Les Jones

Population > "No Country for Young Men" - the Boomers Retire

Megan McArdle looks at likely effects of baby boomer retirement that officially began last week:

At one point or another, you’ve probably heard the speculation that once the Boomers start selling their stocks and mutual funds to support their retirement, the flood of sales will cause the market to crash. That’s plain wrong: the Boomers were born over a period of 18 years, and they will retire over a similar span; moreover, most of them will not start cashing in their stocks immediately. Most people, evidence shows, wait to break into their 401(k)s until they have to. David Wise, the head of the National Bureau of Economic Research’s aging program, has, along with his colleagues, run multiple models looking at what will happen as the Boomers sell out, and he believes the effect will likely be modest.

But the outlook for equity markets is cloudy nonetheless. The problem is more basic: stock prices reflect both a company’s current earnings and its expected growth in earnings. A high price-to-earnings ratio means investors expect fast growth in future earnings. If you think economic growth is going to slow, the stock market looks overvalued today. Historically, stocks in aggregate have tended to trade at P/E ratios between 12 and 20. Right now, the P/Es of the three major indexes are on the high end of that range, implying the expectation of faster-than-usual economic growth. That sort of growth will be awfully difficult to achieve as the Boomers retire—and the problem could persist for decades. It is possible that, as the Yale economist Irving Fisher infamously said in 1929, “Stock prices have reached what looks like a permanently high plateau.”

And on the difficulties and expense of transitioning parts of the economy from catering to the young to catering to the aged:

My grandmother, who is blind and physically frail, was able to live at home much longer than she otherwise could have because she had Meals on Wheels, a home health aide, and a Life Alert-type necklace to call for help in case she fell.

But these services require a lot of labor. According to an analysis by McKinsey Global Institute, the number of hours required to produce an automobile in North America fell by 1.7 percent annually from 1987 to 2002, to an average of about 100 hours. Meanwhile, it still takes about the same amount of time as it always did to drive a senior to a doctor’s appointment, or to help an older patient bathe and dress. Productivity growth is faster in the things that kids consume than in the things that the elderly need.

This is is yet another example of the problems described under the heading of Baumol's cost disease:

Baumol's cost disease (also known as the Baumol Effect) is a phenomenon described by William J. Baumol and William G. Bowen in the 1960s. The original study was conducted for the performing arts sector. Baumol and Bowen pointed out that the same number of musicians are needed to play a Beethoven string quartet today as were needed in the 1800's; that is, the productivity of Classical music performance has not increased.

In a range of businesses, such as the car manufacturing sector and the retail sector, workers are continually getting more productive due to technological innovations to their tools and equipment. In contrast, in some labor-intensive sectors that rely heavily on human interaction or activities, such as nursing, education, or the performing arts there is little or no growth in productivity over time. As with the string quartet example, it takes nurses the same amount of time to change a bandage, or college professors the same amount of time to mark an essay, in 2006 as it did in 1966.

Baumol's cost disease is a fascinating topic that touches on many areas of economics and public policy. For instance, it's a a likely influence on the fact that college tuition and health care costs tend to rise much faster than the general rate of inflation.