Riding for a Fall

Peter G. Peterson

From Foreign Affairs, September/October 2004

Summary:  Three long-term trends are threatening to bankrupt America: the burgeoning costs of waging the war on terrorism, the U.S. economy's increasing reliance on foreign capital, and rapid aging throughout the developed world. Washington must understand that committing the United States to a broader global role while ignoring the financial costs of doing so is deeply irresponsible.

Peter G. Peterson is Chairman of the Council on Foreign Relations, the Institute for International Economics, and The Blackstone Group. He served as Secretary of Commerce in the Nixon administration. This article is adapted from "Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It," published by Farrar, Straus, and Giroux, LLC. Copyright (c) 2004 by Peter G. Peterson. All rights reserved

THIRD GLOBAL CHALLENGE: A GRAYING FIRST WORLD

For generations, the United States has relied on the material assistance of other developed countries in pursuing global projects of common interest--from defending democracy to managing the economy to helping the poor and oppressed. Washington continues to rely on this assistance today, not least for helping the United States meet the global challenges discussed above: the war on terrorism and the financing of fiscal deficits.

In the future, however, this reliance will decline--not out of pique or unwillingness, but from sheer incapacity, caused by the explosive fiscal costs of aging and (ultimately) the accelerating population decline projected to occur in nearly all developed societies over the next several decades. This is the third global challenge facing the United States' long-term fiscal strategy. It will burden Americans by increasing the cost of the first two challenges and by forcing the country to assume global leadership on problems once relegated to others.

The primary cause of the coming demographic revolution is falling fertility. Since the 1960s, birth rates have declined steadily throughout the developed world (and in most of the developing world as well). But whereas in the United States fertility has stabilized at just under 2.1 births per woman, which roughly assures a stationary population, it has fallen much further in other countries: to 1.5 in western Europe overall, 1.4 in Japan, and 1.2 in certain southern European nations such as Spain and Italy. In most of these countries, people live at least as long as in the United States and immigration is much lower. Together, these trends produce very rapid aging.

Superimposing these dramatic demographics on extravagant pay-as-you-go retirement systems creates the fiscal equivalent of a perfect storm. Monthly public pension benefits and tax levels in most of the countries in question are considerably higher (relative to worker wages) than in the United States, and their retirement ages have been dropping even faster. It is common for European workers to retire in their late fifties, often on special disability or unemployment arrangements. In France, only 39 percent of men aged 55 to 64 remain employed, versus 65 percent as recently as 1980. These super-aging societies will also consume more health care. According to the Center for Strategic and International Studies, total public benefit spending on the elderly in Japan, France, Germany, and Italy is projected, on average, to climb from 15 to 28 percent of GDP over the next 40 years. That figure is greater than the total revenues collected at all levels of government in the United States today.

To pay for such costs, these countries may try raising taxes. But many of them already have tax burdens of over 45 percent of GDP and payroll tax rates of over 35 percent of wages. At these lofty rates, many mainstream economists warn that further tax hikes may slow the economy more than they will raise new revenue.

Of course, political leaders can propose trimming benefits, but here they will encounter stiff resistance, because the elderly in these countries are so dependent on public benefits, which in turn are vigorously defended by powerful trade unions and their political allies. In continental Europe, employers do little pension saving on behalf of workers. According to a Merrill Lynch study, only seven percent of Europe's workers are covered by corporate pensions and only one percent by 401(k)-type savings plans. Household savings rates are higher in Europe than in the United States, but the savings are heavily skewed by income. Most median-earning households have little to count on except the promise of a government check. Thus, whether in Paris, Berlin, or Rome, the political leader who suggests even minor benefit reductions is typically greeted by general strikes and mass demonstrations. Washington's foreign friends, in other words, will face the wrenching dilemma of whether to fund weapons or walkers even more than the United States will.

In the end, governments in the developed world will patch together some fiscal expedient to tide them over. But one thing seems certain: they will be subjected to intense pressure to slash other spending and run larger budget deficits. The cuts will probably include defense, security, and international aid. And leaders will grow even more reluctant than they are already to commit public resources to U.S.-led military actions or nation-building operations. Meanwhile, private-sector savings rates are almost certain to fall as the number of retired households rises and the number of working-age households declines. Larger budget deficits combined with declining private savings will end, and perhaps even reverse, the large current account surpluses that these countries have historically generated over the postwar era.

Haruhiko Kuroda, special adviser to Japanese Prime Minister Junichiro Koizumi and former vice finance minister for international affairs, is a world-class financial expert. My recent conversation with him on the issue of aging in the developed world was illuminating. He confirmed that the combination of an aging society and low birth rates in Japan remains a big problem and that, with a 25 percent drop in the number of workers under the age of 30 forecast in the next decade, Japan will face unprecedented deficits in the future. How, I asked, will Japan fund these deficits? "As you know, we have a big savings rate and a big capital account surplus. For some period, we can use those resources," he responded. "But Mr. Kuroda, you are now financing about a quarter of America's current account deficit. Can you really spend the same money twice?" I asked. "Yes. It is a very difficult problem."