A Darker Future For Us

Consider what happened. The stock market recovered spectacularly: lower inflation led to lower interest rates, which caused investors to switch from bonds to stocks. The Dow Jones industrial average, which traded under 1,000 for much of 1982, averaged about 2,500 in 1989 and almost 10,500 in 1999. There was a consumption boom. Feeling wealthier, Americans borrowed and spent. The personal savings rate dropped from 11 percent in 1982 to almost zero by 2005. There were only two mild recessions (1990–91 and 2001). But what's clear now is that this prosperity bred bad habits. The present crisis, though usually attributed to dubious "subprime" mortgages, really traces its origins in the widespread optimism unleashed by disinflation.

By now, the perverse consequences are clear. As stocks and real estate rose sharply in value, many Americans became convinced that prices could only go up. Once that mind-set took hold, lax investment standards (in the case of high-tech companies) and lending practices (in the case of homes) mushroomed. "Bubbles" followed. People overinvested in tech stocks and overborrowed to buy homes at inflated prices or to raise cash from bloated real-estate values. But the borrowing surge could not last indefinitely, because debts increasingly outpaced the rise of incomes. By 2006, household debt was 134 percent of personal income. Sooner or later, consumers had to retrench. They are now; car sales and retail spending are down.

The recession will end, but recovery won't ensure a return to previous rates of economic growth. Just beyond the horizon looms a larger threat: an aging society.

Arithmetically, economic growth reflects the increases in workers' hours and their productivity—a.k.a. efficiency. From 1960 to 2005, annual U.S. economic growth averaged 3.4 percent, split almost evenly between labor-force growth (1.5 percent) and productivity gains (1.9 percent). As baby boomers retire, labor-force growth will shrink. By the mid-2020s, the Social Security Administration expects economic growth of about 2.1 percent, with scant labor-force increases (0.4 percent) and higher productivity gains (1.7 percent). Because productivity reflects many influences—technology, management, workers' skills—even that projection could be optimistic. If productivity falters, as in the 1970s, the U.S. economy would virtually stagnate in the face of growing claims on people's incomes.

A dilemma for the new president is how to reconcile the needs of the present with those of the future. The immediate need is to revive confidence—to rev up demand and spending, thereby absorbing the jobless and increasing the production of underutilized businesses. But the long-term problem is different. It is to mediate between all the competing demands on the nation's income and to expand the economy's capacity to produce the output that satisfies those demands. The closer the economy comes to stagnation, the more Americans will succumb to distributional struggles—not just between the rich and the poor, but also between the young and the old and between immigrants and natives.

Down that path lies "affluent deprivation." To use an old but apt cliché: people will fight over pieces of a fairly fixed economic pie rather than sharing ever-larger pieces of an expanding pie. The winners may be pleased, but the losers will feel short-changed—and so the conflicts may intensify, with yesterday's winners possibly becoming tomorrow's losers. Politics, which is often about rewarding some and punishing others, may become more so. Nor is this prospect merely theoretical. Already, Americans face far more claims on their incomes than can be easily met.

Start with government. It's overcommitted in the sense that it's made more promises than can be sensibly afforded. The largest of these involve retirement costs. As is well known, three programs for the elderly dominate the federal budget: Social Security, Medicare (health insurance) and Medicaid (nursing-home care for the elderly poor). These programs now represent more than two fifths of the $3 trillion budget, and as baby boomers retire, they could nearly double—measured as a share of the economy, gross domestic product (GDP)—in 2030. The tough questions are obvious. How much will we permit spending on retirees to raise taxes or crowd out the rest of government?

Health care compounds the difficulty. About three quarters of the projected increase in federal spending for the elderly involves Medicare and Medicaid. As a society, we haven't learned how to control health spending. Most Americans think that people should get all the medical care they need. Spending controls—for government and private insurance—haven't worked, because Americans don't want them to work. Health spending has gone from 5 percent of GDP in 1960 to 16 percent now and may hit 20 percent by 2015. For workers with employer-paid insurance, that's depressed take-home pay by diverting dollars from wages into premiums. For everyone, health spending puts upward pressure on taxes and downward pressure on other government programs.