Friday, August 05, 2005

Principal Economic Assumptions: What are they?

I constantly talk about "Productivity", but of course it is not the only number series involved. If we take Tables V.B1 Principal Economic Assumptions and V.B2 Additional Economic Factors we see a total of 11 columns:
Earnings as a percent of Compensation
Average Hours Worked
GDP Price Index
Average annual wage in covered employment
Consumer price index
Real wage differential

Average annual unemployment rate
Average increase in Labor Force
Average increase in Total Employment
Average increase in Real GDP
Average annual interest rate

I focus on Productivity for a few reasons. One the Trustee's front it in their discussion, they talk about it in section B.1, they put it in the left hand column of the table. And they characterize it so "The rate of change in total productivity is a major determinant in the growth of average earnings." No they don't say "the major", but "a major" suggests that we should place close attention.

Two, the effects of Productivity on Trust Fund exhaustion are direct: a bigger future economy will have an easier time financing a fixed pool of boomers. This is true however we structure the financing and the payout.

Three, the effects of the other number series are harder to understand. The problem we have is that wage increases and inflation work on the Trust Fund in different ways. Wage increases boost contributions. Inflation increases boost cost. And the interaction is pretty complex. It works this way. Your ultimate initial retirement check depends on a combination of your income history and the overall rate of real wage increases. If workers as a whole do better you do better. But there the linkage stops, adjustments to your retirement check after that are determined by CPI: consumer price inflation. Okay lets unravel this a bit.

Higher inflation means higher payouts both short and long term. So all things being equal a jump in projected inflation is an immediate drag on the Trust Fund via increased payouts. Bad for Solvency (but oddly due to the disconnect from CPI and medical inflation not necessarily bad for current retirees. Topic for another time).

Increases in hours worked and average wage will increase contributions and so inject money into the Trust Fund. On the other hand they will increase your retirement check when the time comes and so increase costs. I have had posters elsewhere claim that this offsets itself, but I don't think so. The time shift between contribution and retirement check should make this a net gain for Solvency in a paygo system and the effect should roll forward. Like I said the effect some of these other number series are harder to understand. But people are free to bring numbers.

From the standpoint of solvency is seems clear that inflation is bad and real wage differential is good. But without a lot of study and more numeric skills than I have it is difficult to determine the significance of any particular number. But what I do know is that if productivity year in and year out comes in above both the Intermediate Cost and Low Cost projection Solvency is increasingly likely. And if we convince ourselves it will permanently come in above those points we are justified in asking skeptics to identify the particular number series that will offset that, and how they specifically work on Trust Fund balances.

Because I just don't think the long-range trends in this table are reversible EPI: Changes in Trustees Projections over time

The differences between projected 2004 and real 2004 (that is from the 2005 Report Table V.B1)
Productivity 2.7% 3.3% Earnings -.3 -.5 Hours worked (increase) .0 .0 GDP Price 1.6% 2.2%
Average wage 3.6% 3.8% CPI 1.2% 2.6% Real Wage Differential 2.4% 1.2%


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From the standpoint of solvency is seems clear that inflation is bad and real wage differential is good.

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