How Do We Respond to the “Dependency Ratio” Dilemma?
Without knowing it, we have already heard a great deal about "dependency ratios." We can expect to hear a lot more, both at the level of nations and individual firms. What is the answer to a dilemma that we are going to be confronting more and more frequently?
Dependency ratios are useful as general indicators of future economic and social health. But they must be managed downward on both a micro and macro basis, in the opinion of the majority of respondents to this month's column. And it will take time.
There was little argument about what growing dependency ratios at the level of the firm tell us, regardless of where we are in the world. But several deplored what has been done about them. According to Francine McKenna, "There's no pension crisis in the executive suite …. The average worker is funding the looting of shareholder value by the fortunate few." As Cass Apple put it, "It is simply a matter of morality." Bob Fitzpatrick said, "This situation is nothing more than an extension of our 'Teflon' culture." At the national level, Richard Eckel pointed out that, "Socioeconomic policy should recognize that there is an optimal … dependency ratio range beyond which increasingly urgent action is needed to stabilize social costs and attract investment."
Several interesting actions were suggested. Many involved the way in which future obligations are funded. Don Rogers commented that, "Short term, the solution is to … require companies to fully fund and expense their current retirement contributions/obligations. Ouch!" Gerald Schultz agreed, saying, "I believe that in the end it comes down to 'pay as you go.'" Akhil Aggarwal suggested, "Self-funding of the old-age pension starting from a young age …." Vernon McKenzie and Akhil Mehta described successful efforts to do just that in Australia and India, respectively. In Australia, "Every employee, by law, must contribute 9 percent of the employee's salary to a superannuation fund of the employee's choice." For people not wishing to manage their funds, they are automatically placed in a balanced fund of investments. In India, the public sector in 2004 was transformed "from a defined benefit to a defined contribution approach …." John Wilson summed up this view in saying that "The only viable long term solution is for people (and their employers) to invest enough over the length of their working life …. [It] is the only way in which the dependency ratio can be made irrelevant."
Other suggestions ranged from Donald Sylvester's, "our laws should provide encouragement for all to work forever" to Deepak Alse's, "Do not retire employees; treat them as part of an extended family where their services may be required." The timeliness of the issue was emphasized by information from Richard Eckel that the FASB (in the U.S.) has, as of October 23, opened a discussion on Accounting for Social Insurance (PV): http://www.fasab.gov/pdffiles/si_newsrelease.pdf
Of course, dependency ratios are not reduced without other economic and social effects. For example, to the extent that current consumption is replaced by saving for the future as a means of reducing the significance of the ratio, what effect will this have on intermediate-term national economic performance, especially in an economy driven by consumption? Would retention of the elderly in the work force have a net negative effect on the productivity of those of typical working age? Or could these trends impact social costs so favorably that they could render dependency ratios largely meaningless? What do you think?
Without knowing it, we have already heard a great deal about "dependency ratios." We can expect to hear a lot more, both at the level of nations and individual firms. The question is, what kinds of responses do they call for?
The dependency ratio is simply the ratio of unemployed to employed people, whether globally, nationally, or organizationally (where retirees are the unemployed). It is linked to such things as birth rates, employment trends, and economic growth rates. But in business, it is also influenced strongly by the cost of retirees, which in turn is determined in large part by the outcomes of negotiations between management and labor.
Harvard economists David Bloom and David Canning attribute at least one-third of a nation's economic success to the dependency ratio, something that can be predicted years in advance based on what we know now about demographic trends. For example, they credit Ireland's economic success in part to a greatly-improved dependency ratio along with other more commonly-cited factors such as a strong emphasis on education. They suggest that China's dependency ratio will peak at about one dependent to 2.6 workers in the next few years. After that, the effects of encouraged reductions in the birth rate will mean that fewer workers will be supporting more retirees in the coming years, placing a burden on the Chinese economy. India, on the other hand, with slower declines in the birth rate, will see its dependency ratio improve as larger numbers of children grow up and enter the work force, where they can support their elders and non-working children.
The concept is even more striking when applied to organizations. GM's dilemma stems in large part from the fact that its dependency ratio has deteriorated as workers take earlier retirement, live longer, and enjoy health and other benefits that become more costly. Those that GM employs find it increasingly difficult to bear the burden. And consumers are becoming less willing to pay for it in the price of GM's products. When dependency ratios become too burdensome, as in the case of Bethlehem Steel in 2001, where each worker was supporting 7.5 retirees, management is increasingly tempted to do what Bethlehem's management did: declare bankruptcy and walk away from as much of its obligation as possible.
Potential management responses can get pretty complicated. In this instance, growth trumps greater productivity, because the latter alone raises the dependency ratio. In a recent article in The New Yorker, Malcolm Gladwell suggests a more complex approach that would involve pooling employee populations among consortiums of companies, presumably some growing rapidly (with low dependency ratios now but higher ones later) and some growing more slowly. Bethlehem Steel had another answer. It merely handed $7 billion in unfunded obligations over to the U.S. Government's Pension Benefit Guaranty Corporation. Then Wilbur Ross, who bought the remaining assets, started over with a completely new employee savings plan and a dependency ratio of 0 (unemployed) to 1. Of course, the more generous the long-term solution for workers in retirement, the less competitive a company can be on costs today. So what is the answer to a dilemma that we are going to be confronting more and more frequently? What do you think?