Measuring “OK Boomer”

In a sense OK Boomer has a history as long as the lives of Baby Boomers themselves – at least if we relate such things to the overlapping generations models in economics.

The literature on OK Boomer/intergenerational transfers

The first “OK Boomer” paper was written by the Nobel prize winning economist Franco Modigliani and his co-author Richard Brumberg in 1954. To analyse the process of saving and wealth transmission, they developed the overlapping generations model of an economy – simply a model in which people of different ages and incomes and wealth all live together, just like the real world.

One of the many insights of this model is that there is a constant transfer of assets between people of different ages, with younger people typically buying assets from older people as the former save and the latter dissave.  Since then overlapping generations models have been a core part of the macroeconomics curriculum around the world.

Two big insights followed. The first came in 1965 when another Nobel winning economist, Peter Diamond, analysed the costs and benefits of different ways of funding government programmes in which the average age of recipients is quite different than the average age of taxpayers. 

He showed that policies that provide resources to young people (such as education) provide an implicit transfer between generations that favour young people if they are funded out of current tax receipts and the economy is dynamically efficient. (An economy is dynamically efficient if the return to capital exceeds the growth rate of the economy – a condition that held in most OECD countries in the 20th and 21st centuries.) 

Conversely, policies that provide resources to old people (such as retirement incomes) provide an implicit transfer between generations that favour old people if they are funded out of current tax receipts. These policies impose large opportunity costs on young people, who would be much better off if retirement incomes were funded by accumulating assets.  

The paper also showed that the size of the government budget does not measure the size of these opportunity costs and benefits on different generations. If a government expands a pay-as-you-go retirement income policy at a particular time, it can have a balanced budget every year, and the policy can still impose very large opportunity costs on all current and future generations of young people. Quite simply the fiscal balance does not adequately measure these costs.

The next insight came from Martin Feldstein in 1977. He showed that tax policies that favour investment in property become capitalised in the price of land and lead to intergenerational transfers by altering the prices at which generations exchange property assets. This idea actually has a much longer history – it was the basic argument of Henry George’s Progress and Poverty (1879), one of the biggest selling books of the nineteenth century. 

Feldstein argued that if income from property was taxed less than other assets the price of land would be bid up, reducing the living standards of all subsequent generations in favour of the first generation of owners, unless the first generation left their additional wealth as a bequest. Moreover, because young people have to allocate more of their savings to property purchase when the prices are high, less is invested in other assets and capital investments (and productivity) in the economy fall.

These insights have made overlapping generations models the tool of choice for analysing the effects of fiscal policy in most countries. They provide a way of appropriately measuring the way that the costs and benefits of different policies fall on different generations. 

Bringing this back to the New Zealand case

In this way it is unsurprising that New Zealand was the first place to see the term used in debate in parliament – as New Zealand has retirement income policies and some tax policies that are very different from those used in most OECD countries in the direction of transferring to the boomer generation.

This isn’t to say this has been an explicit generational choice.  Instead government departments have never developed standard heterogenous agent overlapping generation models to evaluate the intergenerational effects of these policies. Nor do they routinely measure the opportunity costs on different generations of these policies. As a result, New Zealand could have adopted policies that impose huge opportunity costs on current and future generations of young people or provide them with huge benefits, and we wouldn’t know. 

Over the past decade I have tried to estimate some of these costs using a small overlapping generations model that is much less sophisticated than some of the amazing models used overseas. The results consistently suggest young people in New Zealand have a reasonable grounds for complaint. 

In keeping with standard international results, our pay-as-you-go retirement income system imposes very large opportunity costs on young people, costs which are getting higher with every cohort. Moreover, changes made to the way retirement savings were taxed in 1989, – incidentally, changes that have not been copied by any other OECD country – increase the tax advantage of owner-occupied residential property as an asset class. 

Standard overlapping generations models suggest this should lead to higher land prices benefiting the owners at the time of the tax change, who happened to be the boomers. The intergenerational effects on land prices and the welfare of future generations do not seem to have been considered at the time the change was made, as far as I can tell from a detailed reading of the contemporary documents – and it certainly was not modelled using an overlapping generations model, for these were not used in New Zealand at the time. 

With any issue you can form tribes to attribute blame, or you can try and fix it. Fixing tends to be the better option for most people, although some politicians find it profitable to subjugate this process and promote tribal warfare. 

In this case, there seems to be an obvious first step – better measurement of the problem.  For whatever reason, a generation of boomer economists, politicians and bureaucrats have under-invested in the standard economic tools used to evaluate the intergenerational implications of economic policies. 

New Zealand is now one of the very few countries not to have developed National Transfer Accounts, and as far as I know there are no large-scale overlapping generations models in use to understand New Zealand’s unusual fiscal policy settings.  These models are used overseas to study the intergenerational consequences of environmental policies, of long-term wealth distribution, of educational policy. 

Perhaps, 75 years after they were first developed, it is time to develop a proper large-scale overlapping generations to measure the intergenerational effects of New Zealand’s policy choices. 

Note –  a more comprehensive set of references and longer argument is available from the following paper.