By Bill Zettler
Without getting too esoteric in our math I think it is fair to say that the professor and I mainly disagree on the rate of return on investment that Illinois pensions should assume going forward. The Virginia professor suggests 9.3%, the TRS says 8.5%; Warren Buffet says to expect no more than 6.5% over the next 20 years; I say 6%; and Stephen Johnson makes a good argument for 5%, and there is the historical 2.5% from the Dow Jones Industrial Average for the 40-year period 1929-1968. That 2.5% was in spite of the 23-year economic boom following WW II.
Something that appears to be a small difference can end up being enormous when compounded over many years. And since we are talking about Public Act 88-0593 which has a 50-year payment schedule (with 40 years left) and a newly hired 21-year old teacher that has a 62-year life expectancy, these differences can be very large.
For example, if you have a 9.3% return per year (the professors assumption) for 40 years on $10 billion worth of pension assets (Illinois has about $40 billion) you end up with $350 billion. If you have a 6.5% return (Warren Buffets assumption) you end up with $125 billion. As former Illinois Senator Everett Dirksen once said; A billion here a billion there & pretty soon your squo;re talking real money.
In this particular example, if the professor is wrong and Warren Buffet is right Illinois taxpayers are stuck with the extra $225 billion difference because guaranteeing an annual pension amount is the same as guaranteeing a rate of return. This means that families with likely decreasing wealth and retirement assets (private sector workers with no guaranteed pension) have to come up with cash via taxes, to guarantee that public employees; wealth and retirement assets do not decrease. That is unfair to say the least.
Keep in mind that state actuaries have already projected taxpayers contributions of $320 billion over the next 40 years assuming 8.5% returns. They have not made any projections based on an assumption of 6.5% returns.
1. The human population will never double again.
This has never been true before but demographers say the world’s population will level off at about 11 billion in 2100 from 6+ billion now. This is important because new workers are an important part of economic growth as they work, earn, consume and invest. By contrast, the population doubled between 1960 and 2000 the era of highest economic growth in history.
2. Major economic powers have birth rates below replacement rate.
Economic powerhouses China, Japan and Europe will all have decreasing populations in the next decades, another historical first. Economic growth will almost certainly slow from past decades.
3. Life expectancy is growing.
Related to number 1 and 2 above, this means more senior citizens supported by fewer workers. For example China’s life expectancy has gone from 45 to 80 in just the last 50 years. This means current actuarial assumptions for life expectancy are almost certainly too low, resulting in future pension obligations that will be larger than currently assumed.
4. People are retiring at an earlier age.
Earlier retirement age plus longer life expectancy means slower economic growth and more taxes on fewer workers. See 1, 2 and 3 above.
5. All of the above.
All of the above means more income/wealth will need to be transferred via taxes from fewer working/productive people to more non-working/non-productive people thus greatly decreasing investment and economic growth. A given dollar cannot go two places, investment and tax, at the same time.
6. Oil prices since 1973 have actually gone down.
During the greatest economic growth period in history, oil prices were decreasing in real inflation adjusted prices from $80/barrel in 1973 to about $65 with most of that period below $25. This has enabled economic growth because there is a direct correlation between BTU per capita and GDP per capita. If the costs go up the rate of GDP growth will go down. In 1998, during the greatest stock market boom in history, oil hit $10 per barrel. In the coming years, is it more likely that we will hit $10 or $110?
7. Economic engines China and India will slow over the next couple of decades.
As the middle class grows in India and China, the demand for more government services and subsequent taxes will have those economies reverting towards the mean for the growth rate of western countries, which is 0-4%. That leaves only the Muslim crescent from Bangladesh to Morocco and sub-Saharan Africa as potential economic growth engines. I rate the chances of those 2 areas becoming the next China and India as extremely low.
8. The terrorist risk premium.
A dozen terrorists with dirty bombs (let alone nuclear weapons) could simultaneously shut down Manhattan, Toronto, London, Paris, Amsterdam and Berlin causing complete financial chaos and bringing the world economy to a halt. I do not know whether that risk premium is one percent, two percent or more but I do know it is greater than zero.