The eminent domain clause of the Fifth Amendment of the U.S. Constitution states that "Nor shall private property be taken for public use, without just compensation". This clause allows private property to be taken for public use, but requires "fair" compensation. The clause raises three major questions: what is "public use", what is "fair compensation?", and is the principle of eminent domain desirable in a modern economy? I briefly discuss all three questions.
PUBLIC USE. The recent 5-4 Supreme Court decision in Kelo v. City of New London elaborated on the court's interpretation of "public use". The majority argued that it meant "public purpose", even if the project is undertaken primarily by private companies and individuals, as long as it produces general benefits in the form of increased economic development, greater tax revenue, and the like. The minority opinion written by Justice O'Connor considered this interpretation to be excessively broad, and argued for a narrower interpretation, but her opinion did not provide a clear criterion for narrowing it. The Institute of Justice, representing the 15 homeowners who opposed the city‚Äôs plan to raze their homes, wants to limit the clause to situations with actual ownership or use by the public. Examples acceptable to the Institute include construction of roads or public utilities, although courts in the past have allowed a much broader interpretation of the right to eminent domain.
It is difficult to establish a simple dividing line between what is and what is not a public use. Since private companies are involved in building roads, running electric power plants, and other public use projects, why is that fundamentally different from using eminent domain to authorize construction of private baseball stadiums, or private business redevelopment in a poor neighborhood?
Although the majority opinion by Justice Stevens argues the reasonable position that the decision-making power in specific instances should be left to state and local governments, the power to condemn property allows a government to avoid the need to demonstrate that a planned development will actually raise economic value or other benefits. The best judge of this is the market test of whether the new owners could fully compensate the old owners and still benefit, yet the right to eminent domain means that a public project can avoid having to pass this test.
FAIR COMPENSATION. To me, the only reasonable interpretation of "fair compensation" is the worth of property to the present owners. This often is greater than the highest bids for the property in the marketplace. For example, one of the 15 homeowners who objected to selling her home to the city of Bridgeport was born there 87 years ago. Clearly, the house was worth more to her than the city‚Äôs assessment. Why should she be forced to sell at a price that could be way below its full value to her?
A second problem with the fair compensation test is that large property owners usually do better in the litigation over compensation than do small owners. The reason is that larger owners hire better attorneys and spend in other ways to increase their compensation. In the Kelo case, the Institute of Justice, a non-profit libertarian NGO, came to the defense of the 15 small property owners, but that usually does not happen. A PhD study years ago by Professor Patricia Danzon of Wharton showed that smaller property owners generally receive lower compensation relative to market assessments of value than do large owners. The true picture is probably much worse since she did not have data on the subjective value of having lived in a home for a long time.
IS EMINENT DOMAIN DESIRABLE? In addition to analyzing where to draw the line in deciding what is legitimate "public use", we should ask whether the line should be allowed at all. Is eminent domain a desirable principle in the 21st century? In the 18th, 19th, and early 20th centuries, governments did rather little, so there was not much to fear from great abuse of the eminent domain constitutional clause. In fact, the first real eminent domain case was not decided until 1876. Now, however, government at all levels do so much that the temptation is irresistible to use eminent domain condemnation proceedings to hasten and cheapen their accumulation of property for various projects, regardless of a projects merits.
Without the right to eminent domain, governments would have to buy property in the same manner that private companies often accumulate many parcels to create shopping centers, factory campuses, and building complexes, like Rockefeller Center. There are difficulties involved in combining separate parcels into a single more extensive property, but whey should that be made too easy, as through a condemnation proceeding?
To be sure, property owners may have incentives to free ride and hold out, particularly when their homes or businesses help complete a larger property, as in the property needed to construct a road. But usually a road can take competing paths, a power plant can be built in different locations, and so forth, so that buyers, government or private, can use the leverage from competition among sites to reduce the advantage of holding out. And sometimes they can build around stubborn holdouts, as happened when the property to build the privately accumulated Rockefeller Center was put together
I am not claiming that a system without eminent domain would work perfectly--it would not. But modern governments have more than enough power through the power to tax and regulate. Although eminent domain can be considered just another (but highly intrusive) form of regulation, condemnation is too powerful and easy a regulatory form. "Power corrupts" is an old saying, which explains why condemnation has indeed been frequently abused (see Martin Anderson's classic study, The Federal Bulldozer). It allows governments to avoid the market test of whether a proposed project adds value in the sense that a project is worthwhile even after owners of property are bought out through regular market proceedings.
Eliminating the eminent domain clause from the Constitution is obviously not feasible in any foreseeable time frame. But it is still useful to discuss the benefits and costs of this clause, or to question whether it is desirable. A negative answer might help provide guidance to judges, legislatures, and voters in determining how far they want to push the privileged position of property accumulation for an alleged
The Fifth Amendment permits the use of eminent domain, in which government takes private property without negotiation but must pay the owner the market value of the property, only if the taking is for a "public use." (The Fifth Amendment is applicable only to action by the federal government, but the Fourteenth Amendment, which applies to state and local government action, has been interpreted to incorporate the "public use" limitation on eminent domain.) In Kelo v. City of New London, which the Supreme Court decided on June 23, the city took private residential property as part of a redevelopment plan under which the property would be turned over to private developers for office space and parking.
Whether the case was "correctly" decided depends on one‚Äôs theory of constitutional adjudication, which might in turn point one to the origins of the "public use" provision and to the Supreme Court's precedents. I want to abstract from the legal questions and ask three practical questions: When if ever is eminent domain proper? Is it ever proper when the private property taken is going to be transferred to another private entity rather than being kept by the government for some governmental use, such as a post office or an army base? And is the power granted local municipalities by the Kelo decision likely to be abused?
Generally, government should be required to buy the property it wants in the open market, like anyone else. If it is allowed to confiscate property without paying the full price, it will be led to substitute property for other inputs that may cost less to society to produce but that are more costly to the government (a private rather than social cost) than land because the government has to pay the full price for them. This assumes that government in its procurement decisions tries to minimize dollar costs rather than full social costs, but the assumption is realistic.
When the government does take property by eminent domain, it has to pay the owner the market value of the property, but that value will be less than the owner values the property--otherwise he would sell it to the government at market value and there would be no need for the government to incur the cost of eminent domain proceedings. Generally, property is worth more to the owner than the market price (which is why it's owned by him rather than by someone else), because it fits his tastes or needs best as a consequence of its location or improvements (which is why he bought it rather than some other piece of property) or because relocation costs would be high. Real estate is a heterogeneous good and so a particular parcel in the hands of a particular owner will generally yield him an idiosyncratic value that is on top of the market value. Eminent domain operates to tax away that value; if market value is $X and total value (including idiosyncratic) is $1.2X, then if the government takes it by eminent domain it pays for it in effect by spending $X out of the government's own coffers and $.2X out of the owner's pocket. This is an arbitrary form of taxation and one that, as I said, creates the illusion that an input is cheap because its money price is less than its social cost, and as a result causes a misallocation of resources.
The only justification for eminent domain is that sometimes a landowner may be in a position to exercise holdout power, enabling him to obtain a monopoly rent in the absence of an eminent domain right. The clearest example is that of a right of way company, such as a railroad or a pipeline, which to provide service between two points needs an easement from every single one of the intervening landowners. Knowing this, each landowner has an incentive to hang back, refusing to sell to the right of way company except for an exorbitant price. Each hopes to be the last holdout after the company has purchased an easement from every other landowner--easements that will be worthless if it doesn't obtain an easement from that last holdout.
Most right of way companies are private, which answers my second question: the rationale for eminent domain is unrelated to whether the party exercising the eminent domain power is the government or a private firm.
Right of way companies are not the only private enterprises that can make an argument for the use of the eminent domain power. The argument is available in other cases in which a large number of separately owned contiguous parcels have to be acquired for a project that will create greater value than the parcels generate in their present use. It is impossible to tell from the opinions in the Kelo case whether that was such a case. Pfizer had decided to build a large research facility adjacent to a 90-acre stretch of downtown and waterfront property in New London and the City hoped that Pfizer's presence would attract other businesses to the neighborhood. The plaintiffs' residential properties were on portions of the 90-acre tract earmarked for office space and parking, and it might have been impossible to develop these areas for those uses if the areas were spotted with houses (the plaintiffs owned 15 houses in all in the two areas).
The Court, however, did not discuss whether there was a holdout problem; it thought it enough to justify the taking that the City had a bona fide and reasonable belief that the planned redevelpment would generate net benefits for the City and its residents as a whole, although the plaintiffs of course would lose any idiosyncratic values that they obtained from their property. However, in the absence of a holdout problem, there is no need for eminent domain‚Äîprivate developers will rush in without need for City assistance if indeed the property would be worth more in a different use from the present ones. The Court was mindful of the possibility of abuse of the eminent domain power; it made clear that there would not be a public use if all a municipality did was take property from one person and give it to another, with no showing of an increase in overall value. But the Court did not consider whether development plans such as New London's actually on average increase value for the municipality that undertakes them, or rather are usually the product of rent-seeking political deals. Thus the actual impact of the Court's decision on economic welfare cannot readily be determined.
It is possible that what really motivated the Court was a simple unwillingness to become involved (or to involve the lower courts) in the details of urban redevelopment plans; a flat rule against takings in which the land ends up in the hands of private companies would, as I have explained, be unsound. Another practical defense of the decision is that the more limitations are placed on the private development of condemned land, the more active the government itself will become in development, and that would be inefficient. If the City of New London had guilt office space, parking, etc. on land condemned from private owners, a challenge based on the "public use" limitation would be unlikely to succeed--unless the Court confined public use to holdout situations and was prepared to try to determine, case by case, whether a genuine holdout situation existed.
I have only a few reactions to the comments. The various state mandates on health coverage by insurance companies are a major problem in the American health insurance system that I did not address. One person mentions that New York State prohibits large deductions to individual accounts. I was not familiar with this, but I am not surprised. However, I am not sure that this is consistent with the HSA Act of 2003, which requires large deductions in order to implement an HSA.
Catastrophic care is clearly important, but is by no means the dominant source of medical care. In fact, it is generally not important for families up to age 60 or so. These families would gain the most from the combination of an HSA with catastrophic coverage.
If my proposal for catastrophic insurance is implemented, I am convinced many insurance companies would jump into this market, unless price controls over premiums made this type of coverage uneconomic.
One of the interesting aspects about drugs is that costs are typically per pill rather than per unit dosage. I regularly cut pills in half to take advantage of this. I am surprised more people do not do this.
I have no personal interest in the proposals I made. The health insurance at my university is fine, but I hope it moves to an HSA system.
More generally, I always prefer a large deductible on every type of insurance when I am given a choice. Individuals are much better at covering small loses than are insurance companies, and can take various efficient actions to minimize their expenditures on such loses. This is why HSA‚Äôs are such a good idea.
Someone asked my opinion of the attempted takeover of Unocal by the state-owned Chinese oil company, China National Offshore Oil Corporation. I do not see any good reason to oppose it. If they can run this company more efficiently, the United States is better off, not worse off. We went through such fears about Japanese takeovers of American companies during the 1980‚Äôs. Mainly, they overpaid for these companies, and in effect transferred wealth to Americans!
The Japanese Keiretsu have declined a lot in importance since economic stagnation set in there during the early 1990‚Äôs. No, our organization of business is totally different, so I do not see the slightest risk of such a development in the U.S.
Wal-Mart, the nation's largest private employer, has become embroiled recently in a number of controversies. One concerns health insurance. Wal-Mart provides health insurance to fewer than half its employees (though, as some critics neglect to note, many of the others are covered by spouses' health insurance or by Medicare), and it charges those employees whom it does cover a significant fraction of the total insurance premiums. Critics say, first, that Wal-Mart is being "miserly" toward its employees, who tend to be near the bottom of the economic ladder, and, second, that it is exporting medical costs that it should be defraying to publicly financed health systems, such as Medicaid, to which the uninsured who cannot afford to pay their medical expenses out of their own pocket turn. Some of the critics want employers to be required by law to provide health insurance for all their employees.
Economic analysis suggests that these criticisms, especially the first, lack merit, and that employer-mandated health insurance is not a good idea. This is not, however, because employee health insurance is likely to be more costly than individually purchased insurance, in which event it would be obvious why many employees would want to forgo it. Actually, it's likely to be less costly. Insurance is cheaper when all members of a group satisfying specified eligibility requirements are required to join the insurance plan, because without the compulsory feature those members having the lowest incidence of whatever risk is being insured against, such as the risk of incurring medical costs, would tend to drop out of the plan, since they would be subsidizing the higher-risk individuals in the plan; and the result of this dropping out would be an upward spiral in the cost of the insurance. That is why individual policies are more costly than group policies.
Another, and quite arbitrary, attraction of employee group health insurance is that like many other fringe benefits, it is not taxable. If an individual earns $50,000 and spends $5,000 to buy health insurance, he pays income tax on the full $50,000, and suppose the amount of the tax is $10,000 (20 percent). Then after paying for the health insurance policy he has $35,000 left. But if his employer pays him a salary of $45,000 (on which the income tax is, let us say, $9,000--which assumes the same 20 percent income-tax rate, though it might well be lower) and gives him a health insurance policy that costs the employer $5,000, the employee has $36,000 ($45,000 salary minus $9,000 tax) and so he is better off. But probably few Wal-Mart employees pay much income tax--which may be a partial explanation for why Wal-Mart does not offer health insurance to more of its employees.
It is entirely rational for a subset of employees, especially low-income employees, to prefer not to be covered by their employer's group health insurance policy even if they have no other health insurance. The basic reason is fact that from the employer's standpoint, the cost of a fringe benefit is no different from the cost of a wage. If the employer is prepared to pay an employee a salary of $45,000 and give him an insurance policy that costs the employer $5,000, then if the employee doesn't want the insurance the employer will be willing to pay him a salary of $50,000. Suppose the employee has no significant assets--a realistic assumption if he is a low-income employee. Then if he becomes ill he'll be able to obtain medical care free of charge under Medicaid, though it will be of lower quality than paid-for care. Suppose the value of that lower-quality care is only $3,000. Nevertheless the employee is better off without the insurance; his net income will be $53,000 ($50,000 in salary plus $3,000 in insurance value) versus $50,000 ($45,000 in salary plus an insurance policy worth $5,000) with the insurance.
Even if the employee is paid only the minimum wage (which for simplicity I'll assume is $5 an hour), so that the employer, were he to provide health insurance, would be forbidden to make a compensating wage cut, the employee would be better off without the insurance. Suppose the minimum wage, multiplied by 2000 (a 40-hour work week for 50 weeks), yields an annual wage of $10,000. If that is all that the employee's work is worth to the employer, the employer will not offer the insurance. If the employer does offer the insurance, say at a cost to him of $2,000, then he would be willing to pay the employee more than the minimum wage--an additional $1 an hour ($2,000 divided by 2000)--if the employee forewent the insurance and relied instead on Medicaid.
The second criticism of Wal-Mart's refusal to provide health insurance to all its employees who do not have other coverage has somewhat greater merit. There is an externality: employees who lack health insurance usually lack significant assets as well, so when they get sick the taxpayer pays their medical expenses. These employees thus externalize the costs of their medical treatment. This is true even though there is a sense in which a program like Medicaid does not eliminate the insurance principle but merely substitutes social for private insurance, with the taxes that pay for Medicaid corresponding to conventional insurance premiums. But only the poor are eligible for Medicaid, and they do not pay their actuarially fair tax to support the program. Otherwise there wouldn't have to be a Medicaid program.
But the externality cannot be fully eliminated by passing a law that would require Wal-Mart and other employers of low-income employees to insure all their employees. This is clearest in the case of minimum-wage employees who at present are not insured. Since the labor cost that an employer incurs is the sum of the wage he pays and the cost of any fringe benefits, forcing the employer to incur a total labor cost of $12,000 for an employee worth to the employer only $10,000 will simply cause that employee to be fired, with little prospect of obtaining another job; so he will lose his health insurance and be thrown back on Medicaid. Suppose instead that the employer is willing to incur a total labor cost of $12,000 for this employee, but the latter prefers a cash wage in that amount and no insurance, and now suppose as before that the employer is forced to insure him. The employer will reduce the employee's wage to $10,000, which may inflict significant hardship because the employee needs the cash more than he wants insurance (if he has no assets, he may well not need or want any health insurance). Notice the perverse redistributive effect: the average taxpayer, who is indeed made better off because the employee is now paying for his own health care, is wealthier than the average low-income employee.
The analysis is slightly complicated by the fact that if low-income employees have equally good alternatives to working for their current employer, they may not have to accept a reduction in wage equal to the increased cost to their employer of being forced to provide health insurance. Suppose in the example just given that although the health-insurance policy costs the employer $2,000, it is worth only $200 to the employee, so that he will perceive a reduction in his wage to $10,000 as a reduction in his full income from $12,000 to $10,200. And suppose that when he took the job with Wal-Mart he turned down an equivalent job with another employer that would have paid him $11,500 and that this job is still open. Then it might seem that Wal-Mart, to retain the employee, would have to pay him $11,300, since that amount, plus the $200 that is the value he derives from the health insurance policy, equals $11,500.
But this ignores the fact that the other employer, too, presumably is being subjected to the requirement of providing health insurance. It too will see its labor costs soar and therefore it will not pay as high a wage as before the requirement was imposed.
I mentioned that Wal-Mart is also criticized for making its employees pick up a big portion of the health insurance tab. But this may actually benefit the employees. Suppose that if Wal-Mart paid the entire tab, the average cost to the company of health insurance would be $5,000 per employee per year. If it charges the employee $1,000 a year in premiums, the cost to Wal-Mart will be only $4,000, so it will be willing to raise the employee‚Äôs salary by $1,000. This may seem a complete wash, but it is not. For with the employee paying a big chunk of the premiums, the total cost is likely to be lower than $5,000, which would permit a net wage increase. The reason it is likely to be lower is that employees will economize on their demand for medical care if they incur a positive marginal cost for that care.
I agree with Posner that companies should not be forced to provide health insurance for all their employees since some employees may not want such insurance--for example, they may get it from a spouse. I also agree that co-payments should be required from employees since otherwise they have a strong incentive to use excessive medical care. Some of the older companies with generous health insurance plans, such as those in the automotive sector, now face staggering health expenses, in part because their plans had negligible co-payments by employees.
However, even employee co-payments of 10 or 20 per cent--which is at the high end--may not provide sufficient incentive for them to economize on health spending. An important improvement is health savings accounts (HSA), which were authorized by Congress in 2003 for everyone not on Medicare who has a health plan with high deductibles, such as $1000 for an individual and $2000 for a family. A family can make an annual tax-free contribution to its HAS that cannot exceed its deductible on its health plan, and is subject to an upper limit-- in 2005 the limit for families is $5250. If in any year they spend less on medical care than they put in, they can carry the balance forward, and invest the remainder on a tax-free basis until age 65.
No further contributions are allowed once a person reaches age 65 and usually enrolls in Medicare. Remaining balances on an HSA can then be used as a retirement annuity. This annuity is taxed without penalty as resources are withdrawn for spending on non-medical expenses.
HSAs provide a strong incentive to economize on medical expenses in any year since unspent amounts can be carried forward to future years when possibly more important medical problems arise. They can also be carried into retirement and used as a supplement to retirement income. As a result, HSAs give families a much stronger reason to scrutinize whether various medical expenses are really necessary since they would be trading off present care for future care and other future benefits.
Although co-payment medical systems also provide some incentive to economize on spending, most of the additional expense would be borne by the medical insurer, such as his employer, HMO, or insurance company, since the co-payment rate is a fraction of the total. HSAs provide stronger incentives to use medical care efficiently because all dollars saved today by the insured can be used for medical care in the future.
Since an HSA requires a large deductible, they are best when combined with a form of catastrophic insurance; that is, medical insurance that pays only for large, expensive, and unusual medical problems. For this reason, and to cut down free riding by the uninsured on taxpayers, I believe everyone should be require to have catastrophic medical insurance--with the very poor covered by Medicaid. The premium on such catastrophic coverage might be allowed to be deducted from taxable income, the way HSA contributions are.
Although employers are increasingly providing HSAs, families that start them on their own would receive the same tax benefits as when they are provided by employers. The United States' system of employer provided health care is not the usual one in most of the world. It was given a boost during World War II because employers could offer this "fringe" benefit to help get around controls over wages during a tight labor market with strong competition for a limited pool of labor. It remained afterwards because the growth in income tax rates gave an increasing advantage to any system that allowed premiums for health insurance to be provided tax-free.
Prior to the passage of the 2003 law on HSAs, individuals and families who purchased health insurance on their own were at a disadvantage compared to employee health insurance since they could not deduct their health insurance premiums unless they itemized their medical expenses. This advantage explains why employers provide the vast majority of health plans for persons of working ages.
But now an HSA provides an alternative that allows tax-free contributions to medical accounts that can be independent of employment. An HSA combined with catastrophic health insurance provides a very good system of health coverage. Catastrophic plans also need not be taken through an employer but could occur through a fraternal organization, church, professional association, or other group that gains the economies of administrative scale from group coverage, and can average risks of serious illness among different members.
The establishment of HSAs provides an opening wedge into removing the special privileges granted to employer provided health insurance. The next step would be to remove the tax advantage from all employer plans except HSAs, and except perhaps catastrophic health coverage if contributions to non-employer catastrophic plans are also tax-free.
I would like to respond briefly to a few comments on my posting on retirement in Japan. I never argued Japan has an ideal system in labor markets or elsewhere in the economy. In fact, I have been critical of many aspects of the Japanese economy. But they do seem to have made a better adjustment than Western nations to the trend toward increased life expectancy with better health at older ages.
Americans do not seem to value leisure more than the Japanese. In fact, American men and women now work longer hours per year at most ages prior to 65 than Japanese men and women do. I believe many more Americans would also want to work past age 65 mainly if the social security system and other retirement systems were more flexible, and perhaps also if the labor market handled older workers a little better.
No one would be required to work past age 65. But with a growing recognition that the present social security system is not likely to pay future retirees sufficient benefits, many more workers are likely to want to continue beyond 65.
Japanese fertility is low in rural as well as urban areas. Since the rural population is a very small fraction of the total, Japanese fertility is dominated by urban fertility.
Later retirement does not automatically solve the medical care problems for older persons. But it would be reasonable to combine later retirement with later ages of qualifying for medicare. That would help the medicare system a lot.
In our last posting, I argued that many mentally and physically healthy older persons in developed nations retire earlier than is socially efficient. Since retirement benefits are not sensitive to the accumulated social security taxes that a person pays on his or her earnings, workers who become eligible to retire often find the improvement in retirement benefits from working longer too small to provide enough incentive to continue working.
We come back to the retirement issue this week because I discovered during a just concluded trip to Japan that this country has taken the lead in encouraging much later effective retirement than other developed nations. The system in Japan is a bit complicated, but has several important features that could be implemented in the United States and other nations. The Japanese approach also has implications for many comments on our discussion last week- I respond to these separately.
The official retirement age at medium and large Japanese companies is 60 for both men and women, and it is quite rigidly enforced, even for top executives. This retirement age is close to the lowest among rich countries, with official retirement in the United States being about five years later at age 65, and the average among 30 OECD member nations being about 64. As Posner and I discussed in the previous entry, the American Age Discrimination in Employment Act of the early 1990‚Äôs even prohibits mandatory retirement for professors and a few other occupations.
Most Japanese do not stop working at age 60. The OECD reports that Japanese men generally continue to work until almost age 70, and the average retirement age of women is only a few years younger. These retirement ages of both men and women are the highest among all OECD nations that include not only the United States, but also the nations of Western Europe.
I was initially puzzled by these OECD data for Japan since they suggested much later retirement ages than I presumed from my erroneous belief that actual retirement ages were close to the official ones. But Japanese specialists on older workers indicated to me that their numbers are similar to those of the OECD. According to these Japanese sources, about half of all men aged 65-70 are working, and so too are about one quarter of men between 70-75. Hence they too estimate an average retirement age of near age 69.
Even when they stay at the same company after age 60, which is fairly common, workers and executives are placed at lower level jobs with significantly reduced pay. Others go to smaller companies with lower pay, although perhaps in comparable positions that they had in the larger companies that had employed them for many years. In all cases they work at their new jobs for a fixed term, usually five years. Upon finishing that term at age 65,they tend to move on to other jobs, also with a fixed term, and frequently with a further reduction in their earnings.
What spurs the Japanese to work beyond the official retirement age is partly that they usually are in good health, and do not look forward to about 30 years of retirement without much to do. However, they also continue to work because retirement benefits from the government and private companies are modest, even for higher-level executives. Retirement income of about $2000 per month is at the high end, so most workers who retire at 60 receive much less than that. They decide to work in their 60's and their 70's in order to supplement greatly their incomes.
In this way the Japanese system enables men and women to keep working to relatively late ages while at the same time providing flexible earnings and activities of older workers. In effect, this system recognizes that while older workers generally remain productive in the modern era of good health, they may not continue to merit the earnings reached after many years of employment. Some economists have attributed mandatory retirement to the need to move older workers out of the labor force because they are paid more than their contribution to production. Whether or not this interpretation of mandatory retirement is correct, the Japanese system does provide flexibility in both the earnings and occupations of older workers while still mandating official retirement at the early age of 60.
The Japanese system where employees past age 60 sometimes work for lower pay at the same company that had employed them would not be possible in the United States and some other countries because of legislation that prohibits alleged discrimination against older workers. The combination of legislation that prevents companies from lowering the earnings of older employees, and of legislation that prevents mandatory retirement in some occupations, creates a major rigidity in the market for older workers.
In several crucial respects the retirement system of many European countries is the opposite to that of Japan. For example, the official retirement age of men in Belgium, German, and the United Kingdom is 65, five years higher than in Japan. Yet, actual retirement ages are considerable lower in these countries than in Japan. For example, the typical age of retirement is 59 and 61 in Belgium and Germany, respectively. Effective retirement ages are also below age 60 in Italy, France, and several other Western European countries. In these countries inflexible labor markets make it difficult for older persons to find work, and generous benefits encourage retirement at even earlier ages than the official age.
Early ages of actual retirement and generous retirement benefits contribute to the very serious problems faced by the social security systems of most West European nations, and to a lesser extent of the United States. By extending their actual retirement ages to the Japanese levels, these nations would go some ways toward solving their problem of financing old age benefits.
The Japanese intrinsically face a tougher retirement problem than most other member nations of the OECD since they have one of the lowest birth rates in the world, the oldest life expectancy, and virtually no immigration. As a result, about 40 per cent of the Japanese population is expected to be aged 65 or older by the year 2050, the largest fraction of elderly among OECD countries. The continued employment of most of their men, and to some extent their women, well beyond the official retirement age of 60 has helped to meet, although it has not solved, Japan‚Äôs challenge of a rapidly aging population. Still, however, their flexible approach to the employment of older persons provides an excellent example to be emulated by other nations faced with a rapidly growing elderly population.
It stands to reason that if retirement benefits are chintzy, people who reach retirement age, provided they are allowed to accept their retirement benefits while still working, will continue working. That appears to be the main reason why, as Becker explains, although Japanese workers obtain their full retirement benefits at 60 the average retirement age is 69. However, there is nothing paradoxical about the disjunction between the nominal retirement age, that is, the age at which one begins to receive one's full retirement benefits, and the actual retirement age. Indeed, the earlier the official retirement age, the later the actual retirement age is likely to be because retirement benefits are always lower the earlier they are taken. If one were entitled to full retirement benefits at the age of 30, the benefits obviously would be too low to support one‚Äôs standard of living--indeed, so low that one might not be able to afford to retire ever!
The disjunction works in the opposite direction in the United States. The "official" retirement age is higher than in Japan, at 65, but the actual retirement age is lower. The explanation is the same: the higher the retirement age, the larger the retirement benefits, and so the smaller the incentive to work past that age.
A curious feature of the Japanese system is the tendency to demote workers when they reach the official retirement age of 60. But this does not appear to be a consequence of the law. In the U.S., many workers are entitled to take early retirement at reduced benefits, and if they do so their employer can rehire them at a lower wage. (Thus U.S. companies can adjust the age profile of their workforce by early-retirement programs, which create monetary inducements to early retirement.) But this is not, as far as I know, particularly common. It seems that Japanese employers have devised a system of staged retirement--partial at 60, with an appropriately small pension because the employee is continuing to work, albeit at a reduced salary to reflect his reduced productivity, and full at (about) 69.
A staged system, by matching salary to productivity, seems more efficient; but, if so, one wonders why more American employers do not adopt it, as they could do by rehiring at a reduced wage employees who had taken early retirement at age 60. One possibility is that Americans value leisure more than Japanese do and that this rather than differences in pension law or practices explains the earlier average retirement age in the United States. The fact that private as well as public pension plans tend to be less generous in Japan is consistent with this conjecture. The less people value leisure, the later they will want to retire and so the less money they will want to put aside for retirement.
For a detailed description and economic analysis of the Japanese retirement system, see Bernard H. Casey, ‚ÄúReforming the Japanese Retirement Income System: A Special Case?‚Äù (Sept. 2004).
I will try to respond to a few of the many good comments on my discussion last week of retirement. One person asked if I believe I am capable of doing work of the same quality that I had done in the past. My answer is no--age brings valuable experience, but at some point one loses some capacity for originality.
Some of you believe that early retirement is necessary to provide full employment. Yet labor markets can employ the vast majority of people who want to work if conditions of employment are flexible. Japan has low unemployment rates with high levels of employment among the elderly (see my posting this week) because it allows flexible earnings of older workers. Other nations could employ many more of their older workers if they allowed compensation to be market determined.
What is the so-called "natural" rate of unemployment is somewhat controversial. A couple of decades ago, it was believed to have risen in the United States to 6 per cent or more. But experience of the past 20 years suggests that the United States can achieve full employment with 5 per cent, or perhaps even lower, unemployment.
I agree that flexibility is necessary in dealing with older (and other) workers since the deterioration in their health and other measures of productivity varies greatly. That is why I believe conditions of employment of older workers should not be determined by legislation--which tends toward rigid rules--but by market forces.
I am no fan of age discrimination legislation, such as the ADEA in the United States. After all, older workers are among the best paid of all workers and have among the lowest rate of unemployment. African Americans by contrast have relatively low pay and high unemployment rates. So the argument for anti-discrimination legislation in their case has essentially no applicability to older workers.
As one of the commentators responded, pensions generally now vest when an employee is discharges, so there is no saving in pension costs by firing older workers. Health costs may be another matter, but that is a further reason to separate medical insurance, and its tax benefits, from employment.
I have always believed that economists have to consider nonmaterial aspects of life like character, love, and the like. Economics can deal in a useful way with these traits.
Some of you claim that capitalism and capitalists are the source of inequality and hard-hearted treatment of older workers. I do not believe that is correct. Inequalities, for example, under Mao and Stalin were enormous, including those in the economic sphere. And employee-owned companies, such as United or Avis, have usually fared very badly because of incompetent management.