Entitlement, Oil Depletion, and Fiscal Crisis

By John Attarian
Volume 15, Number 3 (Spring 2005)
Issue theme: "Facing our geo-destiny: honoring the work of geologist Walter Youngquist"

Federal Reserve Chairman Alan Greenspan's call for cutting future Social Security and Medicare benefits is a jolting reminder of a reality which politicians would rather forget the soaring burdens which our aging population will put on the Treasury and the economy.

The fiscal problem, however, has two sides demand and supply. The latter the economy's capacity for carrying these burdens is equally important. We must ask not only how will federal government demands on the economy change, but also what changes will occur in the economy which will affect its ability to meet them. Unfortunately, a supply-side trend is operating which may be even more ruinous than demand-side demographics the worldwide depletion of oil and natural gas.

Oil and gas are crucial for modern economies. Cheap energy largely oil made possible America's phenomenal output and productivity growth. Our transportation depends almost entirely on oil. No other energy source matches oil for energy density (energy yield per unit of fuel), portability, storability, and versatility of use. Oil, fueling farm machinery, and natural gas, an input for nitrogen fertilizers, underwrite America's industrialized agriculture.

In 1949, geophysicist M. King Hubbert argued that since these fuels were created in prehistoric times, their quantity is fixed and finite, therefore their annual output must rise initially, peak once or more, and then decline. Applying this to estimates of America's oil resources, he predicted in 1956 that U.S. output would peak in 1970. It did.

The Association for the Study of Peak Oil and Gas (ASPO), an organization of veteran geologists, foresees this happening worldwide. In the Essence of Oil & Gas Depletion, Colin Campbell, a prominent ASPO member and longtime depletion Jeremiah, presents annual production plots for all oil-producing countries. Every plot shows the pattern Hubbert postulated. Almost all producers outside the Persian Gulf have already gone into decline. Moreover, as recently reported [New York Times, February 24, A1, C2], even Saudi Arabia's giant oil fields are declining. Depletion isn't a scare scenario it's a reality.

ASPO projects world oil output peaking in about 2012, and oil plus gas peaking in about 2015, then declining every year. Wind and solar are decades away from being major energy sources.

Now, the oldest baby boomers can start collecting Social Security early retirement benefits in 2007 and start getting Medicare in 2010. At about the same time, the boomers will start flooding Social Security and Medicare, and oil and gas extraction will peak and begin irreversible decline. So just as Social Security and Medicare costs begin exploding, the cheap oil and gas bottom will start dropping out of the economy which will have to support them a gruesome coincidence.

The implications for America's ability to finance old-age entitlements are grim. Oil and gas depletion will inflict an energy drought. Recall that a painful inflationary recession followed the 1973-74 OPEC oil embargo. Irreversible declines in oil and gas will mean prolonged economic contraction. Since all goods and services require energy, rising energy prices will raise all other prices, driving up inflation-adjusted benefit outlays. Meanwhile, real wages will shrink and unemployment will rise, with obvious consequences for the Social Security and Medicare tax base.

The stagflation largely caused by the 1973-74 oil crisis helped precipitate the first financial crisis in Social Security's history. Higher-than-anticipated inflation drove benefit outlays up rapidly while unemployment showed revenue growth. The trust fund ran a deficit in 1975 and, despite a massive Social Security tax increase enacted in 1977, continued doing so through 1981, thanks to another inflationary recession in which oil also figured. This time, the oil shock and stagflation will be permanent. Connect the dots.

Deficit hawks such as the Committee for Economic Development have projected Social Security, Medicare, and Medicaid spending rising from 7.6 percent of Gross Domestic Product in 2002 to roughly 14 percent of GDP by 2030. Assuming budget policy remains unchanged, the federal deficit would explode from roughly 1.6 percent of GDP in 2002 to about 10 percent of GDP by 2030.

These frightening figures incorporate only demographics and don't take depletion into account. Moreover, all forecasts by Social Security and Medicare actuaries, including the pessimistic ones, assume long-term growth in real wages, productivity, and GDP. But an economy crippled by depletion will see declines in all three.

Oil and gas depletion, then, will disastrously worsen the coming fiscal crisis, as rising demand for revenues collides with declining supply. Moreover, this will constrain policymakers' options. A contracting economy cannot support massive tax increases. The economic consequences of depletion mean bearish financial markets killing Social Security privatization stone dead. Depletion may leave us no choice but rigorous cost cutting, e.g., means testing, to reduce charges on the economy to affordable levels. Unwelcome as Mr. Greenspan's recommendations are, they are probably inadequate.

We need a more comprehensive picture of our situation. The economy's future condition will govern what we can do about entitlements. Factors overlooked today, such as oil and gas depletion, may mean unpleasant surprises tomorrow.

About the author

The late John Attarian, Ph.D., with a doctorate in economics from the University of Michigan, has been a freelance writer living in Ann Arbor. A frequent contributor to The Social Contract, he is the author of Economism and the National Prospect (American Immigration Control Foundation) and Social Security False Consciousness and Crisis (Transaction) and Immigration Wrong Answer for Social Security (American Immigration Control Press).