Population Age Structure, Inter Generational Transfer, and Wealth

Population Age Structure,
Intergenerational Transfer,
and Wealth
A New Approach, With Applications
to the United States
Ronald D. Lee
with the assistance of Timothy Miller
ABSTRACT
Resources are reallocated across age and time hy means of capital
accumulation, credit transactions, and transfers. Each takes place
through three channels: the family, financial markets, and public sector
programs. These age-specific flows give rise to stocks of age-specific
wealth. Weighting by population age distribution and summing yields ag-
gregate wealth, which equals capital plus tran.^fer wealth; the aggregate
credit balance must he zero. Forms of aggregate wealth are related to
properties of the macroeconomy. A framework is developed for relating
flows to stocks. Flows and stocks for the United States in 1987 are ana-
lyzed hy applying this framework to the 1987 CES. For example, the av-
erage household has about IOOK in federal transfer wealth, a debt of
I5K in state/local wealth, and a debt of I OK in interhousehold family
transfers.
I. Introduction
The human life cycle has two stages of economic dependence—
childhood and old age—separated by a long middle stage of surplus production.
At each age, earning in excess of production augments wealth, while consuming
Ronald D. Lee is in demography and economics at the University of California at Berkeley; Timothy
Milter is in demography at ihe University of California at Berkelely. The authors are grateful to
Robert Willis for many helpful discussions, and for the extensive use made of his earlier work: and to
Michael Anderson for excellent research assistance. Finis Welch, David Weil, and other participants
in the RAND-National Institute on Aging workshop on intergenerational relations provided many use-
ful suggestions and criticisms. Comments from an anonymous reviewer are appreciated. Research
support from tbe Institute for International Studies of the University of California at Berkeley is grate-
fully acknowledged. The 1987 Consumer Expenditure Survey, which is the primary data source for
this paper, is in the public domain.
THE JOURNAL OF HUMAN RESOURCES • XXIX • 4
1028 The Journal of Human Resources
in excess of earning reduces wealth or increases debt. In this way, discrepancies

between planned life cycle trajectories of earnings and consumption generate, at
each age, a demand for the wealth or debt necessary to achieve the life cycle
plans. For example, the desire to consume in old age generates a large demand
for wealth, leading to accumulation at preretirement ages. Wealth is also de-
manded for other reasons: to buffer risk, to provide bequests, or for the pure
pleasure and power of possessing it. Summing the demand for wealth over all
ages in a population yields an aggregate demand for wealth, or perhaps for debt.
Aggregate wealth can be held in two broad forms: real wealth and transfer
wealth. Real wealth is physical or human capital. Transfer wealth, as defined
here, is the present value of expected future transfers to be received minus trans-
fers to be made. Typically transfers are carried out through the family or through
the public sector, although sometimes they are also made through the market.'
Examples of familial transfer wealth include net support that the elderly expect
from their adult children; bequests that the adult children expect from their elderly
parents; and child rearing costs that parents expect their children to bear when
they become parents themselves. Public sector transfer wealth includes net pen-
sion and health care obligations of the federal government to all those who partici-
pate in the system and property tax obligations of adults whose children have
already been educated. Transfer wealth also includes the purchasing power of
cash (fiat money) and holdings of government debt.
Individuals borrow from one another and lend to one another in financial mar-
kets. Such transactions, and the corresponding net worths, must sum to zero
across all individuals. The government also borrows in financial markets, and its
total debt shows up as a large positive amount when we sum across the financial
assets of individuals. Firms sell equity and borrow funds in financial markets,
and the sum across all individuals of their holdings of equity and firms' debt
equals the value of the firms' capital, broadly construed. We will assume the
economy is closed, so that foreign participation in credit markets need not be
considered.
One might expect that transfer wealth would also cancel in the aggregate, just
as borrowing and lending among the individuals does. Indeed, it is true that the
sums of current transfers made and received at every instant must be zero. But
transfer systems can obligate the as yet unborn to make future transfers to mem-
bers of the existing population who themselves have made corresponding net
transfers to those now dead. Consequently the sums of transfer wealth across
the living population need not add to zero, and aggregate transfer wealth can be
positive or negative.
From the point of view of the individual, real wealth and transfer wealth may
be close substitutes, although most transfer wealth cannot be bought or sold,
may have annuity-like properties, and involves different kinds of risks than real
wealth. From the point of view of the macroeconomy, however, real and transfer
I. To some degree, inlerage transfers also take place Ihrough other means such as philanthropic organi-
zationis and charitable donations from households and corporations. Annual Rows through these channels
are substantial, totaling around $1,500 per household, or about 5 percent of total labor income. Lacking
data on their age specificity, however, we have ignored them.
Lee with Miller 1029
wealth have very different properties. Real wealth is preserved past output; trans-
fer wealth is claims on future output. Real wealth can only be positive; transfer
wealth can be positive or negative. Real wealth would survive a change of sociai
system, although ownership rights might change; transfer wealth can be created
or destroyed overnight by social or legal change. Real wealth yields valuable
services which are often complementary to labor, raising its productivity and
raising per capita income. Transfer wealth yields no productive services, and has
no effect on per capita income. Instead it alters the level and age pattern of life
cycle consumption which can be realized from a given per capita income.
This paper will begin with a sketch of the formal results, and a discussion of
related research by others. Then a long section develops the formal analysis,
which may be skipped by those not interested in the details. After discussing the
empirical approach, the paper continues with estimates of age specific flows and
stocks of wealth for the U.S. in 1987. The conceptual framework owes much to
a pioneering paper by Willis (1988), although we have altered and extended his
analysis.
II. Overview of Forma! Results

A. Transfer Wealth, Real Wealth, and Aging
Let W, K, and 7" denote the per capita levels of total, real, and transfer wealth.
Then W = K + 7". In a stable population and a steady state economy, these
grow exponentially; with no technical progress, they remain constant. In this
paper. I will consider the special case of a golden rule economy, in which the
capital stock is maintained at the level which maximizes steady state per capita
consumption. It is well known that in this case, the rate of return on capital {real
wealth) equals the population growth rate plus the rate of productivity growth,
n + \, and total consumption equals total labor income. I will show later that in
this case, the levels of wealth bear a simple relationship to the underlying age
profiles as follows: Total wealth per person, W, equals the average age of consum-
ing minus the average age of earning, times per capita consumption. This makes
sense, since the difference in average ages is the length of time that the average
dollar is held, and presumably invested, while per capita consumption is the
average number of dollars involved each year. In low mortality industrial nations
(United States, Japan, England) this difference in average ages is about four years
(Lee 1985; Ermisch 1989), which under the golden rule assumption implies a
wealth:consumption ratio of 4. The capital:consumption ratio could be quite
different, however, depending on the sign and magnitude of transfer wealth, T.
Transfer wealth per person equals the average age of receiving transfers minus
the average age of making them, times the average gross transfer flow. Real
wealth, or capital, is the difference between total and transfer wealth.
Because population aging alters the relative sizes of population age groups, it
affects the amount and forms of aggregate wealth, and the rate of return on it. A
surprising result links the system of transfers to the effect on consumption of
population aging: When aging results from low fertility and consequent low popu-
lation growth rates, its proportional effect on the present value of life cycle
consumption across golden rule steady states equals transfer wealth per capita
divided by the birth rate, Tib. In a golden rule economy with transfer wealth
netting out to zero, this implies that fertility-induced population aging would not
affect life cycle consumption: the tendency for per capita consumption to rise
with slower growth and capital deepening would be exactly offset by the increase
in numbers of high-consuming elderly relative to low-consuming children. Thtis
the case of T - 0 on a golden rule path corresponds to Samuetson's fl975)
"goldenest golden rule" in which both the capital stock and the population
growth rate are optimal. (For a proof, see Kim and Willis, 1982).^
B. Transfer Wealth and Real Wealth in Equilibrium

Let us now consider more carefully the effect on the macro economy of the
allocation of total wealth between real wealth and transfer wealth, taking Tobin's
(1967) and Willis's (1988)^ diagram of the demand for and supply of capital as
our point of departure. The demand for wealth at any given age will depend on
the interest rate, r, since it affects the life cycle consumption plan. In a stable
population, the aggregate demand for wealth will also depend on the population
growth rate and survival schedule, since these jointly determine the relative num-
bers of people of different ages. The demand for wealth by individuals, W{r. n),
is also a supply of wealth to the economy—not in the sense of aflowof investment
funds, but rather as a willingness to hold stocks of capital or of transfer wealth.
At any given interest rate and population growth rate, there will also be a certain
demand for capital K{r, n). This is made up of demand by the production sector
(for equipment, buildings, inventories, or farm animals, for example), by the
government (for social infrastructure), and by households (for homes, cars, and
consumer durables). If institutions do not support transfer systems, so that
T{r, n) = 0, then r will equilibrate at the value such that W{r, n) = K{r, n), for
given n. However, in practice transfer systems do exist, effectively disconnecting
the demand for total wealth, W, and the demand for capital or real wealth, K. in
equilibrium (see Starret 1972). In principle, a system of transfers could always
be constructed which would enable the golden rule case to be sustained, with
W(n, n) ^ K(n, n) + T{n, n). This might require that 7 be positive or negative.''
It has been shown that steady states with r < « are Pareto inefficient, in that the
golden rule path could be attained by increasing T and reducing K without harming
any generation (Starret 1972, Willis 1988). However, if r > H it is not generally
possible to move toward the golden rule path by reducing T and increasing K
without harming some generation (Starret 1972, Willis 1988).
2. Kim and Willis (1982) show that the second order condition for an optimum (in a three age group
model) is that the variance of consumption (across ages) exceeds the variance of earnings. Consumption
spreading over the life cycle should ensure that this condition is met.
3. Willis does not use the concept of transfer wealth, 7"; his corresponding concept is the aggregate
credit balance in financial markets, which does not take into account nonmarkel forms of wealih.
4. Willis (1988) argues that a golden rule equilibrium with a negaiive credit balance could not be sus-
lained. However, Tin, n) < 0 is possible through noiunarket institutions, such as familial or public sector
transfers to children.
r>n ^"Tfc:-
Demand for Total. Real, and Transfer Wealth
Figure 1
The Supply of Wealth. The Demand for Capital, and The Role of Transfers:
Golden Rule With Negative Transfer Wealth.
Note: r'n on the venical axis locates the goiden nile equihbriuni. Golden rule requires
Ihe amount of real wealth, K. indicated by ihe intersection of the K(r,n) schedule
with the horizontal dashed line. This is more than the demand for wealth, so the
difference is made up by transfer debt equal to the horizontal distance between the
K(r,n) and the W(r,n) schedules. Other possible equilibria occur for r > n . The
diagram shows the one where the rate of interest is high enough to raise the
demand for wealth, and reduce the demand for K, sufficiently to make them
equal. Al thai point all wealth is real wealth, and net transfer wealth is zero. This
diagram is modified from Willis 1988.
These points are illustrated by Figure 1, modified from Willis (1988), which
shows the cases in which r ^ n, for n fixed. The W and K schedules intersect at
r > n; this is the interest rate for equilibrium with no transfer wealth, and hence
all wealth held in the form of capital. The figure also shows the golden rule
equilibrium in which the optimal capital stock greatly exceeds the willingness of
the population to carry out the saving and investment necessary to accumulate
the corresponding capital. In the face of that unwillingness, the equilibrium can
nonetheless be sustained by large transfers from the old to the young, generating
negative transfer wealth to bridge the gap between the demand for wealth and
the demand for capital. Similar diagrams could be drawn for the inefficient cases
with r s n, and for the goldenest golden rule case in which the population happens
to want to hold an amount of wealth exactly equal to the golden rule amount of
capital, so that the golden rule can be sustained with net transfers equal to zero
(Samuelson 1976, Willis 1988).
III. Interpretive Issues and Comparisons to j^

Other Work
A. Feldstein, Barro, and Becker: The Need to Consider AU Forms of Wealth Jointly
Suppose the government creates a pay-as-you-go [PA YGO) pension system be-
cause it believes that workers are improvident and myopic about their retirement
years, and that they consequently demand insufficient wealth to realize their
consumption plans. By creating the system, the government forces transfer
wealth on the population. No matter what the initial equilibrium {r <. ^ n), since
the demand for wealth has not changed, it appears that people will restore their
wealth holdings to the desired level by reducing their holdings of capital (ieading
to a change in r, and hence in the demand for wealth). If there is initially less
than the golden rule amount of capital, the policy will reduce steady state con-
sumption. Thisis the core ofFeldstein's (1974) claim that social security displaces
private savings and thereby reduces capital formation. The argument that govern-
ment debt crowds out private investment is exactly the same, since government
debt is another form of transfer wealth.
There is another possibility, however. People can maintain their total wealth
position and their capital holdings by making downward transfers within the fam-
ily, creating familial transfer debt to offset their new transfer wealth in the
PAYGO pension system. In this case, no new net wealth is created, and the
capital stock is unchanged. This is Barro's (1978) refutation of Feldstein's argu-
ment,^ and of course it applies to government debt, as well (Barro 1974). Becker
(1987) points out that these compensating changes raise the cost of children and
therefore reduce fertility.
Becker and Murphy (1988) have a more comprehensive theory about offsetting
changes in transfer wealth, relating bequests, investments in children's education,
public education, and public sector pensions. They argue that if parents make no
bequests, then they are probably also investing suboptimally in their children's
education, because they cannot be sure that optimally educated children would
repay them later with reverse transfers to restore their desired total wealth. The
state intervenes by establishing public education supported by taxes, to achieve
the optimal investment in education. But then the wealth of parents is depleted
by these additional taxes they must pay. To restore their original wealth, the
government introduces a public sector pension program, which now compels the
reverse transfers that the family was unable to guarantee. This theory explains
why we might observe large offsetting flows in the family and the public sector.
These arguments of Feldstein, Barro. and Becker-Murphy show clearly the
importance of taking a comprehensive view of the system of transfers, capital
accumulation, and wealth in general. Studying any single subcomponent of total
wealth, and in particular studying any single transfer system such as money,
government debt, social security, public education, private costs of children,
bequests, or familial support of the elderly, could give a very misleading impres-
sion.
5. The implications of Barro's dynastic utility function are reflected in the demand for wealth, which
includes the desired transfers to children.
B. Kotlikqff, Modigliani, and Bequests versus Life Cycle Savings As the Source
of Wealth
Kotlikoff and Summers (1981) define transfer wealth at age x to be the cumulated
value of all transfers received up to age x. Aggregate transfer wealth. T', is the
sum of transfer wealth over all ages. They then express total wealth, W, as the
sum of a life cycle component, L, and transfer wealth, T'. This is a very different
decomposition than the one presented here. First, in my view transfer wealth can
play an important part in life cycle saving, so the dichotomy is inappropriate.
Second, T'. as they define it. is actually the negative of transfer wealth, T. in my
accounting. Someone who has received a bequest, but has not yet made one,
might be said to "owe" an equivalent amount to the next generation, and there-
fore to have accumulated transfer debt. Yet it is true in my framework as well
as theirs that transfer wealth does contribute to the formation of real wealth. To
see this, imagine two populations with identical plans for life cycle consumption
and earning, and therefore identical demands for aggregate wealth. W. In one
population, differing norms, tax laws, or feelings of altruism lead to a pattern of
bequests, generating negative transfer wealth, T - -B. In the second population
there are no bequests, and 7" = 0. In the first population, although adults receive
bequests at the death of their elderly parents, they wish to leave similar bequests
to their own children, so they are compelled to save and accumulate real wealth
in order to do so. Real wealth in this population will beA^^ W - T ^ W + B.
Real wealth in the second population, in which no such saving is necessary, will
be only K = W - T = W. Of course, the first population will have more capital,
higher labor productivity and earnings, and a lower interest rate, all of which
makes a ceteris paribus assumption about consumption and earning plans unap-
pealing, but the point is clear.
Consider one more example. The question arises whether parental payments
for the college education of their children should be considered an intergenera-
tional transfer along with bequests {Modigliani 1988). If parents pay for their
children's college education, then additional transfer debt is created: the average
member of the population will have received such support from his/her parents,
but not yet repaid it by paying for college for his/her own children. To pay for
their children's education they must save and accumulate wealth. As above, total
real wealth must be higher by the value of aggregate transfers for higher educa-
tion, about 12,000 per household in the United States as we will see. The same
is true if higher education is funded through public sector transfers. However, if
the same education is paid for by the student, who takes out a loan, then no
transfer debt is created, and the cumulation of real wealth is less. Therefore, it
is important to take into account the way in which costs of childrearing, including
college education, are born. It is also important to handle accounts consistently
on either a household basis, or an individual basis. More will be said about this later.
IV. Formal Analysis

Readers who are not interested in the formal derivation of some
of the results summarized earlier are invited to skip to the empirical sections.
A. Assumptions: Stable Populations and Golden Rule Paths

Consider a stable population in which age profiles of labor earning, yi(x), and
consumption, cU), are fixed. The economy is on a golden rule steady state growth
path, so that the interest rate, r, equals the population growth rate, /i, plus the
rate of labor-augmenting technical progress, \ , and aggregate consumption equals
aggregate labor earnings. (A full list of assumptions is given in Appendix 2. They
will be introduced as needed throughout the development of the model.) Labor
earnings depend on physical capital per efficiency unit of labor. A, and in a more
complete analysis, would depend on the education of each age group as well.
The earnings profile and the cross-sectional consumption profile both shift up at
the exponential rate \. In the analysis below, \ is taken to be zero, but it is easily
shown that all the results continue to hold more generally, except that per capita
averages have an exponential trend when \ ^ 0, which does not affect the results
of interest.
Let p{x) be the probability of survival from birth to age x, and let Bit) be the
number of births at / (actually, the number between / and / -I- dt). Then the stable
population age distribution at time / is:
(1) A^(jc,r)
and the proportional age distribution is:
(2) e-'^pix) / r e-'^p{x)dx = be-'"p(x),

I h
where b is the crude birth rate in the stable population.
B, Consumption and Labor Earnings

Total consumption by the population in some year can be found by multiplying
the population at age x by consumption at age x, c(x), and integrating over all
ages. Dividing this by total population, we get per capita consumption, c. If we
instead divide total consumption by the number of births, B{t), then in a stable
population we will get:
(3) C= r e-'"p(x)c(x)dx.
Jo
In both cases, the quantity is invariant over time in a stable population. C can
be seen to be the present value of expected life cycle consumption with a discount
rate of n.^ Evidently per capita consumption c is related to the present value of
life cycle consumption (with discount rate n) by: C = c/b.
Per capita labor income in a stable population, denoted y,, is defined similarly.
The present value of expected life cycle labor earnings, discounted at n, is de-
6. That is. if we interpret p(x) as the probability of being alive at age x, then p(x)cU) is expected
consumption at age x as viewed from age 0. The interpretation for a household is more compticated.
noted Y,. This equals yi/b and is given by:
(4) Y,=
In a golden rule population, C = K/ (or equivalently, c = >•;).
C. Transfers
Assume that a system of transfers is established by some combination of legisla-
tion, social norms, and individual choices, such that on average an individual age
X makes transfers to others in the amount iîx) and receives transfers from others
in the amount I'îx), for a net gain or loss of T(A:) = 7*{x) - 7~{x). (Later we will
distinguish between familial and governmental transfers, using the superscripts/
and g.) These are averages for age groups, and need not hold for individuals. All
such transfers will be treated as inter vivos, so bequests can be included for most
purposes. It is clear that the societal total of all transfers among age groups at
any instant must sum to zero, since every transfer given is also a transfer re-
ceived. For present purposes, I assume that all public sector transfers are also
strictly pay as you go [PAYGO).^ Likewise, public sector activities other than
transfers will be ignored for the moment.
In a stable population with a strictly PAYGO system of transfers, the following
social budget constraint must hold, whether or not the economy is golden rule:
(5) /•
This cross-sectional budget constraint can also be given a life cycle interpretation:
the present value of net transfers over the life cycle is 0. so the implicit rate of
return earned through the transfer system is n, the population growth rate. This
result is well known for the social security system, but holds more generally.
D. Government Debt
Government debt can be viewed as a form of public sector transfer wealth, al-
though of course it is quite different in many respects from entitlement programs.
Under the golden rule steady state assumption, the per household level of govern-
ment debt does not change, so the total value of the outstanding government
bonds must grow at the population growth rate n. The government does not issue
new (net) debt, nor does it retire old (net) debt, or make (net) interest payments.
Its outstanding debt, dating from some distant earlier time, simply grows at rate
n. Of course, we could decompose the government's actions into issues of new
bonds, purchase of old bonds, and payment of interest, but the net result must
be as described above. Although the government stands ready to buy back the
bonds at their appreciated value at any time, in fact it never needs to do so. For
7. Real world deviations from this assumption, such as the cumuialion of social security trust funds,
will be viewed as a form of real asset accumulation, and treated differentiy than pure transfers. (Some
forms of intergenerational transfers, such as holdings of money, will be ignored for present purposes,
but will be incorporated in the analysis later.)
this reason we can assume that bonds appreciate in value at the market interest
rate, n, so that their return is realized at the time of sale rather than as an annual
flow of interest payments, an assumption made purely for convenience.^ With
financial institutions as intermediaries, all trading in bonds is carried out by house-
holds and by firms owned by households.
Let dîx) denote the value of bonds sold by a household head age x (where d
stands for debt). d~(x) the value of bonds bought, and d{x) the net value of sales.
d^{x) - d~ix). Then the following cross-sectional constraint must hold at all
times, since on net, every bond purchased is bought from another household in
the population, and consequently the purchases and sales must sum to zero:
(6) \ e-'"p(x)d{x)dx = 0,
Jr0
This is exactly like the aggregate constraint for transfers given above. It should
be clear that in aggregate, the purchases and sales of government bonds play the
same role as transfers, and indeed may be considered to be a form of transfer.
Younger households buy bonds from elderly households, thereby providing the
funds for the elders" retirement. Later in life they in turn sell them at an appreci-
ated value to fund their own retirement.
Obviously, from the point of view of an individual household, bonds have
different properties than transfers, since unlike transfer wealth, holdings of bonds
can be converted into cash at any time. Furthermore, the value of the bond is
independent of the survival of its holder, while many transfers are contingent on
the survival of the recipient. Participation in bond markets is voluntary, in con-
trast to participation in public sector transfer systems. Nonetheless, government
debt, under steady state conditions, shares important properties with transfers
such as Social Security, It enables households to achieve efficient allocations of
consumption over the life cycle, independently of the demand for capital. While
it is a form of transfer from younger to older households, it does not, under
steady state conditions, lead to intergenerational inequity, Intergenerationai ineq-
uity occurs only when the debt is increased or decreased, just as it occurs when
the Social Security benefits or taxes are increased or decreased. In these cases,
some generations receive windfall gains or losses.
From now on. we will group the flows of bond purchases and sales with other
transfer flows in TU), and the outstanding debt with other forms of transfer wealth
in 7", while distinguishing it where appropriate with the superscript d, as in r'îx)
ovT''.
E. Credit Market Transactions Not Involving Government Debt

Let m'^(.T) be the How of funds received through credit transactions, and let m~(x)
be the flow of funds paid out, with m(x) the net receipt, m*{x) includes borrowing,
interest payments received, and repayments received of principal from past loans,
m~{x) including tending, payment of interst on previous loans, and the repayment
8. Bonds are assumed to be infinitely divisible so that as they appreciate in value they can be sold to
more and more households, with the per household value of holdings retnaining constant.
of principal. Loans to the government are treated separately, as above, and we

will ignore foreign participation in credit markets. As for the debt of firms, we
will allocate this to the households owning the firms. With this convention, every
credit transaction is symmetric, involving one household which pays and another
which receives.** Therefore, the net payments must cancel when summed over
the whole population:
(7) r e-'"p{x)m{x)dx = 0.
Jo
This cross-sectional budget constraint can also be interpreted as a life cycle bud-
get constraint for credit transactions.
F. Balancing Equations for Flows

We can now assemble these various flows into the budget constraint for individu-
als or households at age x:
(8) 0 = y,(x) - c{x) + T(jt) -I- m(x) - i{x) -(- nK{x)lp{x).
Here i(x) is the flow of net savings invested in capital and K(x) is the value of
capital owned per original member of the birth cohort. Stocks here and elsewhere
are defined per original member of the birth cohort to take account of the stocks
of those who have died. Bequests are treated as occurring inter vivos just before
death, and if given to members of other age groups, they are reflected in T(JC).
However, transfers within the age group (between spouses or siblings, for exam-
ple) are not reflected in ^{x).
If we integrate this across all ages, weighting by cohort size, we have estab-
lished that the flows must sum to zero, except for investment. The only nonzero
elements after summing are minus the integral of investment, which is the aggre-
gate investment flow, and nK. Thus, aggregate investment equals nK, which it
must on a golden rule path.
G. Accumulation of Assets
Let us now look more closely at the accumulation of capital and other forms of
wealth. Note thatp(j)/(x) = K(x); that is, the rate of change of capital per original
member of a birth cohort equals the proportion of survivors in the cohort times
the investment rate per survivor. The budget constraint on flows can be solved
for i{x), and the result substituted into this expression, yielding a differential
equation. Assuming that K{Q) = 0, it has the solution:
(9) K{x) = r e'''^-'"p(a)[y,(a) - c{a) + T(a) + m{a)]da.

Jo
We can also just view this as the cumulation of all investment flows from age a
to age x, where each investment earns interest n.
9. With this convention, we must also value the equity in finns held by households at the full value of
the capital stock, rather than at the net worth of the firms.
The integral on the right can be seen to equal various components of wealth
at age x. The integral of ^/(J:) - c(x) up to age x is W(x), life cycle wealth at age
x\ this is simply the net worth per original member of the birth cohort if the
difference between labor income and consumption is borrowed or invested at the
rate of interest, n.
The integral of T(a) is T(,x), transfer wealth at age x. It can be thought of either
as the present value of the difference between expected receipts of transfers and
expected transfer payments over the rest of life, or as the present value of the
difference between payments made into transfer systems and transfers received
up to age X, per original member of the cohort.
The integral of m{x) is A/(x), net debt at age x per original member of the
cohort. Alternatively, we can view it as the difference between the present value
of expected future funds to be received from credit transactions, and funds to be
paid in credit transactions.
We therefore have:
(10) Wix) = K(x) + T{x) + Mix),
= K{x) + T''{x) + T'^(x) + T^{x) + Mix).
H. Total WeaUh
To find total wealth in the population, we integrate this over all age groups,
weighted by initial birth cohort size. In the general steady state case, this integral
should cover all cohorts that ever existed, because wealth accumulated by distant
cohorts may have survived their life times and may continue to exist and earn
interest at time /, In the golden rule case, however, each cohort must leave
neither wealth nor debt, since C = Y,, and net transfers must always integrate
to zero for the population, so the integral can be taken to to.
Initial birth cohort size is B{t - x) = B{t)e~'", and total population size is
B{t)/b, where b is the crude birth rate in the stable population. Therefore, integrat-
ing over all birth cohorts and dividing by the size of the population is equivalent
to integrating over be'"". Recalling that M, the total debt or credit, must be zero,
we have:
The expressions for total wealth are all similar to that for W:
(12) W= b r e-'" f e"<^-''V(fl)[yf(fl) - c(a)]dadx.

Jo Jo
Appendix 3 shows that this expression for W can be rewritten as:
(13) W
Here, A,, and A^., are the ages at which the average dollar is consumed and earned
in the stable population—conveniently referred to as the average ages of consum-
ing and earning. This fundamental result is closely related to a similar result in
Willis (1988) for a population with discrete age distribution and no mortality. It
has an intuitive interpretation: The difference between the average ages of con-
suming and earning is the average gap between the time a dollar is earned and
the time it is consumed, and it is therefore the length of time that the average
dollar is invested in either real capital or a transfer system—in either case the
rate of return is n. Multiplying this by c, the average consumption flow per
household, yields average wealth. This amount may be either positive or negative,
depending on whether consumption on average comes after or before earning.
By a similar derivation, the per capita value of transfer wealth is:
(14) r=T*(-4,. - A , - ) .
Although the flows of transfers made and received at any instant must sum to
zero, transfer wealth is not generally zero, which distinguishes transfers sharply
from private sector loans. Transfer wealth can be nonzero because society can
obligate the as yet unborn to make (or receive) future transfers—transfers which
show up only in the expected payments or receipts of current members of the
population, but not correspondingly in the expectations of the unborn since they
do not enter the integral.
/. Consequences of Aging Due to Low Fertility

Now consider the effect of a change in the population growth rate arising from a
variation in fertility; such a change has a strong effect on the stable age distribu-
tion of the population. We will consider how the change in the population growth
rate affects the present value of life cycle consumption across golden rule steady
states. The effect of change in mortality is also important (see Lee 1994a, 1994b)
but will not be treated here.
When the growth rate, n, and interest rate, r, change across golden rule steady
states, the relative weighting of dependents and earners in the population will
change, and therefore the amount consumed at some or all ages must change or,
alternatively, the amount worked at some or all ages must change. The changes
at age JC required to maintain the accounting identities when population growth
rates change may be denoted dc(x)/iin and dyi(x)ldn. However, the integral over
all ages, x, of these changes must be such that they preserve the equality of C
and YI across golden rule steady states. Differentiating the golden rule identity
with respect to n = r. while holding/J(J:) flxed (and ignoring for the moment the
effect on capital per worker) but letting the age profiles of earning and consump-
tion vary as discussed above, we find:
(15) r e-'"p(x)[dcix)ldn - dy,ix)ldn]dx - C(A^ - Ay) forfixed K.
The changed growth rate will also alter the amount of capital per worker, which
will change the productivity of labor, and thereby change the earnings function
and require additional adjustments. When this model is embedded in a Solow
growth model (Arthur and McNicoll 1978. Lee 1980, and Willis 1988), an addi-
tional term reflecting the effects of capital dilution across golden rule paths is
added to the derivative:
(16) r e-'"p{x)(dc{x)ldn - dy,ix)ldn)dx = C{A, - A,) - Klb,

Jo
1040 The Joumal of Human Resources
where K is the average amount of capital (or real wealth) per person.'° But this
is just {W - K)lb, which equals Tib, the per capita level of transfer wealth (see
also Willis 1988):
(17) f e-^p{x)idc{x)ldn - dy,(x)ldn)dx = Tib. i ,

•'0
One interpretation is that households eam more on their transfer wealth, in the
amount dn y^ T each year, when population growth is more rapid. Multiplying
by \lb converts this annual flow of income into a life cycle gain. For capital,
however, this increased return is exactly offset by the need to save more to stay
on a golden rule path.
Application of this result can be illustrated as follows. Consider two stable
populations with total fertility rates of two and three children and life expectancy
of75; their annual growth rates will differ by .0142. In the one with higher fertility,
individuals may consume more over their life cycles, or work less, such that the
present value of all the expected changes equals .0142 * T. which could be positive
or negative. The specific changes in consumption and earnings at each age are
not determined without additional behavioral assumptions—or put differently,
the result is very general, and must hold across many different institutional con-
texts and preference functions. Consumption could be reduced by increased life
cycle savings, increased social security taxes, or increased familial transfers to
the elderly. Labor earnings could be increased by additional hours of work each
week, or by postponing the age of retirement. The precise size of each such
adjustment could be calculated using this expression. Evidently the effects of
population aging depend entirely on the amount of transfer wealth necessary to
induce the golden rule quantity of real wealth.
This discussion must be qualified in two respects. First, if the results are applied
to households rather than individuals, we must take into account the additional
costs of childrearing when fertility rises. When fertility rises, the number of chil-
dren in the average household changes. This will alter the life cycle consumption
of the adults in the household, which should be taken into account as in Lee
(1985) or Lee-Lapkoff(1988). In this case, there is an additional term proportional
to the net transfers to an incremental child—that is, to the net cost of a child to
its parents.
The second point is that parents" planned bequests for their children should be
treated as a component of the net cost of a child, and included in the augmented
expression just described. If, however, bequests arc an accidental byproduct of
life cycle saving and the uncertainty of age at death, then the analysis presented
above is correct without additional modification. Although bequests were nota-
tionally finessed by viewing them as inter vivos transfers, the substance of the
Modigliani-Kotlikoff debate has an important effect on the calculated effects of
population aging.
10. This derivative, by ignoring the effect of the population growth rate on the age distribution of the
capital stock, and hence on the rate of depreciation, may considerably overstate the role of capital
dilution; see Blanchet 1988.
J. Channels for Transfers and Forms of Capital

Transfers take place through the family and through the public sector, and to a
lesser degree through other institutions. Within the family, we can further distin-
guish different kinds of transfers: costs of rearing children, college expenses,
inter vivos gifts, and bequests, for example. Public sector transfers can be distin-
guished as federal or state/local, or they could be distinguished as related to
education, health, or pensions. Each of these can be characterized by a corre-
sponding age profile of flows of resources (money or goods) contributed by the
average individual and received by him/her. For each of these there is an average
age of receipt and contribution, and an average flow per capita. The entire analysis
sketched above can therefore be applied to each subcategory of transfer, and the
consequences of fertility-induced aging can also be assessed for each category in
this way.
Asset accumulation takes place within the household, in the form of housing,
automobiles and consumer durables, as well as in the production sector in the
form of factories, producer's durables and so on, and in the public sector in the
form of buildings, and infrastructure for transportation, communications, educa-
tion, sanitation, and health. Some of the relevant flows can be distinguished, and
the corresponding age profiles, average ages, and real wealth can be calculated.
In this way, under the assumptions of golden rule steady states we can give a
very simple and intuitive additive decomposition of total wealth into the various
categories of real wealth and transfer wealth. We can give a corresponding addi-
tive decomposition of the consequences of changed population growth rates,
revealing which channels, sectors and institutions will be most stressed, or most
relieved, by aging due to low fertility.
K. Summary of Formal Results

Now let us gather the more important results together:
(18) W=K +T Decomposition of Wealth,
(19) w = bC(A, - A^.) = c(A, - A^^) Age Profiles Determine Life Cycle Wealth,
(20) K = c{A^ - Ay) - T*{A,. - A^-) Age Profiles Determine Real Capital,
(21) T = T'^CA^t - A^) Age Profiles Determine Transfer Wealth,
(22) r e-'"pix)idcix)/dn - dyt(x)/dn)dx = C(A, - A ) - K/h = Tib

-'o
Transfer Weahh Determines the Effects of Aging.
These results can be extended to nongolden rule steady states, but they are
then less readily interpreted in terms of the age profiles. Furthermore, because
nongolden rule results contain factors of l/(r - n), they cannot be evaluated for
the golden rule case, which must be derived separately. However, the limit of
the nongoiden rule case as r approaches n corresponds to the golden rule case,
so the golden rule case provides a useful approximation when r is close to n. I
leave discussion of these matters to a later paper.
IV. Empirical Methods and Procedures
To implement these formal results, we need a set of age profiles

for households or individuals, describing flows of consumption, labor earnings,
and the various kinds of transfers made and received. Such data on consumption
and labor earnings for households are readily avaiiabie for many populations.
Data on public sector taxes and transfers for households can often be constructed
from individual-level survey data and from macro data on governmental expendi-
tures. Information on familial transfers is much harder to find. Bequest data are
notoriously deficient, and special surveys are required to measure interhousehold
flows of gifts, loans and so on. Data on the distribution of consumption within
households are nearly nonexistent for any population, so estimation of transfers
within families and households is particularly difficult. Finer levels of disaggrega-
tion likewise require more specialized surveys, to track purchases and sales of
physical and financial assets, and borrowing and loaning.
While age profiles of economic activity are interesting in themselves, the formal
analysis adds an important interpretational dimension. Equations (18), (19). and
(21) permit a complete accounting and decomposition of average wealth or debt
created through each channel, per household, based on the observed age profiles
of flows. The estimates of transfer wealth, T, based on Equation (21), also indicate
the consequences of population aging for life cycle consumption, as indicated by
Equation (22). Wealth calculations of this sort (W, A:, and T) are useful scalar
summaries of the corresponding age profiles, although they conceal most of the
detail. Equations (19), (20), and (21) also suggest a far more informative exposi-
tional device: arTow diagrams. In these diagrams, an arrow is drawn with its tai!
at the average age of outflow, and its head at the average age of inflow. The
thickness of the arrow is the size of the average annual flow per household. In
this way, the area of the arrow is the per capita wealth (if the arrow points to
the right) or debt (if the arrow points to the left) generated within that particular
channel. The same wealth could be generated by identically shaped arrows, lo-
cated differently on the age axis, or by arrows that are thick and short or long
and narrow.
The wealth estimates based on Equations (19), (20), and (21) are what demogra-
phers call "synthetic cohort" estimates. Like the Total Fertility Rate or period
life expectancy, they are estimates of stocks derived by pretending that the age
pattern of flows observed in some particular year is experienced by a hypothetical
cohort moving through time. Although these synthetic cohort calculations are not
undermined by steady productivity growth or a constant rate of inflation, their
other limitations should be kept clearly in mind. For example, the saving behavior
that generated our current national capital stock may be long gone. The life
expectancy of future retirees will not be the period life expectancy of 1987, be-
cause mortality will most likely continue to decline (Lee and Carter 1992).
Changes in relative prices, for example for houses in the past two decades, distort
measures of current stocks. In addition to these kinds of problems which result
from analytic assumptions, there are also problems with the raw data. The Con-
sumer Expenditure Surveys (henceforth CES) apparently underreport certain cat-
egories of income and expenditure, and there are many other data problems that
will be noted later. Comparisons of these flow-based synthetic cohort estimates

with direct survey estimates of wealth stocks can reveal problems and sometimes
permit adjustments to be made.
Some demographic procedures require explanation. Most of the analytic results
derived earlier apply equally to the individual or to the household, except as
noted; the principal difference is that child rearing costs and private expenditures
on higher education do not enter explicitly in the household framework. The
estimates here are based on the household as the unit of observation, with house-
hold age corresponding to that of the CES survey respondent; further details are
provided in Appendix I." Although the theoretical results were derived for stable
populations, the calculations presented here are based on the actual age distribu-
tion of household heads in the CES sample for 1987. This turns out to give results
very similar to those for a stable population age distribution of household heads
with a TFR of 2, and life expectancy at birth of 75, corresponding to actual
sample period vital rates. However, when fertility in the stable population is
taken to be half a child per woman or higher or lower, the results do change
significantly, as we would expect.
Some economic definitions and conventions also require clarification. Labor
earnings include the employer's social security contribution and the value of
other fringe benefits, and are taken before taxes. They reflect the earnings of all
household members. Consumption is defined very broadly to include not only
the household's purchases of goods and services (excluding purchase of durables
or a home), but also to include the imputed services of consumer durables and
owned housing, and in-kind transfers from the government of education, health
care, and food.
It is not clear how best to treat government expenditures other than for trans-
fers. In what follows, governmental expenditures on defense, police, fire depart-
ments, social infrastructure, and other nontransfer items are for some purposes
allocated to households in proportion to their size, and for other purposes ex-
cluded from the accounts.'^ In a golden rule economy, average labor income
equals consumption. In our sample they are not equal, surely in part because the
economy is not actually golden rule and the population is not actually stable. But
there are other reasons as well. First, I have ignored the production sector which
pays about $2,000 per household per year in taxes, for which it presumably
receives commensurate services; second, housing values have risen; and third, I
ignore the government deficit. For these reasons, estimated household consump-
tion would in any event exceed household labor earnings.
Between 1960 and 1988, output per hour of labor in the business sector grew
on average by 1.9 percent per year (U.S. Bureau of the Census 1990:406), and
over the same period, population grew by 1.1 percent per year. If continued over
the long run, these figures would imply a golden rule rate of interest of 3 percent
per year. However, the intrinsic rate of population growth implicit in the vital
i I. In fact, if we plot the average age of all adults in a household against the age of the head for the
1987 CES households, the two correspond quite closely, with the greatest difference about four years,
probably due to the presence of young aduli children in lhe home.
12. We ignore here the public good aspect of many of these items.
rates of 1987 is slightly below zero, and productivity growth has slowed some-
what. The discount rate implicit in the empirical calculations is therefore in the
range of 1 to 3 percent; since many assumptions are violated, and the economy
is not in fact golden rule, it is impossible to be more specific.
V. Estimates of Interage Flows and Forms of Wealth

Figure 2 plots age profiles of household consumption and labor
earnings, defined inclusively as described above. Some of the age variation re-
flects differences in the age of adult household members, some results from the
differing numbers of adults in households with different age heads, and some
results from differing numbers and ages of children in households with different
age heads. These sources of variation could be disentangled, but we do not need
to do so here. The average dollar is consumed in a household with head aged
46.8 years, and earned in a household with head aged 42.8 years, so the average
dollar is earned four years before it is consumed. (This result corresponds closely
with Lee [1985] for the United States and a replication by Ermisch [1989] for
Japan and England.) Therefore the wealth: consumption ratio is 4.0. On net,
resources are reallocated upwards over the life cycle, from younger to older ages.
Average household consumption is 34,000 and average earning is 30,800. I will
use the average of these two, or 32,400, as the measure of the annual flow for
present purposes (the flows should be equal under the golden rule assumption).
The present value (at a discount rate corresponding to n ^ 0) of the expected
consumption per adult is roughly equal to 32,400 times the "present value" of
the expected number of years spent as a household head, or 28.5 (see Appendix
1): 28.5 * 32,400 = 923,400. Note that this includes consumption by the average
number of children per adult, which I have not explicitly considered since it
involves no interhousehold transfer. Consequently. 923.400 is approximately
equal to the present value of life cycle consumption, from birth.'"^ By Equation
(19), average total wealth per household is given by IV - c(A^ - A,,) = 32.400
* 4.0 = 129,600. The remainder of the paper will view separately the components
which constitute total wealth, W, beginning with transfer wealth, T.
A. Transfer Systems: Household, Public Sector, and Market

I. The Public Sector .,
Age related transfers, in cash or in kind, constitute a large proportion of govern-
mental expenditures at all levels. These include health services (Medicare and
Medicaid), educational services, and social security pensions, and smaller contri-
butions from other programs such as food stamps, unemployment insurance, and
13. It may seem strange to refer lo this as a present value, when the discount rate is zero. However,
on the one hand, lhe discount rate is actually zero plus the steady stale growth of labor productivity;
and on the other hand, it is accidental that the population growth rate implied by the vital rates of 1987
is close to zero, and the procedures followed should produce a present value for other population growth
rates as well.
-I
AFDC. However, altogether these account for only 46 percent of total govern-
mental expenditures. The remaining 54 percent are for such items as defense,
police, fire, diplomacy, research, transportation, and communication infrastruc-
ture. The calculations could be done with or without these nonage-related items.
I have carried out the calculations both ways. When I include the nonage-related
items, I allocate them to households in proportion to the number of members.
Of course, many of these are actually quasi-public goods, so treating them in this
way is not quite right. Fortunately, these nonage-related items have little effect
on the results. A further complication is that some portion of public sector expen-
ditures is investment in capital. In this section I will treat all expenditures as
current consumption, but later I will include estimates of public sector real
wealth.
Figure 3 shows the inflows (benefits) and outflows (taxes) for the federal govern-
ment. As we would expect, the inflows are heavily concentrated at the older
ages, rising sharply after age 65. The transfers at younger ages include Survivors'
Benefits, AFDC, Food Stamps, unemployment insurance, and so on. The tax
profile is largely payroll taxes, with a small amount of income taxes added to
satisfy the transfer balanced budget assumption. Payroll taxes are the "youngest"
of all taxes, because labor income is so low in old age; they have an average age
of 41.2 years, versus 44.5 for income taxes. The associated arrow, shown in the
upper panel of Figure 5, points strongly upwards, reflecting enormous transfers
from young to old, and corresponding positive transfer wealth. Unlike Figure 2,
the average age of paying in is taken over all federal taxes, yielding 42.9 years,
and the average age of receiving benefits from it is 65.5, with an annual flow of
4,300 per year. Evidently, the federal government "owes" the average household
nearly $100,000 [97,000 = 4,300 * (65.5 - 42.9)], in the sense that the average
household has paid this much more into the system than it has yet received in
benefits.
Figure 4 shows comparable age profiles for State and Local government. Here,
the benefits, which are mainly education and Medicaid-funded health care, go to
younger households, with a modal age of 35-44. The property tax is the oldest
tax, with an average age of 52.6 years—10.4 years older than the payroll tax.'"*
The comprehensive average age of paying taxes to State and Local governments
is 46.1 years, and of receiving benefits is 42.5 years, with an average flow of
2,850. In this case, the arrow in the upper panel of Figure 5 points downward,
indicating that state/local programs tax the oid to benefit the young, the opposite
of the main federal programs. The average household "owes" $10,300 [- 2,850
* (42.5 - 46.1)] to state/local government, because it has already received educa-
tional services for its children, but has not yet finished paying for them. The
federal government taxes the young to pay the old, and the state/local govern-
ments tax the old to pay the young.
This information is presented in a different way in the lower panel of Figure
5, which combines all levels of government to show separate arrows for health,
education, social security, and a residual category. The tail of each arrow is
14. The average age for income tax is 44.5 for the federal government, and 44.1 for the state, and for
sales tax is 45.7.
\
S
-3
I
A. By Level of Government
$2,000
40 50 60 70 80
Age of HH head
B. By Type of Transfer
41.2 k 71.7
Social Security / Pensions
$2,270
$2,000
40 50 60 70
Age of HH head
Figure 5
Age Related Government Transfers
located according to the average age of the mix of taxes used to support it. There
are several striking features. First, note that each of health, education, and social
security involves similar average flows per household. What really distinguishes
these is the direction and length of the arrows. Social Security dominates: the
average age of paying in is 41.2, and the average age of receiving benefits is 71.7,
for a difference of 30.5 years. The areas of the arrows tell us the amount of
accumulated wealth in the transfer system for the average household. For pen-
sions, the amount is 69,200 (= 30.5 * 2,270), and for health it is 35,000 [= 1,862
* (61.6 - 42.8)]. Thus, the average household is "owed" about 100,000 by the
government transfer system in health care and pensions. Since there were 90
million households in 1987, this amounts to a total of 9 trillion dollars! This debt
is to some degree offset by the credit of the educational system, in which the
average household has received 17,300 [= 2,342 * (39.3 - 46.7)] more in educa-
tional services than it has yet paid. This is only a partial offset, however.
Kotlikoff (1992) and Auerbach et al. (1991) have made very interesting calcula-
tions which they call "Generational Accounting." In my notation, they calculate
r*^(x), governmental transfer wealth per Individual age x. excluding educational
transfers.'^
2. The Family
I will assume that direct interhousehold transfers are in fact familial transfers.
In the strict household accounting framework, only these inter-household flows
concern us. We will examine two categories: bequests and gifts/transfers. At the
individual level, however, the costs of child rearing, including private expendi-
tures on higher education, are extremely important, and even at the household
level these must be considered for some purposes, such as to make statements
about the consequences of changed fertility for the life cycle consumption of
adults in the household. Likewise, to the extent that the elderly coreside with
their adult children, transfers to or from them within the household have impor-
tant implications. Here I will rely heavily on indirect data to assess each of these,
except for transfers to and from coresident elderly which I ignore. i
a. Interhousehold Gifts and Transfers

The CES provides direct information only on interhousehold gifts
and transfers, which include inter vivos gifts, child support payments by divorced
fathers, alimony, and informal loan transactions. The gross flows are overwhelm-
ingly downward, from older ages to younger ones. Young households just starting
out make no transfers at all, and receive a considerable amount—nearly a thou-
sand dollars per year. As households age, their receipt of transfers generally
declines, and they begin to make more transfers themselves. The age group 45-54
transfers the most, presumably because parents this age have children in the early
stages of household formation, a stage which we saw was one of strong net
receipts. As couples age, and their children become better established, fewer
transfers are made. Somewhat surprisingly, however, there is no increase of
transfers received; on the contrary, transfer receipts diminish steadily at older
15. They calculate the present value of survival weighted expected future transfers {irom the government
minus expected future payments to the government, for al! levels of government but excluding education
and what we call "nonage related" government expenditures, and with a real discount rale of .06. Their
calculations are based partly on real cohorts, and partly on synthetic cohorts. They include in their
calculations the effects of projected changes in the social security payroll taA rate, and other planned
changes. In particular, they pay careful attention to the implieations of changing rules governing the
taxation of wealth.
Lee with Mi]ler 1051
ages. The pattern of interhousehold transfers is also affected by payments follow-

ing divorce, although many of these will be within age groups, and hence cancel
out. The net value of wealth arising from this channel is - 5,000.
b. Bequests
Here I rely heavily on Modigliani's (1988) survey of estimates from
various kinds of data. He finds an average annual flow per household of $1,750
with an average age gap between those leaving bequests and those receiving them
of about 25 years. The average age of death of the second parent may be taken
to be about 77, so the average age of the inheriting child would then be about 52,
and the resulting wealth would be -44.000 (= -25 x 1,750).
For some purposes, the within-household transfers to children must be counted
as well. The following items are calculated on a per child, rather than a per
household, basis.
c. Costs of Childrearing
A number of studies have concluded that in household consump-
tion, a child counts as .4 adults on average, with some variation by age and sex.'^
Using the specific results from Lazear and Michael (1988), I have calculated the
amount of consumption allocated per child in each household with children, and
in this way estimated average child costs by age of head, for children up to age
18. These come to 81,000.
d. Private Costs of Higher Edtication

Average household expenditures on higher education in 1987 were
somewhat under 500 (U.S. Bureau of the Census 1991). Taking the average age
of receiving higher education to be 20, so that parents would be on average about
48, we find an implied wealth of -12,000 per household. Since there are about
two children per household, this comes to -6,000 per child per household.
These various components are shown together in Figure 6. It is striking that
every one of the arrows is downward: net flows are always from older to younger.
Presumably in traditional Third World populations there are substantial transfers
from adult children to support their elderly (and typically coresident) parents,
transfers which in the industrial populations are replaced by private and public
pensions and medical care subsidies.
Combining the bequests and the interhousehold gift flows, we find that house-
holds hold a net transfer debt of about 50.000. Put differently, the average house-
hold has received 50,000 more in gifts and bequests than it has made, and the
expectation is that on average, that deficit will be made good over the remaining
life cycle. Of course, unlike the case of government transfers, there is not even
16. See, for example, Lazear and Miehael (1988). This and most other studies use the so-called "adult
goods" method.
A. Interhousehold transfers
Bequests
$1,750
$1,000
i 52
Gifts / Transfers
$370
38 53
I I I — I I I I I
10 20 30 40 50 60 70 80
Age of HH head
B. Within-Household Transfers (per child)

^ ^ ^ ^ ^ ^ ^ ^ ^ ^ _ Higher Education
$215
20 48
•I
$1,000
10 20 30 40 50 60 70 80
Age of HH head
Figure 6
Familial Transfers
a quasi-contractual basis for such an expectation, which is instead supported by

social norms and individual choice.
Computed on an individual rather than a household basis, this 50,000 would
be divided between the average of two adults per household, and added to the
expenditures per child on child rearing costs and higher education, or 81,000 -•-
6,000. for a total familial transfer debt of about 112,000 per person. The interpreta-
tion would again be that the average person had received far more from his/her
own parents than had yet been "paid back" through investments in own children.
3. Household Real Wealth {Consumer Durables and Houses)

Purchases of cars, stereos, refrigerators, and houses are ways of acquiring desired
flows of services, and also ways of reallocating resources to later years. House-
holds can decouple these two functions of durable and home purchases by bor-
rowing to finance the purchase (eliminating the intertemporal transfer) or by rent-
ing out the home or durable they own (eliminating the consumption of the
service). Inflation confounds this easy separation, however, as does the fact that
houses far outlive the repayment of the mortgage, and continue to provide in-
creasingly valuable services in old age.
The CES evaluated the market value of the housing services received by home
owners, and I have used their figures. I have imputed the value of services from
consumer durables by assuming they have a half life of four years (depreciation
rate of 17.3 percent). Then the flow of services per unit value of consumer durable
is chosen such that its present value, at a discount rate of three percent, equals
the original purchase price of the good. Figure 7 shows the flows as calculated
in this way. The peak in purchase of durables in the 35-44 age group corresponds
to the average age of home buying at age 41. Resale of homes and durables is
counted as an inflow, along with services. The dominant item is, of course, home
ownership, The average age of purchasing durables is 42.7, 6.5 years less than
the average age of receiving services at 49.2.
Housing purchases are strongly concentrated at younger ages, with an average
age of 38.4; the average age of receiving services from owned homes, however,
is 50.2. For other durables the contrast is much less: 44.4 versus 48.2. The annual
flows for the two categories are, on average, almost identical. Within the category
on non-housing durables, car purchases account for nearly two thirds. The to-
tal wealth held in housing and consumer durables is very substantial at 50,350
[^ 5 5 # (7,999 + 7,492)/2], where these items are valued according to the value
of their future services, and debt owed on them is not subtracted from this value.
This is an unconventional measure, particularly for housing, and should not be
compared to standard measures of equity in homes.
4. The Market^Financial Assets. Producers' Capital, and Government Debt

The financial market mediates the borrowing and lending of the household sector,
the production sector, and the public sector. The household sector owns the
production sector, so the net value of equity held by households should equal
the value of the capital of producers. The public sector borrows in financial
markets by selling bonds, which should also show up as net positive financial
asset holdings of households. Other borrowing and lending by households should
cancel. Therefore, aggregate net wealth held by households in financial markets
should equal the value of the capital of the production sector, plus the value of
public sector debt.
Household financial market transactions are dominated by three large items:
borrowing for the purchase of a home in the earlier adult years, followed by
subsequent repayment; borrowing to purchase a car, with subsequent repayment;
and saving for retirement, followed by subsequent drawing down of savings. We
will consider these separately later. Figure 8 shows inflows to households from
= 510.000
49,2
Tolal
S7.746
41.0 50.2
Housing
$3,838
44.^48.2
^ ^ Consumer
Cor Durables
$3,908
4U 45 50 55 60 70
Age of HH head
Figure 7
Consumer Durables and Houses
the financial market, and outflows from households to the financial market, by
age. Inflows include money borrowed as well as interest or dividends received.
Outflows include payment of interest, repayment of loans, purchase of stocks or
bonds, and so on. We see that through the age group 35-44, households on net
receive funds from the market, presumably through borrowing. At age 45-54,
they pay more funds to the market than they receive, while 55-64 are ages of
intense net saving in anticipation of retirement. Finally, above age 65, dissaving
is dominant. Note that inflows from the market are about 16 percent greater than
outflows. This is probably due to inflation in the housing market. Housing prices
used to be far lower, so people paying off mortgage debt (outflow) are making
relatively smaller payments than the amount borrowed (inflow) for new mort-
gages. It is striking that the average age of the outflow profile (45.7) is only slightly
lower than the average age of the inflow profile (46.4), so that the aggregate credit
balance in this market is only 6.000 (= 8,650 * .7). This is puzzling, since as
explained above, we would expect the aggregate credit balance of households
roughly to equal the per household value of the production sector's capita] stock
plus the per household value of public sector debt. This is a troubling problem
to be addressed in future research.
Figure 9 shows the arrows for pensions, housing, cars, and other financial
market transactions. The average household clearly has substantial wealth in
Lee with Miller
= $10,000
• Total market
• S7 750
45.7 f 46.4
^^^k Financial market
• v $3,160
49.6 ^52.3
' $1,000
44.7 64.7
Housing loans
$3,050
38.9* 41 .9
r
d Car loans
i % $1,420
4t.8 42.6
35 40 45 50 55 60 65 70
Age of HH head
Figure 9
Market Transactions
funded pensions: 20,000 (= 20.0 * 1.000). This figure derived from the CES flow
data agrees well with survey estimates from other sources of the stock of pension
wealth. Debt on homes is calculated at 9,100 which is substantially lower than
stock-based estimates, for reasons given earlier.
B. Summary of Estimates
We saw earlier that the average household wealth was $129,600. The arrows in
Figure 10 summarize the wealth-generating roles of familial and public sector
transfers, of assets held through the market, and of homes and consumer dura-
bles. We should not think that market transactions are unimportant for reallocat-
ing resources across age groups, just because the net market wealth of households
is close to zero. First, net market wealth is almost certainly seriously underesti-
mated here. Second, the annual volume of flows into and out of financial markets
is actually very large, as shown by the width of the arrow. However, as we saw
in Figure 8, strong downward flows in the younger half of the life cycle were just
balanced by strong upward flows in its older haif.
Table 1 summarizes the wealth calculations, and provides more detail on addi-
tional forms of transfers and real wealth. The figures are based on the household
= $10,000 43 50,1
Durables
$7,259
Government
$12,744
72,7
Family
$2,120
35 40 45 50 55 60 63 75 70
Age of HH head
Figure 10
Net Reallocation of Resources Across Ages
On a Household Basis
accounting unit. All the entries in the "Transfer Wealth" column have already
been discussed, except for government debt and money. Government debt is
calculated as the sum of Federal and State/Local debt, excluding holdings by
foreigners. Total governmental transfer wealth held by households, including
debt, is 125,000, and public debt makes up 27 percent of this. Holdings of money
are calculated from U.S. Bureau of the Census (1990).
In the "Real Wealth" column, the household estimates are based on the 1987
CES flows and imputations. The other figures are taken from the Statistical Ab-
stract (U.S. Bureau of the Census 1991).
Summing transfer wealth, T, and real wealth, K, we find that total wealth, W,
is 206,000. This conflicts witb the earlier estimate, based on the average age of
labor earnings and consuming, of 130.000—a large discrepancy. The difficulty is
that if we stick with the flow-based CES data, wealth held as financial assets is
only 6,000, while according to independent estimates of government debt and
producers" capital, it should be 83,000. Further research is necessary to under-
stand the underlying causes of these discrepancies.
Table 1
Components of Wealth (in thousands of 1987 $)
Transfer Wealth Real Wealth
Government + 91 Government + 27
Federal -1-101
Social Security + 69
Health + 33
State/local -U Producers + 49
Education -20
Family -49
Interhousehotd -5 Households
Inheritance -44
(To children) (-81)* Homes + 40
(College) (-6)* Consumer durables + 22
Government debt + 34
Government +5
Total + 81 Total (K) + 138
Note: The entries for real wealth do not sum lo the total, because they were taken from diverse
sources, while the lolal was taken from a less detailed but integrated table in Statistical Abstract. The
average value of single family homes sold in 1987 was about 90,000. Valuations of residential real es-
tate which do not simply assume straight line depreciation are difficult to find. This entry may be an
underestimate. Government debt excludes holdings by foreigners.
* This item is calculated on a per child rather than a per household basis: it is not a component of fa-
milial transfers in the household accounting framework.
VI. Consequences of Aging
As shown earlier, the consequences of aging due to low fertility

are indicated by transfer wealth and its components. Taking our estimates at face
value, we can evaluate tbe pressure on each transfer channel due to aging of this
sort, across stable populations. Here I will discuss only the public sector, which
is not affected by within-household transfers. In the neighborhood of replacement
level fertility, a variation of half a child per woman leads to a change in the stable
growth rate of .01 per year. Consider the effect of a decline in the growth rate of
this magnitude, so that dn = ~ .01.
Social Security wealth per household is 69,000; with n lower by .01, the average
household must either pay 690 more per year in payroll tax, or receive 690 less
in retirement benefits, or some combination of the two. For Medicare the corre-
sponding figure is 320, In the case of education, budgetary pressure would be
reduced to the extent of 170 per household per year. On net, the public sector
transfer system would be hard hit, with an annual "loss" of 910 per household
to make up in reduced transfers or increased taxes. Over the life cycle of an
individual, this would come to a total loss of 26,000.'^ From the point of view of
the individual rather than the household, this loss would be more than compen-
sated by the reduction in familial (within-household) childrearing costs, including
a reduced need to save for bequests. Taking all bequests as planned, the average
household would spend 1,120 per year less on children, and the average individual
would spend 32,000 less over his/her life cycle. However, this reduction in expen-
ditures on children would be offset by an equal reduction in utility from children
(see Lee 1985, Lee and Lapkoff 1988).
We may put this last point in another way. Familial transfers are private, and
therefore are internalized as costs or benefits of childbearing, to be set against
the direct satisfaction from childbearing in making fertility decisions. This is not
true of the public sector transfers, which are not viewed as net costs of children
by parents making fertility decisions. Public sector transfers drive a wedge be-
tween the private net costs of children and the net social costs of children, and
therefore represent an external net cost of childbearing (Lee 1990, Lee and Miller
1991). The figure of 26.000 given above is the public cost of a reduction of .5
children per household over the life cycle; the cost of a 1.0 child reduction is
twice this, or 52.000, which is a measure of the externality to childbearing faced
by the decision-making couple.
VII. Conclusions
The desire to reallocate resources over the life cycle—including
the desire to leave bequests—generates an aggregate demand for wealth. For
quite different purposes, there is a demand for productive capital, or real wealth.
If there were no net interage transfers, then the interest rate would be determined
so as to equate the demand for wealth and that for capital. Transfers, however,
generate an additional form of wealth, breaking the link between life cycle plan-
ning and capital accumulation.
This paper has used synthetic cohort methods to explore how resource realloca-
tion over the life cycle generates real wealth and transfer wealth through the
family, the public sector, and financial markets. Data problems, violations of
assumptions, and perhaps shortcomings of the accounting framework preclude
firm conclusions. Taking the results at face value, however, it appears that trans-
fer wealth in the United States is about two-thirds as great as real wealth. Social
Security wealth. Medicare wealth, and government debt are the main positive
forms of wealth, together exceeding the value of real wealth (excluding human
capital).
If Barro's theory, as discussed earlier, is correct, then these vast holdings of
public sector transfer wealth should be offset by corresponding familial transfer
17. Calculated as 28.5, the expected years of household headship over the life cycle, times the annual
loss per household. Note that the total for the public sector transfer cost does not include costs arising
from the increased per capita burden of the public debt. That would add about 10,000 to the individual
cosi of a lower growih rate.
debt, and in the extreme case, there should be no net effect of the public sector
transfer wealth on holdings of physical capital. If Feidstein is correct, however,
this public sector transfer wealth displaces equal holdings of physical capital,
leading to lower labor productivity and higher interest rates than otherwise. In
this case, public sector transfer wealth will have moved the economy away from
the optimal steady state capital intensity, and reduced the steady state per capita
consumption.
This paper has developed a formal synthesis of work on intergenerational trans-
fers, overlapping generation models, generational accounting, and life cycle sav-
ing, within the restrictive assumption of golden rule steady states and stable age
profiles of transfers and economic activity. While much remains to be done,
both conceptually and empirically, this approach already provides an interesting
overview of a territory of which only individual pieces have previously been
explored.
Appendix 1 . i
Individuals and Households

There is no such thing as a life cycle budget constraint for a household, because
the adult membership of households changes over time. For this reason, we must
interpret household accounts in terms of individual probabilities. The analysis
proceeds exactly as in the individual case, except that the probability of being a
household head at age x, h(x), is introduced into all the equations. C is now the
present value of the expected consumption in a household of which a given
individual is head, and K, is similarly interpreted. The derivation, which simplifies
by ignoring various interactions, gives the fiavor of the relation of individual to
household accounts: In a stable population, the average consumption (or income)
per household is related to C by a multiplier equal to the expected discounted
number of years spent as a household head over the life cycle. Consider the case
in which the stable growth rate is zero, so that we can ignore discounting. Then
the multiplier is just the expected number of years of headship over the life cycle.
The probability of headship for the population 18 and over can be found by
dividing the number of households by the population over 18, which yields
1/2.03 or very nearly .5. e,8 is about 57. so 28.5 is the expected years of household
headship. To get C or K,, then, we merely multiply the average household's
consumption or income by 28.5. To find the effect of .01 change in the growth
rate, we multiply the numbers given in the charts and tables by .285—this gives
the effect in individual terms. The difference between fertility of two and three
children per woman corresponds to a difference of .0142 in the population growth
rate. To find its effect, we multiply by 1.42 * .285 = 0.405. Note that for a small
difference in fertility centered on 2, dn/df = .02.
There is inevitably a loss of information about individual life cycles in the
household accounts, because not all adults are the same age as the head. In
societies with complex multigenerational household structures, the loss may be
substantial. Analysis of the 1987 CES households, however, shows that in 44
percent, all adults in the household are the same age; in an additional 23 percent.
all other adults are one to five years younger than the head; and in an additional
11 percent, all other adults are one to five years older than the head. Thus, in 78
percent of households, all adults are within plus or minus five years of the age
of the head. The average age of adults in a household sags a few years below the
age of middle aged heads, but on the whole tracks the age of head quite well.
Discrepancies could be avoided by indexing the household's "age" according to
the age of the average adult, or the age of a randomly chosen aduh household
member.
Appendix 2
Assumptiorts
The formal derivation uses the following assumptions:
1. The population is stable.
2. The economy is steady state.
3. The economy is golden rule.
4. The economy is closed.
5. All bequests are treated as inter vivos.
6. All transfer systems are pay-as-you-go, with balanced budgets.
7. There is no hard currency; all income is consumed, transferred, or invested.
8. Capital is homogeneous and indestructible.
9. The public sector provides no goods and services except as transfers.
Of all these, only I and 2 are essential. Most, or perhaps all, of the remaining
assumptions can be relaxed, resulting in more complicated derivations with some-
what altered results. Assumption 5 matters only for assessing the consequences
of a change in fertility. If 3 is relaxed, then the consequences of a changed growth
rate cannot be assessed without additional behavioral assumptions linking savings
rates, population growth rates, and interest rates.
Appendix 3
Derivation of Average Age Result for Total Wealth
Recalling that Wix) is wealth per member of the birth cohort, we must weight
each cohort by its size, B(t)e~'", before integrating, and then divide the total by
total population size. This yields:
W = b r e-'" r e"^^^''^p(a)iy,{a) - c{a))dadx
Jo Jo
= 6 r r e-'"p(a)(y,(a) - c{a))dadx,
•'o Jo
W ^bT r e-''V(a)(3';(a) " c(a))dxda
= i7 r (to - x)e'""p{x)i,y,(x) - c(x))dx.

.Jo
The second line is derived by changing the order of integration. By the golden
rule assumption, Y, equals C, so the integral of the quantity multiplied by to in
the last expression must be zero. The integral of the quantity multiplied by - x
can be seen to be C times the difference in average ages of consuming and of
labor earning: W = bC{A, - A^) - c(A, - Ay).
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Population Age Structure,

in excess of earning reduces wealth or increases debt. In this way, discrepancies

II. Overview of Forma! Results

B. Transfer Wealth and Real Wealth in Equilibrium

Demand for Total. Real, and Transfer Wealth

III. Interpretive Issues and Comparisons to j^

IV. Formal Analysis

A. Assumptions: Stable Populations and Golden Rule Paths

and the proportional age distribution is:

(2) e-'^pix) / r e-'^p{x)dx = be-'"p(x),

B, Consumption and Labor Earnings

noted Y,. This equals yi/b and is given by:

In a golden rule population, C = K/ (or equivalently, c = >•;).

E. Credit Market Transactions Not Involving Government Debt

of principal. Loans to the government are treated separately, as above, and we

F. Balancing Equations for Flows

(9) K{x) = r e'''^-'"p(a)[y,(a) - c{a) + T(a) + m{a)]da.

(12) W= b r e-'" f e"<^-''V(fl)[yf(fl) - c(a)]dadx.

/. Consequences of Aging Due to Low Fertility

(15) r e-'"p(x)[dcix)ldn - dy,ix)ldn]dx - C(A^ - Ay) forfixed K.

(16) r e-'"p{x)(dc{x)ldn - dy,ix)ldn)dx = C{A, - A,) - Klb,

(17) f e-^p{x)idc{x)ldn - dy,(x)ldn)dx = Tib. i ,

J. Channels for Transfers and Forms of Capital

K. Summary of Formal Results

(21) T = T'^CA^t - A^) Age Profiles Determine Transfer Wealth,

(22) r e-'"pix)idcix)/dn - dyt(x)/dn)dx = C(A, - A ) - K/h = Tib

IV. Empirical Methods and Procedures

To implement these formal results, we need a set of age profiles

will be noted later. Comparisons of these flow-based synthetic cohort estimates

V. Estimates of Interage Flows and Forms of Wealth

A. Transfer Systems: Household, Public Sector, and Market

a. Interhousehold Gifts and Transfers

ages. The pattern of interhousehold transfers is also affected by payments follow-

d. Private Costs of Higher Edtication

B. Within-Household Transfers (per child)

a quasi-contractual basis for such an expectation, which is instead supported by

3. Household Real Wealth {Consumer Durables and Houses)

4. The Market^Financial Assets. Producers' Capital, and Government Debt

Transfer Wealth Real Wealth

VI. Consequences of Aging

As shown earlier, the consequences of aging due to low fertility

Individuals and Households

W ^bT r e-''V(a)(3';(a) " c(a))dxda

= i7 r (to - x)e'""p{x)i,y,(x) - c(x))dx.

. 1994b. "The Formal Demography of Population Aging, Transfers, and the

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