Director’s Blog » Blog Archive » How Slower Growth in the Labor Force Could Affect the Return on Capital

Director’s Blog » Blog Archive » How Slower Growth in the Labor Force Could Affect the Return on Capital: "The labor force in the United States is expected to grow much more slowly in the coming decades for several reasons: a long-term decline in fertility rates, the leveling off of a substantial increase in women’s labor force participation, and the aging and retirement of baby-boomers. CBO projects that the growth of the labor force, which averaged 1.6 percent per year from 1950 to 2007, will slow to about half a percent per year over the next 20 years. Although slower growth in the workforce might affect the U.S. economy and budget in many ways, CBO examined—in a background paper released today—what could happen to the rate of return paid on assets (such as stocks and bonds) and to wages.

Most mainstream economic models predict that the slowdown is likely to make the rate of return on capital—as reflected in the rate of interest on bonds or other borrowing, and the rate of return on stocks—lower than might otherwise be expected, by between 0.8 and 2.6 percentage points. Wages will be higher than would otherwise be the case, although that effect will be much smaller than the increase in wages that is projected to result from productivity growth.

Shifts in wages and rates of return on capital would have budgetary implications, both for the overall federal budget and for individual programs such as Social Security. The lower interest rates that would result from a slowdown in labor force growth would tend to reduce federal interest payments and slow the growth of debt relative to output. Lower interest rates would also reduce the interest income of the Social Security trust fund and increase the actuarial imbalance of the system (because future deficits in the system would be “discounted” at a lower rate of interest), although the accompanying higher wages would tend to increase payroll tax revenues somewhat."