Are 401ks the Solution to the Year 2030 problem

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Are 401(k)s the Solution to the Year 2030 problem?

• Chapin White
• PhD Program in Health Policy
• Harvard University
• Research Seminar Presentation
• October 15, 2002
• http//www.people.fas.harvard.edu/cdwhite/Chapin_
  White.home.html

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The Year 2030 Problem

• Many elderly (20.0 versus 12.6 today)
• High medical spending (45k per elderly versus
  11k in 1998)
• Large fraction of GDP devoted to medical spending
  on elderly (15.7 in 2030 versus 5.2 today)
• Fuchs, 1998, "Provide Provide"

Notes The elderly as a fraction of the
population is taken from the Census Bureau's
middle series projections (http//www.census.gov/p
opulation/projections/nation/summary/np-t3-f.txt).
Medical spending per elderly person is projected
using spending per elderly spending in 1998 (from
a manuscript by Ellen Meara, David Cutler and
Chapin White) and assuming an annual growth rate
of 4.3, which equals the annual growth rate in
medical spending (all ages) for 1963-1998. The
fraction of GDP devoted to medical spending is
based on the Census Bureau's middle series
projection of the working age population (18-64)
and real productivity growth (output per person
of working age) of 2.1 which equals actual real
productivity growth from 1950 to 1999. GDP is
taken from the National Income and Product
Accounts (http//www.bea.doc.gov/bea/dn1.htm).
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Types of Saving

• Micro view I accumulate assets for a rainy day
• Macro view We (society) forsake consumption to
  expand capital stock (factories)

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401(k)s

• 401(k) personal, tax-advantaged, automatic
  deposit savings
• Wealth after Y years
• - wtraditionaler(1-t)Y(1-t)
• - w401(k)erY(1-t)

Note For simplicity, I assume that a single tax
rate is applied to dividends, interest, capital
gains, and income.
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Effect of 401(k)s on Saving

• Orthodox view perfect foresight gt 401(k)s
  increase lifetime wealth, increase consumption in
  all periods, reduce savings
• Low church view poor foresight gt higher returns
  and automatic deduction increase savings
  (Poterba, Venti and Wise)
• My view 401(k)s inflate asset prices, increase
  consumption, reduce savings

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Low Church View (cont.)

• firms invest if
• return gt interest rate
• individuals save if
• return gt impatience
• 401(k)s increase return to individuals, decrease
  interest rate, divert output from consumption
  into investment

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Low Church View (cont.)

• How does output get converted from consumption
  goods into investment goods?
• Firms issue new stock (equities), and invest
  funds
• Firms issue bonds, and invest funds
• US exports goods, buys overseas assets

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My Experience

• 2000 Roth IRA, bought PARS (biotech)
• PARS HOT!, bought 2000 more, sold hi, bought
  Honda

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My View

• asset values judged on last price paid, not on
  fundamentals
• 401(k)s drive up asset prices
• everyone feels wealthy, consumes more
• cash flowing into stock market was consumed, not
  converted into factories and equipment

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Are 401(k)s Big Enough to Matter (cont.)
Net addition to capital stock is calculated from
Flow of Funds accounts for nonfarm nonfinancial
corporate business (F.102). It equals capital
expenditures (FA105050005.Q) minus consumption of
fixed capital (FA106300015.Q). All figures are
inflated to equal 1996 dollars using the
quarterly GDP deflator. The quarterly figures are
smoothed using a 1-year moving average.
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Funds for new capital are calculated from Flow of
Funds accounts for nonfarm nonfinancial corporate
business (F.102), net funds raised in markets.
New equity equals net new equity issues
(FA103164003.Q), new credit equals credit market
instruments (FA104104005.Q). All figures are
inflated to equal 1996 dollars using the
quarterly GDP deflator. The quarterly figures are
smoothed using a 1-year moving average.
12
Net 401(k) deposits are calculated from Flow of
Funds accounts, Private Pension Funds Defined
Contribution Plans (F.119.c). Net 401(k) deposits
equals net acquisition of financial assets
(FA574090055.A). This series begins in 1986. I
assume that net 401(k) deposits were 0 in 1981
and linearly interpolate net deposts for 1982
through 1985. Net IRA deposits are estimated from
Venti, Stephen F and Wise, David A. 1997. "The
Wealth of Cohorts Retirement Saving and the
Changing Assets of Older Americans," S. Schieber
and J. B. Shoven, Public Policy toward Pensions.
Cambridge, MA MIT Press, Figure 3.2. I assume
that IRA deposits for 1980 through 1987 equal net
deposits (i.e. there are no withdrawals) and that
by 1990 net deposits equal 0. I linearly
interpolate net deposits for 1988 and 1989. All
figures are inflated to equal 1996 dollars using
the annual GDP deflator.
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Funds for new capital are calculated from Flow of
Funds accounts for nonfarm nonfinancial corporate
business (F.102), net funds raised in markets.
New equity equals net new equity issues
(FA103164003.Q), new credit equals credit market
instruments (FA104104005.Q). All figures are
inflated to equal 1996 dollars using the
quarterly GDP deflator. The quarterly figures are
smoothed using a 1-year moving average.
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Source Shiller, Robert J. "Stock Market Data
Used in "Irrational Exuberance"," Shiller, Robert
J, 2002 online http//www.econ.yale.edu/shiller
/data.htm. I estimate the PE ratio for October
2002 using 10-year moving average of real
earnings from December, 2001 the CPI from July,
2002 and the SP 500 quote of 834.89 from
October 14, 2002.
15
Source Shiller, Robert J. "Stock Market Data
Used in "Irrational Exuberance"," Shiller, Robert
J, 2002 online http//www.econ.yale.edu/shiller
/data.htm. I estimate the PE ratio for October
2002 using 10-year moving average of real
earnings from December, 2001 the CPI from July,
2002 and the SP 500 quote of 834.89 from
October 14, 2002.
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Alternative Approaches to Saving

• Transportation infrastructure
• Alzheimer's research