How Do We Respond to the Dependency Ratio Dilemma?

James Heskett

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.

                         

James Heskett is a Baker Foundation Professor at Harvard Business School.

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?