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Thought for Thursday

December 18th, 2003

My column in today’s Fin (subscription required) continues my efforts to debunk the generation game. (So far these efforts appear to be pretty much as futile as a campaign against astrology, but I persist anyway). I’ve extended my range of targets from the general pop sociology on this topic to the Treasury and its analysis of intergenerational equity.

This reminds me that I really ought to say something about the Auerbach-Kotlikoff idea of generational accounting, which had something of a vogue in the early 90s and is still helping to justify generational chatter. Auerbach and Kotlikoff tried to systematically assess the impacts of government fiscal policy on members of different generations. In my opinion, what they produced was a complicated way of answering the question “Are the present settings of tax and expenditure policy sustainable in the long run”. If there’s interest, I might try a more detailed post on this some time.

In the meantime, here’s my article:

It’s almost impossible these days to open a newspaper without seeing some reference to generational conflict, generational change and intergenerational equity. Issues as diverse as the leadership of political parties, the price of housing and the appropriate level of public savings are routinely discussed in terms of the birthdates of those affected.

Moreover, arbitrary markers such as the decline in the birth rate in 1961, are used as a basis for labelling people as Baby Boomers or as members of Generations X and Y. All of this is little better than astrology, but seems to be taken seriously by people who should know better.

As I pointed out several years ago

most of what passes for discussion about the merits or otherwise of particular generations is little more than a repetition of unchanging formulas about different age groups – the moral degeneration of the young, the rigidity and hypocrisy of the old, and so on.

Membership of a particular age cohort is an important factor for those who reach adulthood at a time of war or economic chaos, but otherwise is relatively unimportant. Even in these cases, age is less important than class or educational levels (not to mention gender) in determining life experiences and life chances.

But the generational analysis that is popular at present doesn’t even have this limited validity. The great divide in terms of the experience of coming of age falls in the early 1970s with the collapse of the long postwar economic boom and the end of the Vietnam war. Those who reached adulthood before the 1970s, having been born during 1930 and the early years of the baby boom entered a labour market with an endless supply of jobs.

Employment opportunities for new entrants to the labour market dried up rapidly in the early 1970s. By the time the last of the baby boomers left school, the rate of youth unemployment was 30 per cent, higher than today..

The pop sociology surrounding generational discussion makes a complete mess of all this, splitting groups with similar experiences, and lumping together people with nothing in common except the fertility of their parents.

The real problems arise when economists get in on the act. The Intergenerational Statement released as part of the 2002-03 Budget .was a prime example. Projections of public expenditure over the next 30 to 50 years revealed that, under current policy settings, expenditure would grow more rapidly than tax revenue, creating a gap that would need to be filled either by higher taxes or by changes in public spending policies.

This result was presented in terms of generational conflict. In reality, however, it reflected nothing more the long-term structural trend in which the share of GPD allocated to services, particularly health care, has grown.
There are good economic reasons why the expectation of future growth in spending demands should lead us to support larger surpluses in the near future than would otherwise be the case. The most important such argument is that this helps to avoid costly variation in tax rates over time.

Given such surpluses, it is natural to raise the question of how they should be allocated. Since the object is to smooth tax rates, investments that do not yield a financial return to the public sector may be disregarded. One possibility is to reduce public debt. Over the long term, however, higher returns may be achieved through equity investment, whether this takes the form of passive investment in a diversified portfolio or active ownership of public enterprises.

The New Zealand government has adopted a portfolio investment approach as part of its plan for smoothing the financing of health and retirement incomes policy. A similar approach has been advocated for Australia by Ric Simes of Lateral Economics.

There are sound arguments to support these proposals. But casting the issues in generational terms obscures the issues. Even if we are not inclined, like Groucho Marx, to ask, ‘What has posterity ever done for me’, it is hard to sell the idea that we are morally obligated to scrimp now in order to benefit future generations who will, undoubtedly, be substantially richer than we are.

Arguments about tax smoothing and structural change may lack the pop appeal of claims that we are robbing future generations. But these are the arguments we need to have if we are to are to formulate a long-term Budget strategy.

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  1. PK
    December 18th, 2003 at 12:50 | #1

    Very good article. However, as a member of Gen X, I demand you stop this infernal logic. You’re completely ruining our scam.

  2. December 18th, 2003 at 14:16 | #2

    What is this GPD? Can I have some?

    More specifically, I worry about people who infer that “if this goes on we will have to raise taxes, etc” without realising how much of that will only change nominal cash yields and not affect real amounts that stay tied to demographics. That is, some forms of compensating activity really will change how the cake is split, but others will only cause a reaction that will feed back to restore the split.

    As a general question, what about differences between generations that are living through different birthrate regimes? Wasn’t it the usual case that most men paired off with women because they weren’t looking among their exact contemporaries but among a slightly larger, slightly younger group? And I suspect there may be other differen effects now that birthrates are materially lower than they usually were.

  3. December 18th, 2003 at 15:06 | #3

    Queries for Pr Q,

    Is the long term trend of increasing expenditure on health & education an indication that the costs & values of these services are rising autonomously ie secular improvements in productivity?

    Or is this healthy & savvy cost-inflation a defensive expenditure function of the secular aging trend in the community, , ie higher health costs for sicker people and higher education costs as older people switch careers during life-long learning?

    If the latter, then surely cohort-based accounting is relevant to generational equity. Certain groups eg baby boomers, may extract a lot more in services than they put in as taxes, and vice-versa for baby gloomers.

  4. Norman
    December 18th, 2003 at 20:45 | #4

    EVERY generation has been able to receive more than it “put in”, because growth made it possible to do this. Reliance on “eternal” growth must fail eventually; but who cares about the distant future? After all, that will be “somone else’s” problem.

  5. gordon
    December 18th, 2003 at 21:00 | #5

    The Draft Canberra Spatial Plan recently released by the ACT Government provides another angle. They claim that the projected ageing of the Canberra population is “unsustainable”, not in the sense of graveyard humour but that some kind of Budgetary/economic meltdown will occur. I find that the ACT Government’s own consultant’s report from Allen Consulting called “Economic and policy implications of the aging of the ACT population: An Input to the ACT Economic Development White Paper” (http://www.allenconsult.com.au/publications.php?doccat=8) disagrees, as does another Allen Consulting paper done with a National focus: “The financial implications of caring for the aged to 2020; A Report commissioned in conjunction with The Myer Foundation project 2020: A Vision for Aged Care in Australia” (same site). An ACIL Consulting paper done for the Dept. of Health and Aged Care further debunks the “we’ll all be rooned” attitude to population ageing: “Ageing Gracefully: an overview of the economic implications of Australia’s ageing population profile.” at http://www.health.gov.au/pubs/hfsocc/ocpanew10a.htm.

    It is interesting to note that the Canberra Spatial Plan also adheres to the view that increased migration can solve this “problem”, which is also probably not true. The ACT Govt’s. own Demographic Unit has indicated clearly that migration effects on the age profile are small, as has the ABS in the September “Population Projections: Australia” (Cat.No.3222.0). So in Canberra we are being offered a solution which won’t work to a problem that doesn’t exist!

  6. dsquared
    December 18th, 2003 at 21:29 | #6

    Is the long term trend of increasing expenditure on health & education an indication that the costs & values of these services are rising autonomously ie secular improvements in productivity?

    A secular improvement in productivity would normally see falling prices, not rising. What you’re getting at is the Baumol Effect; increases in productivity in *other* sectors of the economy raise the general wage level, meaning that those sectors of the economy in which genuine productivity improvements are hard to come by (how do you improve the productivity of a home help, given that a crucial part of the job description is to spend a set number of hours in a specific place?) tend to increase as a proportion of the economy.

  7. December 19th, 2003 at 19:26 | #7

    “EVERY generation has been able to receive more than it “put in”, because growth made it possible to do this.”

    Well, no – there have been occasional natural experiments when that wasn’t true. The last significant one was the Black Death. Roughly speaking that had the effect of increasing the proportion of improved agricultural land to people, which in turn made wages rise and capital more important (in relative terms). That time, what showed was that the population no longer had to put effort into clearing and improving land just to stay in the same place as numbers grew – Malthusian limits receded. So at least one other possibility exists than the one of each generation taking its payback from a bigger, later group: it does not need to put more into that bigger, later group, and that reduction may outweigh the other effect.

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