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Kids these days

17 August 2016 By Kevin Allison, Liam Proud

The financial divide between old and young is growing. Mounting evidence suggests that stagnant wages, a graying population and unaffordable pensions risk leaving young people who came of age during the 2000s worse off than their parents. Left unaddressed, a widening inter-generational rift could prove toxic for the economy, markets and even democracy. Smart policy can help, but the barriers to change are high.

Stubborn youth unemployment, coupled with ultra-loose monetary policies that punished savers while inflating the value of houses and stock portfolios owned by more-established, older workers, has sparked concerns about looming inter-generational financial warfare.

The caricatures are well known. Time Magazine, which has an audience mostly of baby-boomer Americans, once referred to the generation that came of age in the wake of the Sept. 11 attacks in 2001 as “lazy, entitled, selfish and shallow.” Millennials, in turn, tend to associate older generations with presiding over the near-destruction of the financial system in 2008.

Yet while it’s true that many 18- to 34-year-olds risk ending up worse off than the generation before, the simplistic picture of older workers keeping the fruits of favorable economic trends and leaving younger people with the tab doesn’t quite stack up. The truth is more complicated, and has at least as much to do with structural shifts as past policy choices (http://tmsnrt.rs/2bkeRo0).

Old age dependency ratio

Receding trend lines

Take pay. A recent study by the McKinsey Global Institute found that 60 to 75 percent of households in advanced economies worldwide fell into an earnings bracket that experienced flat or falling income, after adjustment for inflation, from 2005 to 2014. A generation earlier, from the mid-1990s to the early 2000s, only about 2 percent of comparable households had that demoralizing experience.

According to McKinsey, incomes for U.S. workers under 30 with only a high school education fell at nearly double the rate of over-45s with similar attainment. Highly educated younger workers’ income also slipped relative to older peers – by 6 percent between 2002 and 2012, compared to a 2 percent fall for over-45s.

The decline coincided with falling labor union representation, increasing automation and a rise in corporate profits as a share of rich-country GDP at the expense of wages. These and some demographic trends are largely structural changes rather than the result of policy choices.

That’s not to say policymakers – many of whom are boomers – are blameless. The generational divide has been exacerbated by generous, untouchable pension benefits and rising asset prices. In the UK, for example, a “triple-lock” guarantees that the state pension rises every year by the highest of consumer price inflation, 2.5 percent or average earnings growth. And while some UK millennials will see the gains from decades of house-price growth passed to them by inheritance, the less fortunate could simply be excluded from the real estate market for years to come.

The so-called “lost generation” in southern European states like Greece, Spain and Italy has seen youth unemployment rates between 40 percent and 50 percent in recent years, while the better employment rights and pension benefits previously enjoyed by their elders have been eroded (http://tmsnrt.rs/2bkksul).

Youth unemployment

Mixed blessings

It’s not all bad for millennials. Falls in disposable income have been more muted than the pre-tax figures suggest, thanks to tax and welfare policies that transfer cash from high-income to low-income households. Today’s young people are also better off in other respects. While inflation-adjusted house prices have roughly doubled in the United States since baby boomers stepped on to the housing ladder in the late 1970s and early 1980s, mortgage and income tax rates are much lower for today’s homebuyers.

Despite higher property prices, Federal Reserve data show that American households today shell out less money, measured as a percentage of disposable income, on household debt than they did in the 1980s. Most electronics and home goods like TVs and dishwashers also either cost less or provide a richer experience than they did a generation ago.

Even so, things are going to get tougher for younger workers as baby boomers fill traditional pension rosters over the coming decade. A graying population means the ratio of workers to retirees is set to fall significantly across much of the OECD, increasing the burden on active workers to fund rising healthcare costs and state retirement programs. With fewer workers paying tax to support a growing number of retired people, one policy discussion governments need to have seriously is how to raise taxes or cut promised benefits as fairly as possible.

A gradual phasing out of defined-benefit pensions – which pay, for example, a percentage of a worker’s final salary for life – over the past three decades in favor of schemes in which participants set aside their own money for retirement means younger workers also have to fund their own golden years.

Participants in U.S. defined-benefit schemes accounted for 74 percent of the private-sector total in 1975, a figure which fell to 30 percent by 2013, according to figures from the U.S. Department of Labor. If younger workers want any income beyond basic Social Security, they’ll have to save for themselves. That’s arguably the biggest problem with income stagnation. Millennials face a rising tax burden to pay for boomer pensions even as they struggle to put enough cash away for their own retirement.

For some affluent families, these problems can be offset by gifts or inheritance. That would still leave a large swath of the population struggling, however. The economy could suffer from a negative feedback loop as squeezed incomes pinch spending. That could hit investment returns, further exacerbating generational tensions.

Left unchecked, that could further stoke the anti-establishment, often anti-immigrant anger that has already manifested itself in June’s Brexit vote in the UK and the rise of Donald Trump as a presidential candidate in the United States. McKinsey found that citizens who held the most negative views on trade and immigration belonged to the same group who felt their incomes were not advancing. But tighter controls on borders, for example, could actually make demographic effects even more acute, given that immigrants in general tend to be young and productive (http://tmsnrt.rs/2bkhVAz).

Cost of debt over time

The gray vote

More policies designed to share the costs of an aging population equitably between retirees and workers would help. But the political barriers to reform are high. Some U.S. states have enshrined promises made to retired employees in their constitutions. The Illinois Supreme Court, for example, recently struck down an attempt by the city of Chicago to plug a multibillion-dollar pension hole by eliminating cost-of-living increases for retired workers. Mayor Rahm Emanuel has been forced to raise taxes instead.

Older voters’ power at the ballot box in the UK, meanwhile, has led to the continuation of pensioner handouts that don’t depend on income, such as winter fuel subsidies and free bus passes, even as child benefit payments and school attendance incentives for low-income students were cut.

Add the power of the baby-boomer lobby to the demographic trends, and a clash of generations becomes a real possibility. Today’s political priorities and discourse – perhaps most notably in the United States – also seem to militate against thoughtful, consensus-driven policymaking.

The good news is that the impact of the coming demographic and retirement storm can be reduced significantly with the right mix of sensible reforms.

This will involve taking a second look at policies that advantage current retirees. Governments need to continue to increase the age at which they start paying pension benefits, and how benefits are indexed to inflation is another area for scrutiny. Higher inheritance taxes could plug part of the gap between old and young, too.

Other measures could be relatively pain-free for older generations. Allowing more working-age, tax-paying immigrants would be one option. And with interest rates ultra-low for many rich world governments, borrowing to fund infrastructure spending would create jobs for unemployed younger people without adding unsustainably to the national debt they will inherit.

More radical policies such as student debt forgiveness for those earning the least and a universal basic income should also be considered. Both these measures could have the added benefit of redistributing disposable income to those groups with a higher propensity to consume – namely, the younger and the less wealthy – thus boosting demand in the economy at large.

All these ideas and more need to be on the agenda long before millennials replace the boomers as the generation in power.


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