepening will be possible because a smaller workforce requires less capital.

And yet another ...

Capital and labor are only two parts of the economic growth equation. Gehrke points to the third and perhaps most crucial: "Employers will need to increase productivity by improving work processes so they don't need as many people to do the same amount of work."

And in fact, research suggests that a slowdown in labor force growth may well be offset, at least partially, by a rise in productivity growth. In the early 1800s, according to economic historians, the United States surpassed Great Britain in technological innovation partly because of the relative scarcity of labor in the United States. Economic theory would certainly suggest that as labor becomes scarce, producers will face an incentive to innovate, and economists have established a fairly solid negative correlation between labor force growth and growth in productivity. In more familiar terms, necessity does appear to be the mother of invention.

Last year, in testimony before the U.S. Senate's Special Committee on Aging, one worker nearing retirement shared his views on this very issue:

Economists understand very little about how technological progress occurs, and research about the effects of aging populations on technological innovation has been sparse. On the one hand, some commentators have worried that an aging population will lead to a less dynamic economy and a lower rate of technological progress. ... On the other hand, a slowed rate of growth or a decline in the working-age population may raise technological growth. ... A relative shortage of workers should increase the incentives for developing labor-saving technologies and may actually spur technological development.

Alan Greenspan
Feb. 27, 2003
Washington, D.C.

May 2004 fedgazette:
The Graying of the District continues with a look at whether gray might mean gold for district states and communities.

Douglas Clement
Editor, The Region

Douglas Clement is a managing editor at the Minneapolis Fed, where he writes about research conducted by economists and other scholars associated with the Minneapolis Fed and interviews prominent economists.