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Life-Cycle Savings in the United States, 1900-1990
Chulhee Lee*
Division of Economics Seoul National University Silim-dong, Kwanak-ku Seoul, KOREA [email protected]
November, 1998
* This paper is based on Chapter 3 of my University of Chicago Ph.D. dissertation. I would like to thank Gary Becker, Charles Bischoff, Dora Costa, Robert Fogel, Casey Mulligan, Tomas Philipson, Sherwin Rosen, David Weir, Sven Wilson, and the participants in 1997 AEA meetings, 1996 NBER/DAE Summer Institute and the workshops at the University of Chicago, Binghamton University, Clemson University, and Northwestern University for their helpful comments and suggestions. I gratefully acknowledge financial support from the Center for Population Economics, from NIH (PO1 AG 10120), from NSF (SBR 9114981) and from the University of Chicago. Any remaining errors are my own. Abstract
Life-Cycle Savings in the United States, 1900-1990
This paper estimates the proportion of savings that represents accumulation for retirement in the United States over the last century. For this purpose, I compute a counterfactual life cycle savings-income ratio for 1900-1990 that would have resulted if the savings for retirement were the only motive for wealth accumulation. The proportion of private savings that represents life- cycle wealth accumulation increased over time, particularly after 1940. I argue that about half of the wealth stock in the U.S. resulted from life cycle savings.
1 1. Introduction
The relative importance of the motives for wealth accumulation has been a major issue among economists. Distinguishing the roles of various motives for saving in the capital accumulation process is crucial to a number of economic issues, such as the source of capital formation in the course of industrialization (Ransom and Sutch 1986; Carter and Sutch 1996), the impact on savings of intergenerational reallocations of resources generated by social security (Feldstein 1974a; Barro 1974,
1978), the nature of wealth inequality (Atkinson 1971; Oulton 1976), and structuring fiscal policies
(Diamond 1970).
The more traditional belief is that life-cycle saving is the main source of wealth accumulation
(Modigliani and Brumberg 1954; Ando and Modigliani 1963; Modigliani 1986). This view was challenged by the work of Kotlikoff and Summers (1981), in which they report that the bulk of wealth accumulation is due to intergenerational transfers. Empirical work to test the life cycle hypothesis has been carried out on various grounds. A number of studies directly estimate the stock of wealth resulting from transfers and from life-cycle savings (Projector 1968; Kotlikoff and Summers 1981;
David and Menchik 1983; Ando and Kennickell 1987). The pattern of age profiles of wealth stock has been investigated (Shorrocks 1975; Mirer 1979; Ando 1985; Bernheim 1986; Hurd 1987).
In spite of all the work done on this issue, the gap between the two views is strikingly wide:
It is suggested by one side that about four-fifths of wealth accumulation result from retirement savings (Modigliani 1988), while the other side reports that only a fifth of current wealth stock is accounted for by life-cycle accumulations (Kotlikoff and Summers 1988). This wide gap results in part from a sharp disagreement on some conceptual and empirical issues which are critical for estimating the life-cycle wealth stock, including how to treat property income, expenditure on durable
2 goods and consumption expenditures of adult children in measuring life-cycle wealth, what is the age
of adulthood, and so on (Modigliani 1988; Kotlikoff and Summers 1988).
Moreover, it is unclear how the relative importance of various motives for savings changed over time. Various features of human lives have been greatly transformed over the last century, which
should may influenced household savings behavior in various ways. A rapid rise in life-expectancy
and a sharp fall in the labor force participation rate (LFPR) of older males, for example, should have
increased the average duration of retirement.1 A longer expected duration of retirement, according
to the life cycle hypothesis, would stimulate savings for retirement. The implementation of a wide
range of social insurance programs, including social security, unemployment insurance, workers’
compensation, and government-subsidized health care may have diminished the demand for private
insurance. In spite of the growing interest in the savings effects of the long-term demographic and
institutional changes, there is still little empirical evidence on their magnitudes.
This paper explains the time trend and the level of private savings in the United States over
the last century by estimating the proportion of savings that represents accumulation for retirement.
The key method of the present study is to estimate a counterfactual savings-income ratio that would
have resulted if retirement savings were the only motive for wealth accumulation and compare it with
the actual savings rates. This approach is distinctive in several aspects from other studies that directly
estimate the relative magnitude of life-cycle wealth stock: First, it measures the size of the demand
for retirement savings (how much should people save to meet the need for retirement consumption),
1At the beginning of this century, life-expectancy of males at age twenty was less than 42 years (Preston, Keyfitz, and Scheon, 1972: 724), while it was longer than 53 years in 1990 (U.S. Department of Health and Human Services 1992a: 34). A century ago, 65 percent of males aged sixty-five or older were in the labor force (Moen, 1987a); only 15 percent of men in the same age group participated in the labor force in 1993 (U.S. Bureau of the Census 1994: No. 615).
3 not the magnitude of savings that eventually resulted. This method is easier to implement empirically and subject to fewer conceptual problems and potential measurement errors compared to a direct estimation of retirement savings. Moreover, the magnitude of the need for saving for a particular motive may convey more accurately the importance of that motive because it captures the amount that people intend to save rather than the amount they actually save. Second, I assess the relative importance of life-cycle savings in terms of a flow measure (savings-income ratio for each year) as well as a stock measure (total wealth stock). An advantage of the former over the latter measure is that it enables us to infer the pattern of changes over time of the relative magnitude of a particular motive for savings. Finally, the analytical tool of this study makes it possible to decompose changes in the size of retirement savings into the contributions of different factors.
2. Conceptual Framework
Anyone who expects to retire at some point in his life will have to accumulate wealth to finance expenses during retirement. The longer the expected length of retirement, the more the person would have to save. The association between the duration of retirement and individual savings over the life cycle may be illustrated by the following simple life-cycle model.2 Consider a man who determines his consumption path over the life-cycle at the time of his entry into the labor market to maximize his lifetime utility.3 It is assumed that he makes the consumption decision for his given age
2This model is a modified version of the life-cycle model by Modigliani and Brumberg (1954). Unlike their model, income and consumption are allowed to vary over the life-cycle. In addition, the effect of a change in the interest rate is explicitly taken into account.
3Although we focus on males in this section for simplicity, the basic implications of the model are similar when a couple is considered as the unit of analysis. In this case, a couple determines how much to save over the life cycle for their given lifetime incomes and the husband's given age of retirement. Indeed, the estimation of a counterfactual life cycle savings rate in the subsequent sections is based on couples rather than individuals, using
4 of entry into the labor force, zero in this model, age of retirement, N, and life-expectancy at the time of entering the labor force, L. We also assume (1) there is no uncertainty about the age of death, (2) there are no bequests, and (3) the income profile is exogenously given, which is zero after retirement.
This man solves the following maximization problem, where Ca, Ya and r denote, respectively, consumption expenditure, income, and interest rate:
L C N Y (1) Max U(C ,...,C ) s.t. a ' a 1 L j a&1 j a&1 C1,...,CL a'1 (1%r) a'1 (1%r)
* * Suppose the optimal consumption profile for this man is {C1 , ...., CL }. The total lifetime saving for
* retirement is given from the budget constraint in the above equation, where Sa denotes the amount of savings:
N (Y &C () N S ( L C ( (2) a a ' a ' a j a&1 j a&1 j a&1 a'1 (1%r) a'1 (1%r) a'N%1 (1%r)
Now, we simplify the model to derive a formula for the individual savings rate. Suppose that income and consumption expenditures in the working and retirement periods are constant at their
age-consumption profiles of husbands and wives. A problem in applying the expected length of retirement of husbands to saving decisions of couples is that women live longer than men on average. Therefore, a couple may have to accumulate greater wealth than suggested by the expected duration of retirement of the husband. It is unclear, however, whether individuals accumulate adequate amounts of wealth to maintain the standards of living of their spouses while in widowhood. The especially high rates of poverty and of co-residence with relatives among widowed women suggest that this is probably not the case. Moreover, the major implications of the present paper are not significantly affected by incorporating the gender difference in longevity in the analysis. Such an adjustment would increase the estimate of the proportion of the wealth stock resulting from life cycle savings, reported in section 7, by 5 to 9 percentage points (A more detailed explanation for the method and result of this adjustment is available from the author upon request). For these reasons, the potential effect of the difference in the life expectancy between males and females will not be considered in the balance of this paper.
5 average levels, respectively, Y, CW and CR. That is, Sa = S and Ca = Cw for a = 1 to N, and Ca = CR for a = N+1 to L. If people allocate their savings for retirement evenly over the life-cycle, making the age- profiles of income and consumption move together, the constant savings in such a simplified model
4 (S = Y - Cw) should be a close approximation of the actual magnitude of savings at each age (Sa ).
Finally, it is assumed that the ratio of CR to Cw is ", that is CR = "Cw.
Under the above assumptions, the budget constraint in equation (2) is reduced to:
N 1 L 1 L 1 L 1 (3) S([ ] ' C [ ] ' "C [ ] ' "(Y&S ()[ ] j a&1 R j a&1 W j a&1 j a&1 a'1 (1%r) a'N%1 (1%r) a'N%1 (1%r) a'N%1 (1%r)
From equation (3), we have the following formula for individual life-cycle savings rate, s:
L 1 "[ ] ( j a&1 S a'N%1 (1%r) (4) s ' ' Y N 1 L 1 [ ] % "[ ] j a&1 j a&1 a'1 (1%r) a'N%1 (1%r)
The association between the life-cycle savings-income ratio and the expected length of retirement is seen more clearly when the interest rate is zero. The formula for savings-income ratio is reduced to the following equation in this case, where R = (L - N) / N:
S ( "(L&N) "R (5) s ' ' ' Y [N % "(L&N)] [1 % "R]
4This assumption is consistent with the empirical findings that household income and consumption profiles move in a similar manner (Carroll and Summers 1991; Deaton 1991; Deaton and Paxon 1993).
6 In this model, the longer the retirement duration (L - N) relative to the length of working period (N)
and the greater the average consumption expenditure in retirement (CR) relative to that while in the
5 work force (Cw), the larger the proportion of income one would have to save. An increase in interest
rate would reduce the savings-income ratio required for the target amount of retirement savings,
owing to the accrual to accumulation.
Under the assumption that the rate of savings for retirement is constant over the working
period, the life cycle savings rate of individuals in a cohort is constant across different years. And the
aggregate life cycle savings rate in a certain year (st) may be defined as the weighted average of the
fixed life cycle savings rate of each cohort (st,k):
st ' j Tt,kst,k k
The weight of a cohort (Tk) is determined by the relative size of its population and income.
Under the above definition, the aggregate savings rate is determined by the following factors: the patterns of mortality, fertility, retirement, consumption and productivity growth, long-term
interest rate, and labor market conditions. The patterns of mortality, retirement, and age-consumption
profile, and interest rate determine the expected length of retirement and individual savings rate.
Shifts in mortality and fertility affect the aggregate savings rate through changing the relative size of
5 If CR and Cw are the same (that is, " = 1) this model is reduced to the stripped-down Modigliani-
Brumberg model, where the proportion of income to be saved for retirement is (L - N) / L. CR and Cw do not appear to be the same, however. The actual age-consumption profile shows that retired people consume less than those in the work force on average because they are older and do not work. Food consumption should be smaller for a older retiree than for a younger worker, for example, because the size of energy requirement for a man depends upon his age and type of activity (Fogel 1993: 7-13). Labor force participation would also require fixed and variable costs of work. See Cogan (1981) for example. Low consumption of the elderly might be attributed to the fact that marginal utility of expenditure is low in older age. It might also be the case that consumption and leisure are substitutes (Deaton 1992: 5).
7 each cohort. If younger households in their accumulation phase account for a larger share of the
population, and retired dissavers for a smaller share, the aggregate savings rate would be greater. The
pattern of productivity growth and the labor market conditions would affect the relative income share
of each cohort. Younger cohorts have larger lifetime resources than older ones as a consequence of
rapid productivity growth, and, therefore, their savings are larger than the dissavings of the poorer,
retired cohorts. A favorable labor market condition for young workers would have the same effect.
3. Estimation of A Counterfactual Life-Cycle Savings Rate
For computing the life-cycle savings-income ratio for each cohort we need to estimate the
expected length of retirement, the ratio of consumption expenditure during the working period to that
in the retirement period ("), and long-term real interest rate. I begin with estimating the expected
length of retirement period at the age of entry into the labor force (ELRP, hereafter) for the labor market cohorts of 1850 through 1990.6 If a male worker retires at age x, the expected duration of his
retirement is his life-expectancy at age x, ex. Among males in a cohort, the proportion of persons who would have a retirement period of ex is equal to the probability of retiring at age x. Therefore, the expected retirement duration of a cohort can be estimated by calculating a weighted average of life-
6Although ELRP is a potentially important parameter determining consumption and saving behavior over the life cycle (Modigliani and Brumberg 1954; Munnell 1974; Modigliani 1986), only a few studies have estimated the length of retirement and these estimates have been based only on short periods of time. Darby (1979) has estimated the expected retirement duration at age 20 for 1890-1920, suggesting that a twenty- year- old man would have expected to have only a brief retirement period in the early twentieth century (1.9 years for 1900). Darby's calculation method is subject to a downward bias because he incorrectly assumes that individuals started to leave the labor force after age sixty-five. For the more recent period, Kotlikoff and Smith (1983) suggest that the expected duration of retirement of 25-year-old males was 5.93 years in 1950 and increased to 11.47 years by 1970. The estimate of Kotlikoff and Smith (1983) is based on survival probability and work experience rate reported in published sources. They indirectly estimated work experience rates as of 1950 because it was not classified by age in the published data. For this reason, their estimate for 1950 could be incorrect.
8 expectancy at each age of retirement. The weight assigned to ex is the probability of retiring at age x, which is the product of the following probabilities: the probability of remaining alive to age x (Sx), the probability of remaining in the labor force until age x conditional on surviving until age x (Tx), and the probability of retiring at age x conditional on remaining in the labor force alive at age x ((x).
Suppose labor force participation status and mortality are independent of each other. Then, among
the men who would retire between age x and x + 1 (SxTx(x), the proportion of those who die is equal to the mortality rate within the age interval (1qx). If the chance of retirement does not vary within the age interval, half of these men die before they leave the labor force. Therefore, the probability of
retirement between age x and x + 1 is Sx Tx (x [1 - (0.5×1q x)]. If a man retires between age x and x
7 + 1, his expected length of retirement is (ex + ex+1 ) / 2. Age twenty is chosen here for the mean age of entry into the job market.8 ELRP is given as:
7An implicit assumption made here is that life-expectancy at a certain age does not depend upon the labor force participation status. Since retirement is often induced by illness or disability, however, this assumption could lead to an overestimation of the average retirement duration. I have compared the length of remaining life of those who retired and who remained in the labor force at a certain age to see how significant this bias would be, using a longitudinal sample of Union army veterans (Lee 1996, appendix A). The result suggests that an adjustment for the shorter lifetime of retired men would not greatly change the size of the estimate because the life expectancy of retired persons was significantly shorter only for those who retired before age 60 and that number was relatively small. If such an adjustment is made for 1900, for example, it reduces the period estimate of ELRP by about three months or 8 percent. In addition, the difference in life-expectancy between retired men and the entire male population could have changed over time as the relative importance of poor health as a cause of retirement changed, and it is extremely difficult to measure this difference over a long period of time. In estimating the length of the retirement period, for these reasons, the potentially shorter life-expectancy of retired people is not taken into account.
8The mean age of entry into the labor force has changed over time. Twenty-five might be a more accurate entry-age for the later periods as assumed by Kotlikoff and Smith (1983). As long as the calculation of the length of retirement is concerned, however, the choice of the age of entering the labor force between 20 and 25 would not matter much because the mortality rate between ages 20 and 25 was low even at the turn of the century. Among twenty-year-old males in 1900, 3.4 percent would die within the following five years according to the life table. It implies that if twenty-five is chosen instead of twenty, the estimate of the expected retirement duration would be increased by 3.4 percent because the probability of surviving until the starting age of retirement fell by 3.4 percent. This difference is even smaller for the later years because of lower adult mortality.
9 89 ELRP ' j SxTx(x[1&(0.5×1qx)][(ex%ex%1)/2] x'20
If it is assumed that the age of starting retirement is fifty, 9 the following formula results:
89 20&50 ELRP ' D j SxTx(x[1&(0.5×1qx)][(ex%ex%1)/2] x'50 where, D20-50 is the probability of surviving until age 50 at age 20.10
It is crucial in estimating the ELRP to determine correctly how individuals form expectations about their future health, mortality, and labor force participation.11 Here, two extreme assumptions are employed to have upper and lower bound estimates. One assumption is that a twenty-year-old man assesses his retirement duration based on the expectation that current patterns of mortality and retirement will remain unchanged in the future. Since individuals may anticipate a decline in mortality and the LFPR of older males based on the past trend, this assumption would lead to a lower bound estimate of the ELRP. Period life tables and cross-sectional age-LFPR profiles should be used in calculations applying this assumption. The resulting estimate will be called the period estimate throughout this paper. The other assumption is that future changes in mortality and LFPR are
9This assumption is based on the actual age-specific retirement rates estimated from IPUMS of the censuses: the LFPR of males start to drop from around age 55 early this century, and from about 50 later.
10It is difficult to estimate correctly the LFPR of older males for each single age because the number of men aged over 70 is relatively small in the public-use micro samples. For this reason, a five-year age interval is used in the actual estimation. The underlying assumption is that the age-mortality and age-LFPR associations are linear within each five-year age range. This assumption looks like a fairly close approximation of the real age profiles of mortality and LFPR.
11The pattern of labor force participation is not exogenously given. Rather, it is determined by individual preference, income, and social institutions. Therefore, the expectation on the future pattern of retirement may be interpreted as the expectation on the future changes in the determinants of retirement decision.
10 perfectly foreseen by each cohort. In reality, even when individuals adjust their expectations taking into account past changes, they would likely fall short of the actual changes.12 Therefore, the estimate
derived from the second assumption may be an upper bound. Cohort life tables and age-LFPR profiles
of each cohort are needed to apply this assumption. This estimate will be referred to the cohort
estimate hereafter.
The probability of remaining in the labor force among the cohort who survive to age 50 at age
x is calculated as:
Tx = 1 - Rx
where Rx stands for the retirement rate at age x. The conditional probability of retirement during each
age range ((x) is estimated from Rx in the following manner:
1- Rx+1 = Tx+1 = (1 - (x) Tx
(1- Rx+1 ) / (1- Rx ) = Tx+1 / Tx = 1 - (x
(x = 1 - [ (1- Rx+1 ) / (1- Rx )]
Rx is estimated from Integrated Public Use Microdata Samples (IPUMS) of the censuses of 1850 to
1990 (Ruggles and Sobek 1995). For the cohort estimate we need the retirement rates as of 1995 to
2055. The projections of the Social Security Administration (U.S. Department of Health and Human
Services 1992b) are used for these years.13 Interpolations are used for estimating the figures for 1860,
12An example illustrating this point is that past changes in mortality have never been well predicted even by population experts. In the early seventies, for example, the U.S. Bureau of the Census claimed that no further major gains in life-expectancy would be achieved based on the mortality trend of the preceding decade. Today, scholars in a variety of fields are at odds over the future trend in adult mortality. There is no consensus on the biological limit of human lifetime (Fogel 1994; Ahlburg and Vaupel 1990).
13There are three alternative projections according to different assumptions. I use the upper projections of retirement rates because the purpose of the cohort estimate is to get an upper bound estimate of ELRP.
11 1870, 1890, 1920, and 1930, for which micro samples of the census are not available.14
The mortality rate within each age range (5dx) and life expectancy at each age (ex ) were
collected from the period life tables reported in Haines (1994) and Preston, Keyfitz, and Scheon
(1972), and the period and the cohort life tables in U.S. Department of Health and Human Services
(1992a).15 The probability of remaining alive among those who survive to age 50 is:
x&5 Sx ' k (1&5dj) j'50
TABLE 1 HERE
Table 1 presents the period and cohort estimates of the ELRP and their ratios to the life
expectancy at age 20. Both series exhibit a fairly rapid and continuous growth in the ELRP from 1880
through 1990. According to the period estimate, the absolute retirement duration more than
quadrupled, while its ratio to life expectancy tripled between 1900 and 1990. The cohort estimate of
the expected length of retirement is much greater than the period estimate throughout the periods under investigation. It is about twice as great as the period estimate between 1880 and 1960.
14 The current concept of the labor force has been in use since the 1940 census; the concept of gainful employment was used by the U.S. census through 1930. Therefore, the data on the labor force before and after 1940 are not directly comparable. Following the conventional definition of the labor force employed for the censuses through 1930, I excluded from the counting of the labor force the following males aged 50 and over: inmates of institutions, individuals with no occupation, and those whose occupation was reported as "capitalist," "landlord" or "retired." For the definition of the labor force for the censuses through 1930 see Ransom and Sutch (1986), Moen (1987a), Margo (1993), and Lee (1998).
15The cohort life tables after 1920 are partly based on the projections of mortality and life expectancy of each cohort in the future. The data used for estimating the period and the cohort estimates of ELRP are presented in Lee (1996, Tables D1 to D2).
12 Next, I estimate the ratio ", using micro-samples of the Cost of Living Surveys of 1888-90 and 1917-19, the Survey of Consumer Expenditures of 1972-73, and the Consumer Expenditure
Survey of 1994 (U.S. Department of Labor, BLS).16 According to the estimate, a retired couple would need about two-thirds of the amount they used to consume while in the labor force, and this ratio has been quite stable throughout this century.17
It is unclear what to choose for the long-term rate of return to retirement savings. The long- term average real interest rates for various low-risk securities suggest that one to two percent may be a plausible range.18 I employ six different interest rates ranging from 0 to 3 percent to see how much the estimate of the counterfactual savings rate is sensitive to the choice of interest rate.
Although the real interest rates fluctuate year to year to a great extent, there is little general long-term
16The cost of living surveys of 1889-1890 and 1917-1919 cover two-parent households only, although later consumer expenditure surveys include single householders. I chose a couple rather than an individual as the unit of analysis to make these different data sets comparable. These surveys report the annual expenses of each household, not of each member; therefore, individual age-consumption profile cannot be directly derived from the data. For this reason, I conducted a regression analysis for estimating individual age-consumption profile. Since the age-consumption profile could vary across different items, consumption goods are classified into several categories (seven categories for 1889-1890 and 1917-1919, and ten for 1972-1973 and 1994). For the detailed method and result of the estimation see Lee (1996, appendix B).
17The estimate of " is 0.71 for 1888-90, and 0.67 for 1917-19, 1971-72 and 1994.
18These securities include long-term government bonds (1.12 percent for 1900-1990), long-term corporate bonds (2.00 percent for 1900-1990), commercial paper (1.56 percent for 1900-1990), Treasury Bills (0.75 percent for 1920-1990), and pensions (1.44 percent for 1950-1980). The average of the annual stock yields for 1900-1990 is 1.62 percent. The annual inflation rate based on the CPI is subtracted from annual nominal interest rates to obtain the real rate. The time series for the nominal interest rates for government and corporate bonds and TB come from Homer and Sylla (1996), chapters 17 and 18. The average annual yields on commercial paper are from the updated data series of Shiller (1989), chapter 26, data appendix. The real annual rate of return to pensions is reported in Hu (1985: 221). The source for the annual stock yields is U.S. Bureau of the Census (1975, X479 and X483) for 1900-1970, and various editions of Statistical Abstract of the U.S. for 1971-1990. Kotlikoff and Summers (1981) suggest that the real annual rate of return in the U.S. economy averaged 4.5 percent between 1900 and 1974. The rate of return to retirement savings, however, may be lower than this estimate because people tend to invest in low-risk assets for the purpose of old age security. Even if 3 percent is chosen, the major implications of the result are not much different from those based on interest rates between 1 percent to 2 percent.
13 tendency. Therefore, the perception of the long-term rate of return should not greatly differ from a
cohort to another. For this reason, I apply the same interest rate to each labor market cohort.
The weight of each cohort is calculated in the following manner: First, the male population
is divided according to age: 20-29, 30-39, 40-49, 50-59, and 60 and over. It is assumed that the mean
retirement age is sixty, and thus the life cycle savings rate is zero for the cohort aged 60 and over.
The first four age groups are mapped into a particular labor market cohort; for instance, men aged
30-39 in 1940 are the 1930 labor market cohort. Let Pt,k and It,k denote, respectively, the population
size and the relative mean income of cohort k (the mean income of cohort k divided by that of the
cohort aged 20 to 29) in year t. The weight of each cohort in a certain year is calculated as:
Tt,k = Pt,k It,k / 3k Pt,k It,k
The population size of each age group for 1900 to 1990 is calculated from the data reported in U.S. Department of Health and Human Services (1992b). The mean income of each age group for
1940 to 1990 is estimated from IPUMS of the 1940-90 censuses.19 There is no income data available for the entire population prior to 1940. Relying on several different assumptions and using the consumer expenditure surveys of 1888-90, 1917-19, and 1971-72, I estimate the age-income profile for 1900-30.20 Fortunately, the estimate of the counterfactual savings-income ratio is not sensitive
19For 1940, the information on wages and salaries, not total income, is available. I calculate the ratio of wages and salaries to total income (W / X) for each age group, using the 1950 data, assuming that the ratio remained unchanged between 1940 and 1950. The mean income for each age range is calculated by multiplying wages and salaries and the inverse of the estimated ratio, X / W.
20The time trend in the index of relative income is increasing and approximately linear between 1950 and 1990. The first assumption is that the index before 1950 changed along the same trend. Accordingly, the index of relative income for each age group is calculated by extrapolation. This method gives a relatively flat age- income profile in the earlier period. The second assumption is that the age-income profile before 1940 was the same as that of 1950. This assumption leads to a relatively steep age-income profile for the period before 1940. Finally, the age-income profile may be derived from the cost of living surveys as of 1888-90 and 1917-19, assuming that the change over time of the relative index of income among men in consumer surveys is
14 to changes in the age-income profiles as of 1900-30 within a reasonable range.21
TABLE 2 HERE
Two different counterfactual life cycle savings rates, the period and the cohort rates, are derived using, respectively, the period and the cohort estimates of ELRP. Table 2 reports six different estimates for each of the two rates according to the choice of interest rate. Several features stand out from the trend. The counterfactual savings rate has increased substantially in a remarkably steady manner. The average of the period and cohort rates nearly tripled between 1900 and 1990.22 The cohort rate was well above the period rate throughout the period under investigation.
The results are quite sensitive to the choice of interest rate. For instance, an increase in interest rate from 0 to 2 percent reduces the counterfactual savings rate by a third. This outcome implies that long-term interest rate is an important determinant of the size of retirement savings. The proportional to that of the entire male population. This final method provides an intermediate estimate. See Lee (1996, appendix C) for more detailed explanation for computation method.
21The counterfactual savings rate reported in this paper is calculated using the intermediate estimate based on the final method. The size of population, the relative income, and the weight for each age group, used for estimating the counterfactual savings rate, are reported in Lee (1996, appendix D).
22The time trend in the counterfactual savings rate reflects the changes in the life cycle savings rate and the weight of each age group. The rise in the counterfactual life cycle savings-income ratio is entirely attributable to the growth of ELRP over time. The weight of each age group changed over time in the direction to reduce the aggregate life cycle savings rate. As the population got older on average and the slope of age-income profile became steeper, the weight of young men fell while that of the elderly grew over time. Since the proportion of income to be saved for retirement is greater for young men than the elderly, the bigger the weight of older cohorts is the lower the aggregate counterfactual savings rate would be. Mortality decline and the fall in labor force participation were equally important in accounting for the increase in the length of retirement between 1900 and 1940. After 1940, on the other hand, mortality decline was the dominant factor of the growth of the retirement duration. See Lee (1996, chap. 3) for more detailed method and result of the decomposition of the growth of ELRP.
15 estimates based on the interest rates within the range of 1 percent to 2 percent, which appears most plausible, convey relatively similar implications. In the following sections, therefore, I focus mainly on the estimates based on the assumption that interest rate is 1.5 percent.
4. Relative Size of Life-Cycle Savings, 1900-1990
For examining the relative importance of life-cycle savings, I compare the the counterfactual savings rate estimated above with various actual aggregate savings rates. For this purpose, I first use the conventional definition of savings rate based on the National Income and Product Accounts
(NIPA, hereafter). The personal savings rate (ratio of personal savings to disposable income) is probably the most widely used measure of the household savings rate. A number of studies, however, have reported that personal savings and corporate savings could be close substitutes (David and
Scadding 1974; Shafer, Elmeskov, and Tease 1992). In this respect, the private savings-income ratio
(ratio of personal savings plus undistributed corporate profits to disposable income plus undistributed corporate profits) may be more desirable.
Numerous studies have pointed out the problems of estimating savings rates based on the
NIPA (Blades and Sturm 1982; Auerbach 1985; Holloway 1989; Hendershott and Peek 1989). For purposes of this study, the exclusion of the public savings of households and investment in consumer durable goods, among others, should be the most serious defects of using the private savings rate based on the NIPA.
Savings in public funds. Household retirement transactions with the private sector are accounted for correctly in the computation of savings in the NIPA. However, a contribution to a government retirement plan or social security is not included in personal income and thus is not
16 counted as saving. Since the social security and public retirement plans serve as a means of retirement savings just as private pensions do, it makes little sense to treat them differently in computing the savings rate. To remedy the above conceptual problem, a new private savings rate is computed including contributions to the social security trust funds and government employee pension plans in disposable personal income and savings.
Consumer durables. The personal savings rate based on the NIPA treats expenditure on household durables as consumption. Since durables provide future consumption service, however, at least a part of their purchase represents a form of savings. An increase in savings in the form of purchasing consumer durables may have produced the downward trend in the private savings rate based on NIPA. For a new private savings rate incorporating durables-saving, the net (of depreciation) purchases of consumer durables, measured by the increase in the net stock of consumer durables, are added to private savings. Time series of the ten-year average of these savings rates are given in Table 3.
TABLE 3 HERE
FIGURE 1 HERE
Where the personal or private savings-income ratio is concerned, a marked difference is found between before and after 1940 in terms of the comparison between the counterfactual and actual savings.23 Movement over time in the counterfactual (both the period and the cohort) and the actual
23For this comparison, I recalculated the private savings rate of 1930 by interpolating the rates of 1920 and 1940 to get rid of the impact of the Great Depression from the time trend.
17 savings rates are fairly consistent, if not perfectly matched, during the first four decades of this
century. After the 1940s, on the other hand, the private savings rates fell while the counterfactual
savings rates increased. If the retirement savings in public funds are considered, the downward trend
in the private savings rate after 1940 disappears (see Figure 1). The time-series of the private savings rate between 1900 and 1990 reveals a tendency to increase slightly. In consequence, the new private savings rate is much more consistent with the counterfactual life cycle savings rate in the time trend than is the original private savings rate. The inclusion of durables savings substantially increases the level of the actual private savings rate for the period under investigation, particularly for 1950.
However, it appears not to be a major factor of the overall trend in private savings rates.24
The above result suggests that the long-term decline in the private savings rates since 1940
may be partly explained by the expansion of the social security and public pension plans. Even if the
retirement savings in public funds are added to private savings, however, the growth of the actual
savings rate is considerably slower than is predicted by the life-cycle hypothesis, particularly after
1940. In consequence, the proportion of private savings that represent life-cycle wealth accumulation
increased over time. The ratio of the counterfactual savings-income ratio to the actual private savings
rate was 25 to 45 percent for the first half of this century and 45 to 65 percent for 1950-1990 (see
24Investment in real estate may be another important type of wealth accumulation for households. The net investment in owner-occupied real estate (measured by the increase in the net worth of owner-occupied real estates held by households and non-profit institutions) was about 4.4 percent on average of disposable personal income between 1945 and 1990 (U.S. President 1992: 422). A similar figure (the ratio of the increase in the value of non-farm residential structures and land to disposable personal income) for 1897-1929 was about 2 percent. Though a part of this spending should represent savings, it is unclear what proportion of it should be counted as savings. If the entire part of this investment is added to savings, the new savings-income ratios are 25 to 30 percent higher than the private savings rates incorporating savings in public funds. The long-term trends of the two savings rates are parallel to each other. The inclusion of savings in real estate, therefore, would not affect the implications of the result for the time trend in the relative importance of life-cycle savings based on the actual private savings rate incorporating savings in public funds. It would only reduce the size of relative contribution of life-cycle savings to wealth accumulation to some extent.
18 Figure 1).25
5. Implications for the Motives for Wealth Accumulations
The result of this study suggests that life-cycle savings should have been modest, though not trivial, until the early twentieth century. According to the estimate of ELRP given in Table 1, a twenty-year-old male worker would have expected a considerable length of retirement, 7 to 12 percent of his remaining life at the turn of the century. If the rate of return to savings was 1.5 percent, people would have to save 3.7 to 6.4 percent of their incomes for retirement. This outcome is consistent with the study of Alter, Goldin, and Rotella (1994) who reported that life cycle accumulation was not a major motive for savings in mid-nineteenth century Philadelphia, and with the result of James, Thomas, and Palunbo (1997) that working-class Americans around the turn of the century saved very little.
The existing studies assess the relative importance of a motive for savings largely by looking
25Though beyond the scope of this paper, several possible explanations may be suggested for the slower growth of the actual private savings-income ratio compared to the pace predicted by the life-cycle hypothesis: (1) Individuals may develop a precautionary motive for savings when faced with uncertain future income (Leland 1968; Sandmo 1970; Skinner 1988; Zeldes 1989; Kimball 1990; Caballero 1991; Hubbard 1995). The degree of income uncertainty should have been reduced over the last century thanks to the implementation of a wide range of social insurance programs over the last century, including social security, unemployment insurance, workers' compensation, and government-subsidized health care (Kantor and Fishback 1996; Cutler and Gruber 1995). (2) A number of studies have suggested that when annuity insurance is not available, a risk-averse householder would leave a positive wealth stock at the time of death to avoid the prospect of remaining alive in a state of poverty even if he has no bequest motive at all (Davis 1981; Hubbard 1984; Kotlikoff, Shoven, and Spivak 1986). Such a precautionary motive for saving arising from uncertain lifetime may have been reduced due to a change in the time pattern of mortality and increased annuitization of income. (3) Private savings could have been discouraged by the increase in lifetime social security wealth among individuals, although the empirical evidence regarding this issue is mixed (Aaron 1967; Pechman, Aaron, and Tausig 1968; Munnell 1974; Feldstein 1974a; Barro 1974, 1978; Darby 1979). (4) Private savings may have been replaced by investments of other types such as education and health that are not counted under the conventional definition of saving.
19 at the proportion of the total wealth stock at a point of time that is accounted for by the cumulative amount of savings for a particular motive. Kotlikoff and Summers (1981), for example, infer the relative contribution of life-cycle savings from a comparison between their estimate of the life-cycle wealth accumulated between 1900 and 1974 and the net worth figure for the noninstitutional household sector in 1974.
This paper measures the relative importance of life-cycle savings in a different perspective, based on saving flow, not on wealth stock. It suggests what proportion of new addition to the wealth stock in each year results from life-cycle savings. An advantage of this measure is that it shows the pattern of changes in the relative importance of a motive for saving over time. The result of this study suggests that the proportion of savings that represents life-cycle savings has increased over the last century. For an interest rate of 1.5 percent, retirement savings account for 20 to 40 percent of private savings at the turn of the century. Life cycle savings today explain 50 to 70 percent of private savings including contributions to public funds. Such an increase in the ratio of retirement savings to the total private savings was more pronounced after 1940 than the first four decades of this century. As far as the trend is concerned, the result is robust for the choice of interest rate or the assumption on the pattern of expectation formation.
In order to make the measure comparable to those employed in other studies, I estimate the proportion of the wealth stock accumulated between 1900 and 1990 that resulted from life-cycle savings. The magnitude of life-cycle savings for each year is calculated from the counterfactual savings rate and data on aggregate incomes. If life-cycle savings fully account for private savings each year, the cumulative amount of life-cycle savings should equal to that of the total private savings. The sum of private savings including contributions to public funds between 1900 and 1990 is 20.6 trillion
20 dollars in 1990 dollars.26 The sum of the counterfactual life-cycle savings for the same period is 8.6 to 13.6 trillion dollars (applying, respectively, the period and cohort rates) for real interest rate of 1.5 percent. This outcome suggests that 42 to 66 percent of the wealth stock resulted from life-cycle savings over the last century.27
Although the range of the above estimates is somewhat wide, the upper bound is much smaller than the estimate by Modigliani, 80 percent, and the lower bound is greater than the figure suggested by Kotlikoff and Summers, 20 percent. This study thus suggests an intermediate view on the relative contribution of life-cycle savings to wealth accumulation in the United States. This result, however, does not warrant that about half of private wealth accumulation results from the motive for retirement saving today or in a certain year in the last century. If household saving behavior has changed over time, which is very likely, it may be misleading to infer the relative importance of a particular motive for saving based on the measure of wealth stock accumulated over a long period.
6. Conclusions
This paper has estimated the proportion of savings that represents accumulation for retirement in the United States over the last century. I developed a method of computing the expected length
26The figure is slightly greater than the net worth of household sector, 19.1 trillion dollars in 1990 (U.S. Bureau of the Census 1996: No. 742). The net worth figure for the noninstitutional household sector, which is used by Kotlikoff and Summers (1981) is about 17 to 18 trillion dollars, depending on the proportion of financial assets held by non-profit institutions. Even if these figures are used for the computation, the result does not change much.
27Although the size of the estimate depends on the choice of interest rate, the major implications are similar for interest rates between 1 percent and 2 percent. The estimate of the relative contribution of life-cycle savings to wealth accumulation between 1900 and 1990 is 47- 74 percent for interest rate of 1 percent and 37 -58 percent for interest rate of 2 percent. Nor does the inclusion of savings in consumer durables change the result significantly. The estimate in this case is 42-65 percent for interest rate of 1 percent and 33-51 percent for interest rate of 2 percent.
21 of retirement for each ten year labor market cohort between 1850 and 1990, based on its mortality and retirement experiences. The result suggests that since 1850 the expected length of retirement has increased by seven-fold and now represents up to 30 percent of men's lives after entry into the labor force. I also calculated age-consumption profile, and income and population shares for each labor market cohort. Using these estimates, I computed a counterfactual life cycle savings-income ratio for
1900-1990 that would have resulted if the savings for retirement were the only motive for wealth accumulation. The time trends of the counterfactual and the actual savings rates were fairly consistent between 1900 and 1940 and diverged thereafter. If contributions to the social security and government employee retirement funds are added to savings, then the time series of the two savings rates exhibit similar trends.
Even under the broader definition of saving, the growth of the actual private savings rate was slower than is predicted by the life-cycle hypothesis. In consequence, the proportion of private savings that represent life-cycle wealth accumulation increased over time, particularly after 1940.
Retirement savings accounted for about 30 percent of the total private savings at the turn of the century, about 40 percent in 1940, and 60 percent in 1990. Based on the magnitude of the life cycle wealth stock relative to the sum of total private savings over the last century, I argue that about half of the wealth stock resulted from life cycle savings, less than Modigliani's estimate of 80 percent and more than Kotlikoff and Summers' estimate of 20 percent.
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28 TABLE 1
Estimates of the Expected Length of Retirement at Age 20, 1850-1990
(1) (2) Period Estimate Cohort Estimate Year (Lower bound) (Upper bound)
(A) (B) (C) (D) (E) (F) (G) (H)
ELRP e20 (B) - (A) (A) / (B) ELRP e20 (F) - (E) (E) / (F) (years) (years) (years) (percent) (years) (years) (years) (percent)
1850 1.68 38.41 36.73 4.4 2.65 43.70 41.05 6.1 1860 1.77 40.32 38.55 4.4 3.18 43.95 40.77 7.2 1870 1.83 41.14 39.31 4.5 3.66 44.05 40.39 8.3 1880 1.62 39.65 38.03 4.1 4.27 45.65 41.38 9.4 1890 2.26 40.96 38.70 5.5 4.80 46.50 41.70 10.3 1900 2.93 41.73 38.80 7.0 5.50 47.29 41.79 11.6 1910 3.38 42.63 39.25 7.9 6.55 49.26 42.71 13.3 1920 4.38 44.45 40.07 9.9 8.24 51.36 43.12 16.0 1930 4.95 45.14 40.19 10.9 9.56 53.01 43.49 18.1 1940 5.76 46.77 41.01 12.3 11.59 54.32 42.73 21.3 1950 6.68 49.01 42.33 13.6 13.13 55.02 41.89 23.9 1960 7.88 49.65 41.77 15.8 14.26 55.54 41.28 25.7 1970 8.59 49.63 41.04 17.2 14.98 56.33 41.35 26.6 1980 11.27 51.73 40.46 21.7 15.65 57.17 41.52 27.4 1990 12.66 52.95 40.29 23.8 16.29 57.76 41.47 28.2 Source: Public-Use Micro Samples of 1850, 1880, 1900, 1910, 1940, 1950, 1960, 1970, 1980, and 1990 censuses were used for estimating the age-specific retirement rates for these years. The retirement rates as of 1860, 1870, 1890, 1920, and 1930 were calculated by interpolations. Period life-tables are from Haines (1994) for 1850-1890, from Preston, Keyfitz, and Schoen (1972) for 1900-1960, and from U.S. Department of Health and Human Services (1992a) for 1970-90. Cohort life tables for 1900-1990 come from U.S. Department of Health and Human Services (1992a). The cohort death rate in each age range for 1850 to 1890 was calculated from period life tables reported in Haines (1994). The cohort life expectancy at 20 was calculated based on the 10-year cohort life expectancy estimated by Pope (1992: table 9.2). See text for the calculation method.
29 TABLE 2
Counterfactual Life-Cycle Savings-Income Ratio for Selected Real Interest Rates (Percent)
Period Rate Year r = 0.0 % r = 0.5 % r = 1.0 % r = 1.5 % r = 2.0 % r = 3.0 %
1900 3.4 3.2 2.9 2.6 2.4 1.9 1910 4.0 3.6 3.2 2.9 2.6 2.1 1920 4.8 4.1 3.7 3.3 3.0 2.4 1930 5.5 4.9 4.4 4.0 3.5 2.8 1940 6.3 5.7 5.1 4.6 4.1 3.2 1950 7.0 6.6 5.9 5.2 4.6 3.7 1960 7.8 7.5 6.7 5.9 5.2 4.1 1970 8.9 8.5 7.5 6.7 5.9 4.6 1980 10.2 9.5 8.5 7.5 6.7 5.2 1990 11.5 10.7 9.6 8.5 7.5 5.9
Cohort Rate Year r = 0.0 % r = 0.5 % r = 1.0 % r = 1.5 % r = 2.0 % r = 3.0 %
1900 6.4 6.1 5.5 4.9 4.3 3.4 1910 7.2 6.9 6.1 5.5 4.8 3.8 1920 8.1 7.7 6.9 6.1 5.4 4.2 1930 9.3 8.8 7.8 6.9 6.1 4.7 1940 10.7 10.0 8.9 7.9 6.9 5.3 1950 12.2 11.2 10.0 8.8 7.8 6.0 1960 13.7 12.6 11.2 9.9 8.7 6.7 1970 15.2 13.8 12.3 10.9 9.6 7.4 1980 15.9 14.5 12.8 11.4 10.0 7.7 1990 16.2 14.8 13.2 11.7 10.3 7.9 Note. See text for the definition and calculation method. r denotes annual real interest rate.
30 TABLE 3
Actual Private Savings-Income Ratios, 1900-1990 (10-Year Average, Percent)
(1) (2) (3) (4) (5) (6) Year Personal Private Public Durables S+C+P S+C+P+D S S + C P D
1900 9.9 12.6 0.0 2.4 12.6 14.9 1910 10.1 13.8 0.0 1.7 13.8 15.4 1920 12.9 12.4 0.0 1.7 12.4 14.4 1930 4.1 1.4 0.4 -0.3 1.6 1.3 1940 12.6 15.1 1.4 0.5 16.2 16.7 1950 6.7 12.1 2.0 3.7 13.8 17.2 1960 6.0 9.9 4.1 1.0 13.4 14.4 1970 7.2 10.9 7.5 2.0 16.8 18.6 1980 6.5 10.3 10.0 1.2 18.2 19.2 1990 4.3 6.6 12.1 1.7 16.5 17.9 Definition and source: (1): The ratio of personal savings to disposable personal income. Annual data on personal savings and income were collected from U.S. Bureau of the Census (1975: F6-9; F543; F553) for 1897-1970, and various editions of Statistical Abstract of the U.S. for 1971 to 1993. (2): The ratio of private savings (personal savings + undistributed corporate profits) to private income (disposable personal income + undistributed corporate profits). The annual data on corporate profits for 1929 to 1990 were collected from U.S. Bureau of the Census (1975: F183) for 1929-70, and various editions of Statistical Abstract of the U.S. for 1971-93. The figures for 1900 to 1920 were calculated from the 10-year averages of private savings-income ratios as of 1890-99, 1900-09, 1910-19, and 1920-29, reported in Darby (1979: 25). (3): The ratio of savings in public funds (contributions to the social security trust funds and the government employee pension funds) to disposable personal income. The contributions to the social security trust funds include the net contributions to the Old-Age, Survivors and Disability Insurance (OASDI) and the Medicare (Hospital and Supplementary Medical Insurance). The data used in the computation are U.S. Department of Health and Human Services (1991: 129-30, 263-64) for 1937-1989, and U.S. Bureau of the Census (1994: 375 No. 581) for 1990-1992. The sources for the contributions to the government employee pension funds are Hendershott and Peek (1989: 202) for 1950-85, U.S. Bureau of the Census (1994: 378, No. 584) for 1986-1992. The data for 1929-49 are estimated assuming that the growth rate of the contributions was the same as that of the expenditure. The source for the expenditure on public employee pensions is U.S. Bureau of the Census (1975: 340, H8). (4): The ratio of the net purchases of consumer durables (measured by the increase in the net stock of consumer durables) to disposable personal income. The data sources for durables are Goldsmith (1962: 188) for 1900, 1912, 1922, 1933 and 1939, U.S. President (1992: 422) for 1945-90, and U.S. Bureau of the Census (1994: 483, No. 745) for 1991. (5): The ratio of private savings plus savings in public funds (contributions to the social security trust funds and the government employee pension funds) to the sum of disposable personal income, undistributed corporate profits, and savings in public funds. (6): The ratio of the sum of private savings, savings in public funds, and the net purchases of consumer durables to the sum of disposable personal income, undistributed corporate profits, and savings in public funds.
31 32 FIGURE 1 Private Savings Rates Incorporating Savings in Public Funds and Durables 20
15
10
5
0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 Year
counterfactual savings rate (average for r = 1.5 percent) actual savings rate incorporating savings in public funds actual savings rate incorporating savings in public funds and durables
32