Justifications for the Long-Run Productivity Growth Forecasts in the Trustees' Reports

Justifications for the Long-Run Productivity Growth Forecasts in the Trustees' Reports

MEMORANDUM

To: Dean Baker, Paul Krugman, Other Interested Parties
From: Brad DeLong
Date: March 25, 2005

Paul Krugman observed:

a strange asymmetry between what is updated [in the Social Security Trustees' Report to reflect recent data, and what isn't.... [H]igh productivity growth since 2000... seems like big news... [but] isn't factored in at all. The reason is that the trustees use an average over the past four "full business cycles," measured from peak to peak (Section IV.B.7).... [T]hey won't take the good productivity news since 2000 into account [at all in forecasting the future] until the economy [begins] another recession. There's something very wrong with that...

This raises two natural questions:

1. Why have the Social Security Trustees adopted this estimating convention of taking average productivity growth over the past four peak-to-peak complete business cycles and projecting it forward into the indefinite future?
2. How long have the Social Security Trustees been using this--peculiar--rule of thumb for long-run forecasts of productivity growth?

The answer to question (2) is simple. The 2005 Trustees' Report is only the second year that the Trustees have used this rule of thumb that throws away all the favorable information about productivity growth since the 2000 business cycle peak.

Back in the 1990s the Trustees formed their long-run productivity growth estimates by taking the average level of productivity growth over the previous forty years and then marking down from that average because productivity growth had declined over time. Back in 1996 when the 40-year average was 1.8% per year their forecast was 1.4%. In 1997, 1998, and 1999 when the 40-year average was 1.7% per year their forecast was 1.3%.

In 2000, 2001, 2002, and 2003 as the fast productivity growth of the post-1995 period showed that we were no longer in an ongoing productivity slowdown, and as the gap between the 40-year and the 10-year growth average fell, the Trustees shrank their markdown and brought their estimate of future long-run productivity growth toward the 40-year average: the gap was 0.4% per year in 2000, 0.3% per year in 2001, 0.2% per year in 2002, and 0.1% per year in 2003.

Then in 2004 the Trustees freeze the long-run rate of productivity growth at 1.6% per year, thus for the first time choosing a forecast of future productivity growth lower than both the 40-year and the 10-year average, and for the first time justifying their forecast by saying that since "productivity growth can vary substantially within economic cycles... it is more useful to consider historical average growth rates for complete economic cycles." Had the SSA Trustees followed the 2000-2003 pattern of cutting the gap by 0.1% per year, they would have forecast 1.7% per year. Had the Trustees adopted the convention of averaging the past 40-year and the past 10-year growth rates, they would also have forecast 1.7% per year.

And in 2005 the Trustees continue to freeze the long-run rate of productivity growth at 1.6% per year, again justifying it by chopping off the data at the 2000 business cycle peak. Had the SSA Trustees followed the 2000-2003 pattern of cutting the gap by 0.1% per year, they would have forecast 1.9% per year. Had the Trustees adopted the convention of averaging the past 40-year and the past 10-year growth rates, they would also have forecast 1.9% per year.

Possible answers to question (1) are left as exercises to the readers.

---

2005 Trustees' Report:

For the 40 years from 1963 to 2003, annual increases in total productivity averaged 1.8 percent, the result of average annual increases of 2.5, 1.1, 1.5, and 2.0 percent for the 10-year periods 1963-73, 1973-83, 1983-93, and 1993-2003, respectively. However, productivity growth can vary substantially within economic cycles. Therefore, it is more useful to consider historical average growth rates for complete economic cycles. The annual increase in total productivity averaged 1.6 percent over the last four complete economic cycles (measured from peak to peak), covering the 34-year period from 1966 to 2000. The annual increase in total productivity averaged 2.2, 1.2, 1.3, and 1.6 percent over the business cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively. The ultimate annual increases in productivity are assumed to be 1.9, 1.6, and 1.3 percent for the low cost, intermediate, and high cost assumptions, respectively...

2004 Trustees' Report:

For the 40 years from 1962 to 2002, annual increases in total productivity averaged 1.7 percent, the result of average annual increases of 2.6, 1.1, 1.6, and 1.7 percent for the 10-year periods 1962-72, 1972-82, 1982-92, and 1992-2002, respectively. However, productivity growth can vary substantially within economic cycles. Therefore, it is more useful to consider historical average growth rates for complete economic cycles. The annual increase in total productivity averaged 1.5 percent over the last four complete economic cycles (measured from peak to peak), covering the 34-year period from 1966 to 2000. The annual increase in total productivity averaged 2.3, 1.2, 1.2, and 1.5 percent over the business cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively. The ultimate annual increases in productivity are assumed to be 1.9, 1.6, and 1.3 percent for the low cost, intermediate, and high cost assumptions, respectively...

2003 Trustees' Report:

For the 40 years from 1961 to 2001, annual increases in total productivity averaged 1.7 percent, the result of average annual increases of 2.7, 1.4, 1.3, and 1.5 percent for the 10-year periods 1961-71, 1971-81, 1981-91 and 1991-2001, respectively. The ultimate annual increases in productivity are assumed to be 1.9, 1.6, and 1.3 percent for the low cost, intermediate, and high cost assumptions, respectively. These are the same as the ultimate rates assumed for the 2002 report...

2002 Trustees' Report:

For the 40 years from 1960 to 2000, annual increases in total productivity averaged 1.8 percent, the result of average annual increases of 2.7, 1.6, 1.4, and 1.6 percent for the 10-year periods 1960-70, 1970-80, 1980-90 and 1990-2000, respectively. The ultimate annual increases in productivity are assumed to be 1.9, 1.6, and 1.3 percent for the low cost, intermediate, and high cost assumptions, respectively. These are 0.1 percentage point higher than the ultimate rates assumed for the 2001 report. This increase reflects ongoing assessment of historical data, including the period of rapid productivity growth between 1995 and 2000...

2001 Trustees' Report:

For the 40 years from 1959-99, annual increases in total productivity averaged 1.8 percent, the result of average annual increases of 2.6, 1.8, 1.3, and 1.5 percent for the 10-year periods 1959-69, 1969-79, 1979-89 and 1989-99, respectively. The ultimate annual increases in productivity are assumed to be 1.8, 1.5, and 1.2 percent for alternatives I, II, and III, respectively. These are the same ultimate rates assumed for the 2000 report...

2000 Trustees' Report:

For the 40 years 1959-98, annual increases in productivity for the total U.S. economy averaged 1.9 percent, the result of average annual increases of 3.0, 1.8, 1.3, and 1.4 percent for the 10-year periods 1959-68, 1969- 78, 1979-88 and 1989-98, respectively.... The ultimate annual increases in productivity for all sectors—wage-and-salary workers, self-employed persons, and the total economy— are assumed to be about 1.8, 1.5, and 1.2 percent for alternatives I, II, and III, respectively...

1999 Trustees' Report:

For the 40 years 1958-97, annual increases in productivity for the total U.S. economy averaged 1.7 percent, the result of average annual increases of 2.9, 2.0, 1.0, and 0.9 percent for the 10-year periods 1958-67, 1968- 77, 1978-87 and 1988-97, respectively.... The ultimate annual increases in productivity for all sectors—wage-and-salary workers, self-employed persons, and the total economy— are assumed to be about 1.6, 1.3, and 1.0 percent for alternatives I, II, and III, respectively.

1998 Trustees' Report:

For the 40 years 1957-96, annual increases in productivity for the total U.S. economy averaged 1.7 percent, the result of average annual increases of 3.1, 2.0, 1.1, and 0.6 percent for the 10-year periods 1957-66, 1967- 76, 1977-86 and 1987-96, respectively.... The ultimate annual increases in productivity for all sectors—wage-and-salary workers, self-employed persons, and the total economy— are assumed to be about 1.6, 1.3, and 1.0 percent for alternatives I, II, and III, respectively...

1997 Trustees' Report:

For the 40 years 1956-95, annual increases in productivity for the total U.S. economy averaged 1.7 percent, the result of average annual increases of 2.8, 2.0, 1.2, and 0.9 percent for the 10-year periods 1956-65, 1966-75, 1976-85 and 1986-95, respectively.... The ultimate annual increases in productivity for all sectors—wage-and-salary workers, self-employed persons, and the total economy— are assumed to be about 1.6, 1.3, and 1.0 percent for alternatives I, II, and III, respectively.

1996 Trustees' Report:

For the 40 years 1955-94, annual increases in productivity for the total U.S. economy averaged 1.8 percent, the result of average annual increases of 2.8, 2.1, 1.4, and 1.0 percent for the 10-year periods 1955-64, 1965-74, 1975-84 and 1985-94, respectively.... The ultimate annual increases in productivity for all sectors - wage-and-salary workers, self-employed persons, and the total economy - are assumed to be about 1.7, 1.4, and 1.1 percent for alternatives I, II, and III, respectively...

1995 Trustees' Report:

For the 40 years 1954-93, annual increases in productivity for the total U.S. economy averaged 1.6 percent, the result of average annual increases of 2.4, 2.3, 0.8, and 1.0 percent for the 10-year periods 1954-63, 1964-73, 1974-83 and 1984-93, respectively.... The ultimate annual increases in productivity for all sectors - wage-and-salary workers, self-employed persons, and the total economy - are assumed to be about 1.7, 1.4, and 1.1 percent for alternatives I, II, and III, respectively.

Comments

[howard]

but prof, you left out one key data point for us amateurs: if the trustees had used 1.9% this year, what difference (even in back of the enveloped terms) would it have made to the 75-year forecast?

[anne]

Howard

With the 1.9% long term productivity growth projection, there is no Social Security deficit. The press portrayals of the projections that were made are disturbing.

[anne]

http://www.nytimes.com/2005/03/25/politics/25social.html?pagewanted=all&position=

Republicans Consider Slowing Benefits Growth for Most
By EDMUND L. ANDREWS

WASHINGTON - Can "progressive indexation" help sell President Bush's plan to overhaul Social Security?

Though he has been loath to propose specific measures to reduce future benefits, Mr. Bush and other officials are gingerly promoting the idea as a way to cut costs and still protect low-income retirees.

Supporters of "progressive indexation" say it could achieve several goals: it would eliminate a big part of Social Security's long-running financial gap; it would guarantee benefits at current levels and allow them to rise in real terms for people at the bottom of the income ladder.

Progressive indexation involves reducing the growth in benefits for people with middle and higher incomes, but letting the benefits keep rising for low-income retirees in future generations.

"The president likes it, because it is more favorable to lower-income people than to higher-income people," Allan Hubbard, director of Mr. Bush's National Economic Council, said in an interview this week.

Many Democrats are skeptical. One problem, opponents say, is that middle-income and affluent people would feel increasingly short-changed as their benefits fell well behind their payroll taxes....

[theCoach]

anne,
Is 1.9% the number that gets us at dead even? Is there a good link for that?

BTW, if they start using 2.0%, and it appears that the trust fund will be growing, prepare for an onslaught of opinions decrying what a terrible thing it is for the program to have a surplus.[http://www.jewishworldreview.com/cols/glassman032201.asp]

[anne]

There seems to be an increasing rationale and sentiment developing for selectively cutting Social Security benefits, but cutting benefits by income class will dramatically limit support for the program in more affluent households as Social Security comes to be regarded not as income insurance, but as welfare.

[ChasHeath]

Coach,

You can review the data underlying the low, intermediate, and high SS projections made by the trustees. Here is one link you can follow:

http://www.ssa.gov/OACT/TR/TR05/V_economic.html#wp131307

Productivity is just one of several variables in each model. However, as you can see in the tables, the low cost model - which ends the 75 year actuarial period with a significant surplus - assumes productivity of 1.9% per year, compared with the intermediate model that assumes 1.6% per year.

[Joseph Palmer]

What I want to know is: What happens when you factor in the permanent end of cheap oil? This has to have some effect, no?

[anne]

Coach

Remember, we are projecting 1.9% productivity growth and 0.3% labor force growth, so 2.2% GDP growth and there is no deficit for Social Security. Hmmm :)

[P O'Neill]

Do they make employment growth assumptions at any point, using the same methodology?

[anne]

Joseph Palmer, we would do well to think of your question:

http://www.nytimes.com/2005/03/25/opinion/25deffeyes.html

What Happens Once the Oil Runs Out?
By KENNETH S. DEFFEYES

Princeton, N.J.

PRESIDENT BUSH'S hopes for the Arctic National Wildlife Refuge came one step closer to reality last week. While Congress must still pass a law to allow drilling in the refuge, the Senate voted to include oil revenues from such drilling in the budget, making eventual approval of the president's plan more likely.

Yet the debate over drilling in the Arctic refuge has been oddly beside the point. In fact, it may be distracting us from a far more important problem: a looming world oil shortage.

The environmental argument over drilling in the refuge has often been portrayed as "tree huggers" versus "dirty drillers" (although, as a matter of fact, the north coastal plain of Alaska happens to have no trees to hug). Even as we concede that this is an oversimplification, we should also ask how a successful drilling operation would affect American oil production.

The United States Geological Survey has estimated that the Arctic oil field is likely to be at least half the size of the Prudhoe Bay oil field, almost 100 miles to the west. Opening that oil field was like hitting a grand slam: Prudhoe Bay, which has already produced more than 13 billion barrels, is the biggest American oil field. (I was once at a party with a bunch of geologists from Mobil Oil when an argument broke out: who discovered Prudhoe Bay? Everybody in the room except me claimed to have done so.)

Unfortunately, you don't hit a grand slam in every at-bat....

[theCoach]

Thanks anne.

[RonK, Seattle]

The low-cost model makes other favorable assumptions. The 2005 report includes a sensitivity analysis of Real Wage Differential (nominal wage growth minus CPI, which should track productivity in a fair and balanced economy).

It suggests that "ultimate RWD" would have to rise almost 2% above the current 1.1-1.2% to erase the projected 75 year gap. 1.9% would give us lots of nice options though, as GDP and the incidence of affluence after "bankruptcy" would increase markedly.

[anne]

Relating to the question of the cost of energy and economic growth projections, Paul Krugman noted that rising energy prices cut the real wage of labor last year leading in part to a poorer return projection for Social Security.

[howard]

thanx anne on the productivity point.

on the energy point, it's really a question of whether the inflation projection is accurate or not, which points us to the profound silliness of getting too carried away with 75-year projections in the first place. Perhaps inflation is badly understated for the next 75 years because oil will never again be cheap; perhaps inflation is overstated because markets will respond to expensive oil with efficiencies and substitutions.

I certainly don't know, but i do know that anyone who claims that the intermediate model, which is merely a point on a bell-shaped curve, tells us what we need to know is either dishonest or stupid, as anne implied earlier.

[Oskar Shapley]

The simplest solution would be to fit the benefits growth curve in such a way that the Trust Fund is automatically exhaused at Year 75. That would mean no crisis, ever.

And with regard to the question whether SS is a Welfare or Insurance programme: If the payed out benefits are higher than the subsistance level, it's welfare. It certainly is Welfare for the middle/upper class, which will receive higher benefits than the blue collars folks.

The "insure old people against searching for food in dumpsters" argument simply does not fly if there is a difference in benefits.

[anne]

Howard

Remember as well, there are China and India to consider. There was an extended period when resource prices were weakened since demand could not match extraction and processing. There was technology application at a fundamental level. Can extraction and processing match demand from here? China, India, Brazil, and we would hope more?

[anne]

There is far less investment in resource exploration and processing and transport than might be expected given the increase in commodity prices. Why, I wonder?

[Doctor Biobrain]

Now THAT'S why I visit this blog. Any old blogger can link and quote another website or news story. But all I want from this blog is just good old fashioned economic analysis that is just slightly beyond my ability to replicate or fully understand. I figure, if I can understand it, then I probably already know it.

Professor, I strongly urge you to drop the linking to others' stories and stay more with the original material. Or maybe you should have two separate blogs: one to highlight stuff you think we should read and another with your own expertise. But I don't like having to wade through post after post of somebody else's material to finally get to the gold. I only visit websites of people who I know I can trust, and if I wanted to read that other stuff, I would.

[Doctor Biobrain]

Oskar - What are you talking about? If those who pay in more money receive the same amount as those who pay less, that makes it MORE of a welfare program, not less. The idea of welfare is that those who pay in receive little or nothing, while those who receive it pay little or nothing.

If I pay more into my insurance plan, I should receive a bigger payout when that time comes. That's how insurance works.

[anne]

Appreciate deeply this lovely Blog for all that it is :)

[masaccio]

I have yet to see anything that explains why we have to do something now. We cannot predict far enough to see a sane solution, and there is no immediate problem.

If we want to do something, why not the following. Let's cut the tax so that the program is not in surplus. We cut the tax on the poorest part of our population and put that money into some kind of account for them which will be available when they die, are disabled, or retire, and available to their children when they die, if anything is left.

[howard]

masaccio, you've put your finger on what i regard as the logical outcome of the "trust fund doesn't exist and the money is spent" crowd: in that case, why doesn't some enterprising democrat call their bluff and introduce a motion to cut the payroll tax to pay-as-you-go levels and stop the prefunding (while at the same time, uncapping - or at least expanding - the cap?).

Imagine the fun dems could have with that one, forcing the republicans to either acknowledge the general fund crisis or be finally on the record as cutting taxes for the upper 2% of income-earning households and on very high net worth households while increasing them on working americans....

[anne]

Dear Howard,

No no tempting. The Senate has already voted to cut the tax on Social Security benefits for wealthy retirees, while this tax revenue pays for Medicare benefits. All nicely tucked away in the Medicaid appropriation bill. Careful :)

[lise]

http://www.nytimes.com/2005/03/25/opinion/herbert25.1.html?ex=1111899600&en=b9a9f4a87017310b&ei=5070

The Era of Exploitation
By BOB HERBERT

Congress is in recess and the press has gone berserk over the Terri Schiavo case. So very little attention is being paid to pending budget proposals that are scandalously unfair, but that pretty accurately reflect the kind of country the U.S. has become.

President Bush believes in an "ownership" society, which means that except for the wealthy, you're on your own. The president's budget would cut funding for Medicaid, food stamps, education, transportation, health care for veterans, law enforcement, medical research and safety inspections for food and drugs. And, of course, it contains big new tax cuts for the wealthy.

These are the new American priorities. Republicans will tell you they were ratified in the last presidential election. We may be locked in a long and costly war, and federal deficits may be spiraling toward the moon, but the era of shared sacrifices is over. This is the era of entrenched exploitation. All sacrifices will be made by working people and the poor, and the vast bulk of the benefits will accrue to the rich.

F.D.R. would have stared slack-jawed at this madness. Even his grand Social Security edifice is under assault by the vandals of the G.O.P.

While the press and the public are distracted by one sensational news story after another - Terri Schiavo, Michael Jackson, steroids in baseball, etc. - the president and his party have continued their extraordinary campaign to undermine the programs that were designed to fend off destitution and provide a reasonable foundation of economic security for those not blessed with great wealth....

[Jane Miller]

Finally the battle over the numbers has been joined.

The only way to get this information to people who don't read blogs is to shrilly attack the Trustees now.

[Mike]

2005 reports peak to peak
The annual increase in total productivity averaged 2.2, 1.2, 1.3, and 1.6 percent over the business cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively.

2004 reports different averages for the same peak-to-peak periods. What's up?

The annual increase in total productivity averaged 2.3, 1.2, 1.2, and 1.5 percent over the business cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively.

[godement]

Funny thing, this post. I remember taking a look back in 1999-2000 at the Trustees report then - it must have been the 1999 report, and noted that the Treasury Secretary (was it your friend Larry Summers ?) had signed off on it. At the time, I noticed that he had also signed off on some long run federal budget projections, and that the productivity assumptions embedded in both were rather different and, well, inconsistent with each other, even if the time frames involved were different. At that time, I thought and wrote, what's going on ? why do they absolutely want to show a huge federal surplus and a huge social security deficit ? I am not not that familiar with the US bureaucracy, so I still wonder.

[lise]

The Trustees Report productivity projections for 1999 were completely reasonable and follow the 40 data stream. There could then be no accounting of the surge in productivity of years since:

1999 Trustees' Report:

For the 40 years 1958-97, annual increases in productivity for the total U.S. economy averaged 1.7 percent, the result of average annual increases of 2.9, 2.0, 1.0, and 0.9 percent for the 10-year periods 1958-67, 1968-77, 1978-87 and 1988-97, respectively.... The ultimate annual increases in productivity for all sectors—wage-and-salary workers, self-employed persons, and the total economy— are assumed to be about 1.6, 1.3, and 1.0 percent for alternatives I, II, and III, respectively.

[godement]

lise,

your quote from the 1999 trustees is of course correct. My point however was that the OMB projections, the CBO projections had very different productivity numbers already imbedded in them, thus my puzzlement at the time.

[lise]

Godement

Now, I understand. Important point for me to remember. Right you are, but remember the Treasury does not coordinate each of the offices in question. Ah, projections.

[anne]

What is thoroughly sad is that the latest projections of the Social Security trustees, with the absurd assumptions of impossible to comprehend deficits in 75 and 150 and 300 years, has been taken through the media to mean the system is failing and there must be benefit cuts or tax increases or both.

The truth is we simply do not know if there will eventually be a Social Security deficit. Certainly there will not be for many years. We will not know for years. If productivity growth and labor force participation are moderately above projections, there will never be a problem. Simply assume productivity is a reasonable 1.9% and there will never be a problem. Of course, if we grow convinced Social Security will fail all is lost.

[anne]

Duh!

http://www.nytimes.com/2005/03/26/opinion/26sat1.html

Add-On Accounts Add No Value

The latest trial balloon in the Social Security battle is something called "add-on accounts." Touted as a possible compromise between friends and foes of privatization, they would be like souped-up I.R.A.'s - subsidized savings accounts intended to supplement government-guaranteed Social Security benefits, not to reduce or replace them.

Add-ons appeal to some lawmakers who reject President Bush's privatization idea yet want to look as if they're doing something. But Social Security loyalists warn that add-ons would be the first step in dismantling the system, while ardent privatizers turn thumbs down because such accounts would leave the current system intact.

Both sides are right about one thing: add-on accounts are a bad idea. But their objections miss the most important point. Like the Bush privatization plan, this hybrid does nothing to address the real problem: over the next 75 years, Social Security comes up short by $4 trillion. The only way to close that gap is to raise taxes or cut benefits, or both. A fair and adequate fix would include some of each, phased in over decades....

[Lance]

I'm curious...there must be other programs that use projections that use the increase in productivity value. Has the same pessimistic assumption been used in these projections, or does it change based on what the administration wishes to see?

[Dave]

Let me just reiterate, as someone who as more first-hand experience in how the assumptions are developed than Messrs. DeLong, Krugman and Baker combined: I am _very_ skeptical that the assumptions have been doctored for political gain. It's mostly the civil servants and the public trustes who put these together, not the political types. Don't forget (Table II.D2 in the report) that the net effect of all of the changes, exluding the new valuation period, actually resulted in a small _improvement_ in the 75-year actuarial balance.

I'm not saying that I necessarily agree with all of the assumptions, or the way things are done. It's just that, without stronger evidence, I'm not willing to drop my a priori assumption that the process in on the up and up.

Also, I am not 100% certain about this, but I seem to recall looking at the productivity numbers on a peak-to-peak basis when were developing the assumptions. So while it's true that the _language_ wasn't included in the Trustees reports before 2004, that doesn't mean that the logic behind it was first adopted in 2004. I'll look through my files to see if I can find something on this one way or another.

But surely our host would agree that, abtratcting from the particulars of the 2005 Report, it makes a lot more sense to look at average productivity growth over business cycles, rather than over abitrary decades? Right?