1. Private Asset-Based Reallocations Andrew Mason NTA Workshop June 2010

2. Objectives Preliminaries Conceptual foundations for private asset- based flows NTA foundations: principles and methods Illustrative results Conclusions Assignment

3. Asset-based Reallocations Defined Asset-based reallocations are defined as the net flows to each age that arise from the existence of assets. Inflows consist of asset income and dis-saving. Outflows consist of saving and negative asset income, e.g., interest expense. Asset-based reallocations are one of two economic mechanisms for shifting resources across age.

4. The Flow Account Identity Inflows –Labor Income –Asset Income –Transfer Inflows Outflows –Consumption –Saving –Transfer Outflows

5. Conceptual foundations Lifecycle saving model Credit and age reallocations NTA foundations –Willis 1988 –Lee 1994

6. Lifecycle Saving Model LC saving model most closely associated with Modigliani. Simplest model –People are lifetime planners –Saving is governed by simple economic lifecycle consisting of two periods: work and retirement. –People save during their working years and use that saving to fund their retirement relying on asset income and dis-saving. –No bequests. People know when they are going to die or rely on costless annuities to avoid accidental bequests.

7. Implications of LC Model Aggregate saving rates higher in growing economy (Modigliani). Implications of changes in age structure for saving and wealth (Tobin) Public PAYGO pension systems crowd out private saving (Feldstein) These issues have been explored using NTA concepts and estimates (Lee, Mason, and others).

8. Background LC model controversies Saving is motivated by bequests rather than lifecycle needs (Kotlikoff) Irrelevant to developing countries which rely on familial support systems People do not engage in long-term planning (Attanasio, Carroll, Deaton and behavioral economists)

9. Credit and the Economic Lifecycle Credit can also be used to reallocate resources across age. Individuals can borrow at one age and repay at another. Credit and other financial flows always have a counterpart. –Domestic counterpart: persons of a different age. –Foreign counterpart.

10. Credit and the Economic Lifecycle International differences in population age structure can lead to international financial flows (Taylor and Williamson 1994). Use of credit to fund retirement is limited because there is no generation that can serve as the natural domestic counterpart (Samuelson 1958). Credit can be used to fund limited consumption during early adult years. Borrow from workers and repay them when they are retirees. This provides a limited role for credit as a mechanism for funding pensions.

11. Relationship between NTA and Theory NTA estimates do NOT assume any particular behavioral theory. NTA is an accounting framework. NTA estimates are useful, however, for considering many of the issues that arise in the context of the lifecycle saving model and other theories about age reallocations.

12. Private Asset-based Reallocations NTA principles and methods

13. Important Concepts Assets and asset flows –An economic asset is a store of value over which ownership rights are enforced, individually or collectively, and from which the owner may derive economic benefits by holding it or using it over a period of time (UNSNA 1993, p 56). –Asset flows consist of asset income and saving Private asset-based flows –Asset flows to and from households, corporations, and NPISHs. Financial flows with public and private counterparts –Interest on public debt is an outflow for government and an inflow for owners of government issued securities. –The sale of government securities produces an inflow to the government (dis-saving) and an outflow from the party acquiring the government security.

14. Types of Private Assets Types of AssetsExamples Non-financial assets Produced assetsStructures, vehicles, equipment; inventories; art, jewelry, etc. Non-produced assetsLand, mineral and energy resources Financial assets and liabilities Equity and investment fundsCorporate shares Loans and debt securitiesMortgages, student loans, credit card debt, bonds, bills Insurance, annuities, pensionsAnnuity entitlements, pension entitlements Other Currency, financial derivatives

15. Types of Private Asset Income Types of AssetsAsset income inflow/outflow Non-financial assets Produced assets (Capital)Operating surplus; capital’s share of mixed income Non-produced assetsRent Financial assets and liabilities Equity and investment fundsDividends received (inflow) and paid (outflow) Loans and debt securitiesInterest received (inflow) and paid (outflow) Insurance, annuities, pensionsClass discussion Other Various

16. Capital Income Three components of capital income measured relying on SNA –Net operating surplus of corporations –Net operating surplus of households –Capital’s share of net mixed income Important: all measures are net of depreciation. Surplus of corporations and mixed income must be adjusted to incorporate taxes on production and net subsidies Operating surplus is equal to the imputed rent of owner- occupied housing Capital’s share of mixed income is not reported in SNA. We assume 1/3 of mixed income is return to capital.

17. Age Profiles of Capital Income NTA based on assumption that all assets are held by the household head. Operating surplus of corporations: age profile of property income (dividends, interest and rent). Operating surplus of households: age profile of imputed rent of owner-occupied housing. Capital’s share of mixed income: age profile of income from business, farms, etc.

18. Property Income In UN SNA property income consists of: –interest –distributed income of corporations –reinvested earnings on direct foreign investment –property income to insurance holders, and –rent. Some components not always available. Property income is different than capital income because all property income has a counterpart, i.e., inflows and outflows are matched. Counterpart may be ROW. For residents property income inflows will differ from outflows by net property income of ROW.

19. Age Profiles of Property Income Inflows –All inflows go to the household head –Age profile of property income Outflows –Interest paid by households: interest expense by age of household head. –All other outflows use age profile of property income.

20. Asset Income Age Profiles

21. Private Saving Private saving is the balancing items in NTA (and national income accounts) Private saving at each age is calculated as:

22. Private Saving Private saving for children should be approximately zero because children are not household heads. Private saving not exactly zero for children because of approximation errors introduced through smoothing. Summed over all ages, private saving in NTA is equal to net national saving in SNA.

23. Illustrative Results

24. Overall pattern of asset-based flows (average of all countries)

25. People at all adult ages are relying on asset-based flows. Elderly are funding deficit (lifecycle) Prime age adults funding net transfers.

26. Components of asset-based flows (average of all countries)

27. Some dis-saving at young adult ages Saving increases with age, but never exceeds asset income. Lifecycle surplus is not saved. It funds transfers. Saving is high for elderly; no dis-saving.

28. Role of assets in old-age support

29. US KR Assets and old-age support Korea Asset-based flows much less important for the older-old. Familial transfers are making up the difference. United States Asset-based flows much less important for the older-old. Public transfers are making up the difference.

30. SI KR Age 65-74 ♦ Europe & US ▲ Asia ■ Latin America Cross-country comparison, persons 65-74.

31. MX UY ♦ Europe & US ▲ Asia ■ Latin America Age 75-84 Cross-country comparison, persons 75-84.

32. ♦ Europe & US ▲ Asia ■ Latin America Cross-country comparison, persons 85+.

33. Age profiles of asset income and saving

35. Note that scale is very different than for high income countries. Values are much greater in middle-income countries.

36. Concluding Observations Saving profile in NTA –Similar to other commonly constructed age profiles which report saving rates by age of household head –NTA measure of saving is broader Private saving is used by assigning corporate saving to households Usually saving profiles are based on household saving

37. Concluding observations Use of household head’s age –Asset income and saving profiles do not fully capture within household details Young adults may be accumulating wealth while living in households of their parents Older adults may retain ownership of assets while living in a household headed by adult offspring –Implications of this approach can be analyzed to some extent using estimates of private intra- household transfers that are saved. But these results depend on model of intrahousehold transfers.

38. Concluding Observations Saving provides a partial picture about how assets evolve over time –Bequests –Other capital transfers Dowry, bride price and similar arrangements in rich countries Transition in household headship –Changes in asset prices High asset income of young and middle-aged adults relative to saving suggests that these mechanisms are important.

39. Concluding Observations Reality of asset-based flows is much more complex that economic models and pre-conceptions Elderly do rely on assets in retirement except where public transfer programs are very substantial or in transition economies (China) Elderly do not appear to dis-save, however. In fact, there saving rates are very high. Prime age adults are relying heavily on assets. Their labor income is insufficient to fund their own consumption plus net transfers to other generations. Asset-based flows are very important in lower income countries.

40. Assignment Construct asset-based flows for your country using RA.v2.xls. Required inputs –Aggregate controls –Age profiles of asset income –NTA estimates of LCD and net transfers Illustrative example for Germany is available on the website.

41. Mahalo

42. Further Readings Essential NTA Manual Further Reading Samuelson, P. 1958. "An Exact Consumption Loan Model of Interest with or without the Social Contrivance of Money", in Journal of Political Economy,Vol. 66. Tobin, J. 1967. Life Cycle Saving and Balanced Economic Growth. in W. Fellner (ed.) Ten Economic Studies in the Tradition of Irving Fisher. New York, Wiley. Willis, R. J. 1988. Life cycles, institutions and population growth: A theory of the equilibrium interest rate in an overlapping-generations model. in R. D. Lee, W. B. Arthur, G. Rodgers (eds.) Economics of Changing Age Distributions in Developed Countries. Oxford, Oxford University Press. Lee, R. D. 1994. The Formal Demography of Population Aging, Transfers, and the Economic Life Cycle. in L. G. Martin, S. H. Preston (eds.) Demography of Aging. Washington, D.C., National Academy Press. Feldstein, M. 1974. "Social Security, Induced Retirement, and Aggregate Capital Accumulation", in Journal of Political Economy,Vol. 82, No. 5. Attanasio, O. P., Weber, G. 2010. "Consumption and saving: Models of intertermporal allocation and their implications for public policy", in NBER Working Paper,Vol. 15756.