My Mild Obsession with Demographics

Anne Casscells

When all is said and done, I suspect the thing that I will be most remembered for is a couple of academic articles I wrote a while ago. I say this because I know they still get referenced from time to time and show up fairly high in Google searches on my name. This is the story of how that happened.

I did not major in economics in college, and I went to the GSB to try to make up for that, given that I wanted to pursue a career in finance. Still, I have never felt really adequate parsing the complicated equation of macro-economics, so I developed a kind of hack. When faced with an economics problem, I often reduce it to a very simple form – I imagine a few people on a desert island finding ways to exchange goods and services. And so, I used this method when trying to figure out the future sustainability of the social security system in the United States.

Now, the backstory is that when I started my career in investment banking, I realized that I would likely never work long enough in one place to be able to collect a pension of any size. Therefore, my ability to retire was going to be based on my own savings through my 401 (k) and perhaps social security. Well, when I saw how much of my salary was going to Social Security and then learned that in the 1980s and 1990s some of this money was going to fund the budget deficit,¹ I was irritated. My initial thought was that anything not needed to pay out current retirees should be put into the stock market, instead of into treasury bonds that funded the deficit. I was an early supporter of Social Security privatization.

But one day in the late 1990s, I expressed my opinion on this to some wise person who said something like the following: “you know, it doesn’t really matter whether the Social Security Trust Fund is in stocks or bonds, what is really important is how many workers there are to support the retirees when the time comes.” Truthfully, I don’t remember exactly who it was who said this, but it stuck with me.
Pretty soon, I pulled out my imaginary desert island and started playing with a situation like the one we have in the U.S., where a huge generation of baby boomers was available to pay for retirement of the previous generation (despite their increased life expectancy), but following generations are relatively small. I ended up with a story that looks like the following.

Once upon a time, there was a family that lived on a remote tropical island. As no ships had come to visit, the family had to be self-sufficient. It grew its own food, made its own clothing, chopped wood for fuel, and even made medicines from roots and bark. In the first generation on the island, there were two couples who had four children each. The children intermarried, and as their parents grew older, each couple took turns helping to take care of the old people. As the parents lived only a few years after they stopped working, this was a comfortable arrangement, especially since they had saved up little trinkets – seashells, wood carvings, and semiprecious stones that they passed along to their children in exchange for the food, shelter, and care they received. The children just assumed something similar would happen when they grew old.

But other things happened along the way. The first thing was that each couple in the second generation had only two children. The second was that one of the family members found a new kind of bark that made wonderful medicines. This medicine had two amazing properties. The first was that it extended people’s life spans by many years; the second was that it extended the years of vitality, so that a 65-year-old was often as vigorous and full of life as a 50-year-old of the previous generation.

When the second generation approached the age when their parents had stopped working, the conversation was a little different from the one 30 years before. Mother Charlotte remarked to her daughter, “I’d like to stop working next year, and I expect you will take care of me the way I took care of your grandmother.” Daughter Sydney replied, “I’m happy to do my share, but you weren’t the only one taking care of grandmother. You had brothers and sisters who helped. Besides, grandmother was very frail when she stopped working and lived only a few years. But with the new bark medicine, you are vigorous and strong, fully capable of working, and you will probably live for another 20 years. I’m not going to wait on you hand and foot for 20 years when you can do your share. Why, if I did that, I would never have any leisure time.”

Mother Charlotte replied, “Well, surely I can compensate you. Remember your grandmother’s pearl necklace? And then there are the opals that I found and polished. How about if I give them to you? Only the necklace came to me, so this is twice what I got from my mother.” Daughter Sydney answered, “I do like the necklace and the opals, but they are not worth 20 years of work to me – maybe 15. Why don’t you keep working for another 5 years, and then I’ll agree to swap my taking care of you for the necklace and the opals.”

Mother Charlotte said, “But that’s not fair. Your father and I developed this new fishing net, which makes your life so much easier. You already have more leisure time than we did when we were your age.” Daughter Sydney replied, “Well, it made your life easier too. Besides, your parents came up with the new kind of boat that made it so much easier for you to get out to the fishing cove. Every generation comes up with something new. I hope I’ll be able to contribute something new and better to make my life and my children’s lives easier still.”

Mother Charlotte was upset. “I’ve saved this necklace and the opals all this time, and they seem to me worth 20 years. I supported your grandmother for 10 years, and only got the necklace. I’ll go talk to your brother Robin and see if he will agree to this arrangement.” Daughter Sydney said, “Uh, he already has an arrangement with his mother-in-law. She agreed to work 6 years more. So, basically she’s getting about 14 years of support for her things. I thought I was being nice in offering you a year more than Robin’s mother-in-law got. It’s funny. Growing up, I always thought these necklaces and opals were so precious, but they can’t feed you or clothe you or take care of you when you are sick. Only people can do that.”

In short, in my simple model, it seemed like you couldn’t force one generation to wait hand and foot on an older generation that wanted to enjoy a long retirement. You couldn’t coerce them through taxation, and in the case of privatization, you couldn’t force them to buy your stock portfolios at high enough prices to guarantee the lifestyle the older generation aspired to. Something would have to give, and it was likely that average working lives would be extended beyond the traditional age of 65. Sitting there in the early 2000s, with about ten years before the oldest baby boomers turned 65, it seemed like a good idea to start warning people, so they could adjust their planning and expectations. Otherwise, disappointment could lead to civil strife.

I laid out a few of these ideas at a conference on asset allocation in 2002. My friend Rob Arnott, who is the successful founder of two investment firms, let me know he was thinking along similar lines. We decided to collaborate on a paper, which ultimately became so long it was turned into two papers, one published in the Financial Analysts Journal, and one published in the Journal of Investing. The latter was conveniently titled “Will We Retire Later and Poorer?”, and in it we used the desert island fable I quoted above. I would summarize our messages as:

• Demographics are destiny. You can see what is coming decades from now in terms of age cohorts of population and life expectancy. And what was coming for the U.S. was a dramatic aging of the population.
• Retirement at 65 was a notion that was created at a time when not that many people lived long after reaching 65. Huge gains in life expectancy added many years of life and health to the lives of the Greatest Generation and the Silent Generation, which were affordable largely because the Baby Boom generation was so large.
• Given that the following generations were either smaller or equal in size to the Baby Boom, the ratio of workers to support retirees would fall almost in half.
• We also looked at how much immigration might be required to solve the demographic problem, but concluded immigration on that scale would cause a huge political backlash.
• We thought that average working lives would have to extend from 65 to about 72 to get the ratio of workers to dependents to a sustainable level, and we thought people were like to start looking ahead to figure this out around 2010, which we thought might be problematic for markets.

After publication, several journalists who write about investments and retirement planning picked up on this theme and started mentioning our articles, and I had my fifteen minutes of fame. Rob went on to found Research Associates and to be most famous for his work pioneering Fundamental Indexing, which is foundational for much of the smart beta movement that has been so influential in the last fifteen years.

For me, I left the Stanford endowment and went on to build my own money management firm, Aetos Alternatives, devoting my energies to developing the people and the culture there, as well as trying to make the world a better place through the non-profits I work with. But the lessons from this experience have shaped my life and my interpretation of events. When the financial crisis hit in 2008, I thought “maybe the problems we expected around 2010 have simply arrived a little earlier?” I could see how GDP growth (which is a function of population growth and productivity) was slowing in the first decade of the 2000s and how a housing bubble had been artificially propping that growth up. Since then, I have seen the massive monetary stimulus used to try to recover from that crisis, but have also seen how many people are left behind, either because they don’t have enough in their 401 (k)s or because they lost their jobs in the crisis and could not get replacement jobs at the same income.

Indeed, as we predicted, many people are having to work longer than they had hoped, and it is not easy for them. Rob and I thought that figuring out how to divide up the pie among Americans was likely to get more contentious as the Baby Boomers aged, and that seems to be true also. Finally, we thought that there would be pressures to increase immigration to solve the demographic problem and that this would cause social strife. We were wrong about the former, but right about the latter in terms of immigration being a big political issue. One thing we did not address, which is the difference in life expectancy between income strata. That difference is fairly dramatic, for a variety of reasons including access to healthcare. This has become a pressing concern in recent years.

It’s not fun to be right about something that is largely bad news. It is kind of like being right about global warming being a big problem. Saying “I told you so” is not that satisfying when people are suffering. But, while I am good at making pessimistic projections, I am by nature an optimistic person, so let me try to find the silver lining here. Our demographics mean we have difficult decisions to make in allocating resources between the generations. But with some give on all sides, those decisions are feasible. Most people are not that selfish. I know grandparents who forgo vacations so they can help out their children and grandchildren. There are grandchildren out there who do not want to cut the Social Security or Medicare of their grandparents.

Social Security is in better shape than you might think from reading the press. I often talk to young people who think Social Security will be out of money by the time they are due to collect it, but that is not true. In the intervening years, we have taken a close look at Social Security, and it turns out that even when the trust fund runs out, enough money comes in to pay about 75–80% of scheduled benefits, so a worst case is that benefits could be cut that much (as opposed to going to zero). Some tweaks like raising the cap on wages subject to Social Security are likely to be on the table as part of the fix. It’s also the case that Social Security is providing a really important lifeline to a lot of Americans. Twenty-five percent of retired Americans rely on Social Security for more than 90% of their income, and Social Security provides half of the income of about 50% of the population, so it has turned out to be a decent replacement for the pensions that so many have lost.

I have noticed through the presidential primaries this year and the COVID-19 crisis, that notions of income support or Andrew Yang’s universal basic income are starting to be taken seriously, and I think I am encouraged by this. After all, issues about how we pay for retirement are really about our safety net. Our fragmented system for providing this in the U.S. has generally been good for corporate earnings and stock markets, but may have contributed to instability. I am hopeful we will use this moment to think through how we can do better.