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How Do We Respond to the "Dependency Ratio" Dilemma?

Published on Thu, Oct 12, 2006 at 16:24 | Source : Moneycontrol.com

Updated at Thu, Oct 12, 2006 at 16:36

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Without knowing it, we have already heard a great deal about "dependency ratios." We can expect to hear a lot more, both at the level of nations and individual firms. The question is, what kinds of responses do they call for?

The dependency ratio is simply the ratio of unemployed to employed people, whether globally, nationally, or organizationally (where retirees are the unemployed). It is linked to such things as birth rates, employment trends, and economic growth rates. But in business, it is also influenced strongly by the cost of retirees, which in turn is determined in large part by the outcomes of negotiations between management and labor.

Harvard economists David Bloom and David Canning attribute at least one-third of a nation's economic success to the dependency ratio, something that can be predicted years in advance based on what we know now about demographic trends. For example, they credit Ireland's economic success in part to a greatly-improved dependency ratio along with other more commonly-cited factors such as a strong emphasis on education.

They suggest that China's dependency ratio will peak at about one dependent to 2.6 workers in the next few years. After that, the effects of encouraged reductions in the birth rate will mean that fewer workers will be supporting more retirees in the coming years, placing a burden on the Chinese economy. India, on the other hand, with slower declines in the birth rate, will see its dependency ratio improve as larger numbers of children grow up and enter the work force, where they can support their elders and non-working children.

The concept is even more striking when applied to organizations. GM's dilemma stems in large part from the fact that its dependency ratio has deteriorated as workers take earlier retirement, live longer, and enjoy health and other benefits that become more costly. Those that GM employs find it increasingly difficult to bear the burden. And consumers are becoming less willing to pay for it in the price of GM's products.

When dependency ratios become too burdensome, as in the case of Bethlehem Steel in 2001, where each worker was supporting 7.5 retirees, management is increasingly tempted to do what Bethlehem's management did: declare bankruptcy and walk away from as much of its obligation as possible.

Potential management responses can get pretty complicated. In this instance, growth trumps greater productivity, because the latter alone raises the dependency ratio. In a recent article in The New Yorker, Malcolm Gladwell suggests a more complex approach that would involve pooling employee populations among consortiums of companies, presumably some growing rapidly (with low dependency ratios now but higher ones later) and some growing more slowly. Bethlehem Steel had another answer.

It merely handed $7 billion in unfunded obligations over to the U.S. Government's Pension Benefit Guaranty Corporation. Then Wilbur Ross, who bought the remaining assets, started over with a completely new employee savings plan and a dependency ratio of 0 (unemployed) to 1. Of course, the more generous the long-term solution for workers in retirement, the less competitive a company can be on costs today. So what is the answer to a dilemma that we are going to be confronting more and more frequently? What do you think?

Reader Comments:

The Organizational Dependency Ratio would be irrelevant if management (and labor) had the ethics to fully fund retirement obligations when they agreed to the arrangements, keeping the obligations fully funded as they go. Instead, both managers and labor leaders sought (and some still seek) agreements that hide the costs of promised benefits.

This is not a sophisticated problem. It is simply a matter of morality.

Cass Apple
Vice Chairman
DRC
This situation is nothing more than an extension of our "Teflon" culture:
1. CEOs, leaders, celebrities, sports stars, etc ... not accepting responsibility for their actions (or inactions).
2. Proliferation of disposable consumer products and disposable employees.
3. "Doing the right thing" is not always rewarded socially and/or financially.
It is a systemic issue with no clear near-term solution in sight other than going down the path of least resistance by declaring bankruptcy and starting over.

Bob Fitzpatrick
As we all know, actuarial "science" can easily be manipulated by adjusting certain assumptions.

The "science" recognizes probability factors such as death and disablility but doesn't properly recognize the inevitability of change to the sponsoring organization's Dependency Ratio.

This might increase funding requirements but should still be manageable.

Bob Higgins
Consultant
BPP
I've commented before on this subject in this forum when we discussed pension reform in Mexico. At that time I noted, "...even in the U.S. many are losing the type of pension benefits that their parents and grandparents enjoyed after many years of work. Most employers in the U.S., other than the federal government, have dropped defined benefit plans for 401k and other self-savings plans. Many who work will never have anything other than social security unless they save on their own. And many who thought they would get a healthy pension will be cheated, as failing companies shirk their obligations and pawn them off to the Pension Benefit Guaranty Corporation (PBGC). One only has to look at the headlines to see the crisis in funding these obligations looming on the horizon.

"Mexico as well as the U.S. needs to find ways to raise employment, especially in above minimum wage-paying jobs, to more of the workforce. In Mexico, this may someday discourage Mexican workers from thinking the grass is greener on the other side of the border and allow them to save more for tomorrow, rather than living from day to day. In the U.S., this may mean the reduction in the numbers of the working poor and an increase in their confidence and self-respect, as well as their personal savings. Let's address first things first, as so many here and in Mexico have suffered during the last four years under the first president since Herbert Hoover to oversee a net loss in jobs during his administration."

Employers no longer feel an obligation to their employees and employees and, for the most part, no longer fund their fellow employees under a self-funded pension scheme. Companies like GM are dinosaurs. Although their failures and mistakes go beyond being "too generous" with their workers, it's the workers that are taking the blame but it's also the workers who are bearing the pain of the bad management and poor planning.

There's no pension crisis in the executive suite. Let's talk instead about the "dependency ratio" between the average corporate executive and his workers. In 2005, per the AFL-CIO, it stood at 411 to one. The average worker is funding the looting of shareholder value by the fortunate few.

Francine McKenna