Thursday, August 31, 2006

Dependency Ratios and Economic Growth/Decline

Malcolm Gladwell has an article in the August 28 issue of the New Yorker that caught my attention (by the way, his website and blog are also interesting if you like that sort of thing).

In the article, he linked the cause of Ireland's economic miracle and the financial crisis at G.M. to what demographers call the "dependency ratio". This is the "relation between the number of people who aren't of working age and the number of people who are."

The relationship is this.

"In the past two decades, for instance, Ireland has gone from being one of the most economically backward countries in Western Europe to being one of the strongest: its growth rate has been roughly double that of the rest of Europe. There is no shortage of conventional explanations. Ireland joined the European Union. It opened up its markets. It invested well in education and economic infrastructure. It's a politically stable country with a sophisticated, mobile workforce."

"But, as the Harvard economists David Bloom and David Canning suggest in their study of the 'Celtic Tiger,' of greater importance may have been a singular demographic fact. In 1979, restrictions on contraception that had been in place since Ireland's founding were lifted, and the birth rate began to fall. In 1970, the average Irishwoman had 3.9 children. By the mid-nineteen-nineties, that number was less than two. AS a result, when the Irish children born in the nineteen-sixties hit the workforce, there weren't a lot of children in the generation just behind them. Ireland was suddenly free of the enormous social cost of supporting and educating and caring for a large dependent population."

G.M.'s decline, on the other hand is, according to Gladwell, due to the 1950's president of General Motors, Charles E. Wilson. At the time there was a proposal in 1959 by the head of the Toledo local of the United Auto Workers, Richard Gosser to create a regional pension plan to spread risks across many small auto-parts makers, electrical-appliance manufacturers, and plastic shops in the Toledo area. "Every company in the area, Gosser proposed, should pay ten cents an hour, per worker, into a centralized fund."

According to Gladwell, business owners were terrified: 'This might be efficient and rational, but it's too dangerous.' Instead, they, lead by Wilson, offered a company pension. "They took on the costs of setting up an individual company pension, at great expense, in order to head off what thye saw as too much organized power for workers in the region." Or, in other words: "collectivization was a threat to the free market and to the autonomy of business owners. In [Wilson's] view, companies themselves ought to assume the risks of providing insurance."

This is all fine and dandy when you've got a lot of business, and loads of workers and only a few retirees. Or, in demographese: low dependency ratios (nonworker-to-worker ratio). "Charlie Wilson's promise to his workers, then, contained an audacious assumption about G.M.'s dependency ratio: that the company would always ahve enough active workers to cover the costs of its retired workers--that it would always be like Ireland."

Apparently Wilson never read Schumpeter.

Or any economic development theory for that matter.

Of course, as it happens in strong, dynamic economies, where people are free to act entreprenurially, production in any and all industries a) becomes mroe efficient(read: less workers needed to produce the same output) and b) evolves in order to decrease costs (read: any attempt to substitute capital for labor in order to decrease labor costs which are usually the bulk of expenses). "In 1962, G.M. had four hundred and sixty-four thousand U.S. employees and was paying benefits to forty thousand retirees and their spouses, for a dependency ratio of 1 to 11.6. Last year, it had a hundred and forty-one thousand workers and paid benefits to four hundred and fifty-three thousand retirees, for a dependency ratio fo 3.2 to 1.

What does all of this mean? "Markets work best when the burdens of benefits are broadly shared."

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