Capital is the Key!
Image source: http://www.amycrossnance.com/bequests-in-wills/
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Note (04.12.2014)
Note that this article best reflects the state in which most developing and least developed nations exist. Developed nations have their own side of the story, but they are doing better in terms of resources allocation, especially from capital owners (retirees who would have otherwise left their wealth idle) to those who demand capital (want to borrow to invest). Developed nations have done a much better job when it comes to capital circulation thanks to their well-functioning and robust financial structure (active financial intermediaries). Of course, wealth is not just in the form of money but also in various other forms with lower liquidity such as land, houses, precious metals, etc. So, maybe, developed nations are also affected by increasing life expectancy and late employment of bequest, but the effect should be much less dramatic. We can’t say for sure at this point since we need a solid statistical proof.
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29.11.2014
I, personally, find this topic to be quite intriguing because it points out a simple fact that there are negatives and positives to every decision made, to every turn of event, to every path taken towards the future. Gloomy it may sound, but what should be inferred from such this sort of speculation is the need for us to weigh carefully the pros and cons of any decisions to be made in the future concerning policy making and the construction of political, economic, and social frameworks.
So, let’s get right into the discussion.
What is bequest? Bequest is simply inherited wealth. In this article, we want to theoretically analyse the potential outcomes of increasing life expectancy and delayed reallocation of wealth. In other words, how can the increasing life expectancy of a population impact the employment of bequest, and how will that in turn affects the growth of the economy?
Basically, wealth is capital. Capital can be anything from money to machinery used to convert input into output. In that sense, capital is a major driving force of our economy. Capital is used to start a business, to be loaned to new entrepreneurs of innovative ideas either directly or indirectly via savings (with banks as intermediaries), or simply to be consumed/spent to purchase products and services the economy has to offer. In essence, this is the creation of wealth using wealth. Subsequently, the public wealth will then grow along side private wealth. This is because new wealth is taxable, which implies higher tax revenue for the government that allows for improved public services. In the financial realm, the availability of loanable capital will also lower interest rate making new investment more attractive. This, however, would necessitate the existence of a proper financial system that functions as the middleman connecting lenders and borrowers. In the case of developing countries, interest rate is usually higher, so this is where bequest comes in. Bequest is a form of interest-free transfer of wealth from predecessors to their successors, and this ease the burden of borrowing (having to pay high interest rate) for entrepreneurs who possess less capital (of course, we assume no inheritance tax). Even for developed nations, bequest is crucial for bolstering income of those at the bottom who have difficulties acquiring borrowed capital from banks (since they possess low periodic income and little asset usable as collateral). Furthermore, there are certain type of wealth that cannot be channeled easily, which is illiquid assets like house and tangible valuables that are normally obtainable through bequest. If capital is vital for economic growth, then so is bequest. This is because the act of injecting wealth into the economic circulation will also create and redistribute wealth either directly or indirectly to the workforce.
However, note that capital is not something that is self-employed. We, humans, are the ones who put our wealth, the capital, to uses. And this is when the characteristics of the population comes into play.
The above implies that no matter the amount of wealth/capital, if it is not utilized appropriately, if it sits idle in our basement, it will never be supplied to enrich our economy. Think about food. Why are there people starving even when there are abundant food, enough to feed the whole globe? In fact, based on an article written over one and a half decades ago by Danielle Knight (see reference), it was found that, even back then, we were capable of providing at least 4.3 pounds (roughly 2kg) of food per person a day; yet, there were those who died miserably of hunger. Tragic it is, but the obvious reason here is that people died, even with sufficient aggregate amount of food, because there was a portion of food that was wasted or not accessible to the starving population.
Wealth, in the form of capital, follows the same causes and effects. Wealth that is not invested/loaned/consumed/donated is no different from food that is placed 500 meters above your head, with you starving and given only a 2-meter ladder.
And how is that related to the increasing life expectancy?
You see, people normally are born with a certain amount of wealth generated by their predecessors. They then grow up, join the workforce, and accumulate their own wealth over time. Here is the catch. People mostly spend their wealth when they are at young and middle ages, while at the same time, they save for old ages. As they get older and older, and when they retire, they produce much less for the economy, spend less, pay less tax, while sitting on a pile of untapped wealth. The longer they are able to live beyond the age of 60-65 (retiring ages), the longer the wealth will be unemployed.
Diving deeper into this issue, I have realized that, besides a tiny percentage of those old tigers and dragons of the business world, the average old people just do not have the spark, the incentive to invest and spend. This is a problem that is most relevant to us, now. Why?
Because when we look at the historical trend, the baby boomers (born after World War II from 1945-1960s) are now retiring. They are the ones who benefited the most from the recovering and booming global economy after the dark era of war. This gave them significant advantages over us of the generation Y and Z, the younger generations, in terms of wealth generation capabilities. Once they retire, they are also sitting on a huge stock of wealth. Another way to look at this is that as more of the baby boomers are retiring, on top of having less tax generated from the workforce and more government spending on the retired/former workforce, there will also be less capital trafficking on the economic highway of our time due to the large amount of wealth left idle by the retirees. What is more is, now, they are retired in the time of significantly increasing life span, better healthcare and life sustaining means than ever before, and that also means that the capital, that could otherwise be employed, will not be put into effective uses for a much longer period of time.
So, if wealth is not passed down to their descendants, it will deprive the younger generation of the greater investment potential through the employment of a larger amount of capital to kick start their economic activities. As the life expectancy increases, wealth might be passed down from a 100 year-old father to a 70 year-old son or a 40+ year-old grand-daughter. This slows down the potential growth rate as the inheritors of wealth might have been able to make a much better used of the bequest (which would have produced positive outcomes for them and spillovers for the others) had it been bestowed to them much sooner.
What does this tell us? This tells us that our growth right now are highly dependent on technological growth to make up the slack. The increasing rate of technological advancement allows us to create much more advanced machines that can remarkably raise the output-per-capital ratio (because higher output-per-capital ratio also means that a unit of labour can produce more outputs with a unit of capital). So as the workforce is shrinking due to the retirement and the declining fertility rate, technology is our savior. In addition, we also have more efficient and effective workforce due to the better education standard, the more efficacious institutional and organization structure, and the more resources unlocked.
But how long can it last? At the current rate of technological growth, we can’t say for sure. However, is it enough? That is probably a better question. Why? Because we cannot ignore the exogenous/external adverse forces such as global warming, natural disaster, disease outbreak, etc. These can drastically reduce the world outputs even with the current technology and efficiency we enjoy so much.
This article is, as of now, simply introduces us to the less visible problem we are facing. Therefore, it is of our best interest to start looking into the idle resources/wealth/capital, to find a way to fairly and equitably employ them. We need to construct sensible knowledge and understanding, rules and regulations, social and economic structures, and suitable policies revolving around this issue.
How can we do that? One way is to construct a financial system that is able to relocate idle resources (such as pension fund). The rest, I will leave it to you, or maybe, we can discuss it together in the next article.
I hope you find this piece of economic knowledge interesting and useful.
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Reference:
http://www.psrast.org/nowohu.htm