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The economics of the elderly.

The Economics of the Elderly

In recent decades, the economic and social position of the elderly has improved in many ways. Poverty has been substantially reduced; the income of the elderly relative to other groups has risen; and they are living longer.(1) However, in some respects, the well-being of the elderly appears to have deteriorated. Over 60 percent of those over age 60, and 57 percent of those over age 85, now live alone, compared with only 25 and 13 percent, respectively, in the 1940s. At the same time, the rate of institutionalization has more than tripled: today, almost a quarter of those over age 85 live in institutions, compared with only 7 percent in the 1940s.

In addition to living in circumstances that potentially are more isolated, the elderly in many ways face greater financial risks than existed in the past. The continuing trend toward early retirement, coupled with increases in lifespan, is leaving the aged with more and more years of retirement over which their resources must be rationed. Many married women in particular are at risk of suffering severe declines in their living standards if they become widows. But surely the biggest risk is of institutionalization, which for most elderly holds the prospect of rapid impoverishment.

These facts raise a number of interesting economic and demographic questions that my colleagues and I began to explore in 1984 as part of the NBER's Project on the Economics of Aging. Much of my research has been supported by the National Institute of Aging, to which I am exceedingly grateful.

Family Support of the Elderly

In order to study family support of the aged, researchers need matched data on the elderly and their children. Unfortunately, as of 1984 there were few datasets with that type of detailed information (particularly on the very old). So John N. Morris, of the Hebrew Rehabilitation Center for the Aged (HRCA), and I designed a survey and administered it to 850 children of elderly residents who were also participating in a ongoing HRCA survey of Massachusetts elderly.

Using both datasets, we learned that over one-fifth of the elderly (over age 60) in Massachusetts have no children. Further, daughters tend to be involved in care-giving more than their sons. But over half of the elderly either do not have a daughter, or do not have one who lives within an hour of them.

We also found that over half of the single elderly, and two-fifths of the vulnerable elderly (defined by needing help with daily living activities), live completely alone. Of the elderly who have children, fewer than 25 percent live with their children. And, in a typical month, over 25 percent of the elderly who have children do not spend any time with them.

Further, children with institutionalized or vulnerable parents spend less time with them than children with healthy parents do. Some of the elderly receive a considerable amount of help and attention from their children, while others receive very little. And, financial assistance from children to their elderly parents, even in cases in which the elderly are quite poor, is extremely rare.(2)

Living Arrangements

In the past, many studies suggested that the elderly wanted to live alone, and pointed to their rising incomes as the explanation for their increasing propensity to do so. But virtually none of these studies considered the attitudes and incomes of the children who would have had to house their aged parents.

Morris and I constructed a model of the joint decision of parents and children to live together; it uses data on living arrangements and on the characteristics of children and parents.(3) Based on the NBER-HRCA data, we found that children generally prefer to live alone, and that many agree to share housing with their elderly parents only because it is economically advantageous. Since incomes of parents and children are correlated positively, the earlier findings--that as their incomes rise, the elderly choose to live alone--may really reflect the fact that, as children's incomes rise, they choose not to live with their elderly parents.

Of course, the living arrangement decision can and does change over time.(4) My coauthors and I have found that when changes occur, they are often triggered by deteriorating health or by the death of a spouse. Changes in living arrangements typically occur within a year of the triggering events. Also, indexes of functional ability, but not subjective health reports, tend to be very good predictors of the living arrangements of the elderly.

Children's Time with Their Elderly Parents

While the elderly may need, and appear to be receiving, less financial help from their children, their need for companionship and for physical assistance may well have increased in the postwar period. The increased longevity of the elderly often means living for years in poor health.(5) Using the NBER-HRCA survey data, my coauthors and I have found that older parents receive more time from their children. Also, younger or healthier children provide more time to their parents than other children do. In contrast to these demographic differences, economic variables, such as children's wage rates and income levels, appear to be unimportant in determining time spent together. In addition, parents do not appear to "purchase time" from their children.

Altruism and Financial Transfers

While private intergenerational transfers are a very significant determinant of U.S. saving,(6) most of these transfers occur at discrete points in the life cycle. There is little evidence of systematic, annual, inter vivos transfers running either from older parents to their adult children or from adult children to their older parents. This pattern does not necessarily contradict the Becker/Barro model of marginal altruism: their model requires only periodic intergenerational transfers. But it also requires that altruistically linked family members share their resources, in terms of consumption, both at a point in time and over time.(7)

To test the implication of marginal altruism--that parents and children share their resources--Altonji, Hayashi, and I use matched data on the consumption and income of parents and their adult children. We find strong evidence against resource sharing: American extended families do not pool resources at a point in time, nor do they appear to share risk by pooling resources over time.

Of course, there are other models of altruism whose predictions are potentially more in accord with the data. In some models, the altruist doesn't know the potential donee's true need. As Razin and I show, in order not to be manipulated, altruists will condition transfers on the donee's earnings or saving behavior.(8) Also, Rosenthal and I argue, donees may try to manipulate altruists by refusing to accept transfers below specified amounts.(9) But their ability to do that depends on their initial resource positions, or their "threat points." My findings with Altonji and Hayashi do not rule out these models of transfers.(10)

Productivity of the Aged

An inability of firms to cut wages of older workers, because of age-discrimination laws and other reasons, combined with a decline in productivity with age, would explain the strong early retirement incentives of many firms. But one problem in determining how productivity varies with age is that workers are hired on a long-term basis, so that their current productivity is reflected in their future, as well as their current, wages.

I use data on expected future, as well as current, compensation to analyze the age-productivity relationship in a Fortune 500 firm. In each of the five occupations that I consider, productivity falls with age, exceeding earnings when workers are young and falling short when they are old.(11) If this finding--that compensation is backloaded--is found to hold more generally, then it may help to explain the low ratios of market-to-replacement values for U.S. firms. Backloaded compensation is an implicit form of debt that will be capitalized into the value of equity.

Early Retirement and Private Pension Provisions

My research with David A. Wise on early retirement and private pension plan provisions demonstrates that a large number of U.S. firms design their defined-benefit pension plans to provide very significant incentives for their workers to leave their main jobs as early as age 55.(12) The age pattern of pension accrual often exhibits a sizable positive spike at firms' early retirement ages, and is typically small or negative thereafter. Our analysis of workers' departure rates indicates a very substantial effect on the age-accrual profile on retirement decisions.

Do American Households Have Adequate Life Insurance?

Alan J. Auerbach and I consider how the death of a spouse would impact the living standard of the surviving widow or widower.(13) We find that husbands, in both middle-aged and older couples, are pervasively under-insured. Almost half of wives in households that need life insurance protection are not adequately insured. As a consequence, in the event of early death of their husband, they will suffer declines in their living standards of 30 percent or more.

Demographics and Saving

Like virtually all developed economies, the United States is projected to experience a dramatic demographic transition over the next 50 years. By 2040, 31 percent of the U.S. population will be 55 and older, compared to 21 percent today. The overall dependency ratio (that is, the ratio of those under age 18 plus those over 65 to those aged 18 to 64) will rise from .62 in the 1980s to .73 in 2040.

Auerbach and I have begun to explore the effects of these demographics on saving rates, growth, factor prices, and fiscal policy.(14) Using our simulation model, we predict gradual but dramatic declines in U.S. saving rates, and potentially large increases in payroll taxes to sustain the pay-as-you-go Social Security system. On the other hand, the demographic transition will feature significant growth of capital and increases in real wages. Because of different rates of aging of the population and different fiscal policies, demographic transitions will differ dramatically in the United States, Japan, Sweden, and Germany, Auerbach, Robert Haggeman, Giuseppe Nicoletti, and I find.(15)

Auerbach and I asked how U.S. saving would change over time if the relationship between age and earnings remained constant. We predicted somewhat higher savings rates in the 1990s, but steadily declining rates of saving thereafter.(16) Our results also suggest, rather strongly, that demographics cannot explain the low rate of U.S. saving in the 1980s, nor, indeed, the post-war pattern of U.S. saving.

With Jinyong Cai, we also used consumption and earnings data to examine the predictions of three models of saving: the life-cycle model; the representative agent, infinitely lived consumer model; and a simple reduced-form, Keynesian model.(17) Each model predicts substantial long-run declines in U.S. saving, but the timing of the changes is quite different. These different predictions may help us to sort out which model best characterizes U.S. saving behavior.

Generational Politics

The aging of the American population surely will have important implications for the political process. To better understand the potential effects of generational politics, I have coauthored a number of papers that assume that the political process represents the outcome of selfish bargaining between autonomous generations.

Torsten Persson, Lars E. O. Svensson, and I show how such generational bargaining can lead to social compacts.(18) But if one generation is unable to coerce the other, then there will be no intergenerational redistribution.(19) While younger generations may pay off the debt issued by older generations, debt policies will have no real effect on the economy, since the young will be compensated fully through the political system for accepting the "burden" of the debt.

Rosenthal and I point out that selfish generations will seek to monopolize their factor supplies by enacting distortionary taxes on their labor supply and saving.(20) This monopolization of factor supplies leads to a marginal tax rate on capital income equal to labor's share of output (roughly 75 percent in the United States), and a marginal tax rate on labor income equal to capital's share of output (roughly 25 percent). We also argue that selfish generations will not supply enough durable public goods, both at the regional and at the national levels. That is, the impact that a state or region's durable public goods have on its land values in general is not enough to ensure adequate state highways and other public facilities.

Measuring Generational Burdens

From the broad perspective of neoclassical economics, the deficit has no fundamental relationship to the generational stance of fiscal policy; that is, it tells us nothing about the burdens that current generations are foisting on future generations.(21) That is because "the" deficit reflects economically arbitrary decisions about labeling government receipts and payments. But the lack of definition of the term "deficit" is not specific to one type of neoclassical model. Rather, as I show, it exists in essentially all economic settings, including those with uncertain fiscal policy, liquidity constraints, and distortionary policy.

Auerbach, Gokhale, and I estimate the lifetime net payments to the government that current and future generations can expect to make under existing policy.(22) We conclude that unless fiscal policy is changed dramatically, future generations will face at least a 15 percent larger fiscal burden over their lifetimes than existing young generations will.


The issues addressed thus far in my research on the economics of the elderly are far from settled. Rather than attempt to provide the definitive answer to any single question, I have tried to cut a wide swath through the field in order to raise new issues and, where appropriate, question old conclusions. In the next stage of my research, I intend to focus in more depth on a number of empirical issues to determine whether my initial findings are robust to different datasets and specifications.

(1)M. L. Boskin, L. J. Kotlikoff, and M. Knetter, "Changes in Age Distribution of Income in the United States," NBER Working Paper No. 1766, November 1985. (2)L. J. Kotlikoff and J. N. Morris, "How Much Care Do the Aged Receive from Their Children?" in D. A. Wise ed., The Economics of Aging, Chicago: University of Chicago Press, 1989. (3)L. J. Kotlikoff and J. N. Morris, "Why Don't the Elderly Live with Their Children?" in D. A. Wise, ed., Issues in the Economics of Aging, Chicago: University of Chicago Press, 1990. (4)A. Borsch-Supan, L. J. Kotlikoff, and J. N. Morris, "The Dynamics of Living Arrangements of the Elderly," NBER Working Paper No. 2787, December 1988, and A. Borsch-Supan, V. Hajivassiliou, L. J. Kotlikoff, and J. N. Morris, "Health, Children, and Elderly Living Arrangements: A Multiperiod-Multinomial Probit Model with Unobserved Heterogeneity and Autocorrelated Factors," NBER Working Paper No. 3343, April 1990, and in D. A. Wise, ed., Aging Chicago: University of Chicago Press, forthcoming. (5)A. Borsch-Supan, J. Gokhale, L.J. Kotlikoff, and J.N. Morris, "The Provision of Time to the Elderly by Their Children," NBER Working Paper No. 3363, May 1990, and in D. A. Wise, ed., Aging, Chicago: University of Chicago Press, forthcoming. (6)L. J. Kotlikoff, "Intergeneration Transfers and Savings," NBER Reprint No. 1311, November 1989. (7)J. G. Altonji, F. Hayashi, and L. J. Kotlikoff, "Is the Extended Family Altruistically Linked?" NBER Working Paper No. 3046, July 1989. (8)L. J. Kotlikoff and A. Razin, "Making Bequests Without Spoiling Children: Bequests as an Implicit Optimal Tax Structure and the Possibility That Altruistic Beguests Are Not Equalizing," NBER Working Paper No. 2735, October 1988, and L. J. Kotlikoff, "Justifying Public Provision of Social Security," in Journal of Policy Analysis and Management (Spring 1987). (9)L. J. Kotlikoff and R. W. Rosenthal, "A Strategic Altruism Model in Which Ricardian Equivalence Does Not Hold," NBER Working Paper No. 2699, September 1988, and Economic Journal (December 1990). (10)J. G. Altonji, F. Hayashi, and L. J. Kotlikoff, "Is the Extended Family . . .?" (11)L. J. Kotlikoff, "Estimating the Age-Productivity Profile Using Lifetime Earnings," NBER Working Paper No. 2788, December 1988. (12)L. J. Kotlikoff and D. A. Wise, The Wage Carrot and the Pension Stick: Retirement Benefits and Labor Force Participation, W. E. Upjohn Institute for Employment Research, 1989; "Employee Retirement and a Firm's Pension Plan," in D. A. Wise ed., The Economics of Aging, Chicago: University of Chicago Press, 1989; and "Pension Backloading, Wage Taxes, and Work Disincentives," in L. H. Summers, ed., Tax Policy and the Economy, Volume 2, 1988, Cambridge, MA: The MIT Press, 1988. (13)A. J. Auerbach and L. J. Kotlikoff, "How Rational Is the Purchased of Life Insurance?" NBER Working Paper No. 3063, August 1989, and "Life Insurance of the Elderly: Adequacy and Determinants," NBER Reprint No. 870, May 1987. (14)L. J. Kotlikoff, Dynamic Fiscal Policy, Cambridge, England: Campbridge University Press, 1987. (15)A. J. Auerbach, R. Haggeman, L. J. Kotlikoff, and G. Nicoletti, "The Economic Dynamics of an Aging Population: The Case of Four OECD Countries," NBER Reprint No. 1268, September 1989. (16)A. J. Auerbach and L. J. Kotlikoff, "Demographics, Fiscal Policy, and U.S. Saving in the 1980s and Beyond," in L. H. Summers, ed., Tax Policy and the Economy, Volume 4, 1990, Cambridge, MA: The MIT Press, 1990, pp. 73-101. (17)A. J. Auerbach, J. Cai, and L. J. Kotlikoff, "U.S. Demographics and Saving: Predictions of Three Savings Models," NBER Working Paper No. 3404, July 1990. (18)L. J. Kotlikoff, T. Persson, and L.E.O. Svensson, "Laws as Assets: A Possible Solution to the Time Consistency Problem," NBER Reprint No. 1081, December 1988. (19)L. J. Kotlikoff, "Is Debt Neutral in the Life-Cycle Model?" in L. J. Kotlikoff, What Determines Savings? Cambridge, MA: The MIT Press, 1989. (20)L. J. Kotlikoff and R. W. Rosenthal, "Some Inefficiency Implications of Generational Politics and Exchange," NBER Working Paper No. 3354, May 1990. (21)L. J. Kotlikoff, "From Deficit Delusion to the Fiscal Balance Rule: Looking for an Economically Meaningful Way to Assess Fiscal Policy," NBER Working Paper No. 2841, February 1989. (22)A. J. Auerbach, J. Gokhale, and L. J. Kotlikoff, "Generational Accounting--A Meaningful Alternative to Deficit Accounting," NBER Working Paper No. 3589, January 1991.
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Author:Kotlikoff, Laurence J.
Publication:NBER Reporter
Date:Dec 22, 1990
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