Life Cycle Earnings in a Fast-Growing Economy

Zheng Michael SongDennis Tao Yang

Discussion by Christopher CarrollJanuary 7, 2011

Song and Yang China’s Saving Rate

Bottom Line

Very interesting paper; fabulous new data from China

“Highly Preliminary” – as is my critique.

Previous literature: Habit formation, precautionary saving,capital market imperfections, or other factors are needed toexplain remarkable increase in Chinese saving rates

Authors: It is explainable by an old-fashioned life cycle model

Intertemporally separable utility (no habits)Perfect foresight about income growthNo important capital market imperfections

Just need to account for changing pattern of income by age

Bottom Line

Depends on What the Meaning of Is Is

My interpetation: Chinese behavior is not explained credibly by anoff-the-shelf model

By “off the shelf” I mean a model with:

Preferences that are stable over time and across countries

Time preference rate; intertemporal elasticity; bequest motive

Plausible assumptions about expectations of income growth

Why “stable” preferences?

Arbitrary variation in preferences can explain anything

What are “plausible” expectations about income growth?

Forecasts that could plausibly have been made at the time

Agents not allowed “sneak peek” at future outcomes (notperfect foresight)

What version of a LC model is consistent with their data?

1 Today’s Chinese HH’s are much more pessimistic about theirown personal income growth than today’s American HH’s

2 HH’s in 2007 believed income growth in the future would belower than households believed growth would be in 1992.

In 15 years to 1992, avg income growth was a remarkable 5pct per yearin 15 years to 2007, avg income growth was an amazing 8 pctper year

1992-2007 certainly fastest sustained growth in Chinese history

Required beliefs: HH’s in 2007 (after astounding 1992-2007growth) are much more pessimistic about growth than HH’s atsimilar ages were in 1992

3 HH’s in 1992 were more pessimistic about income growththan HH’s in 1978

Economists have been accused of being willing to believe 8impossible things before breakfast. But it is slightly after breakfastnow, so you might be excused if you join me in not believing thesethings.

Accounting for Growth

Alternatives:1 Individual (idiosyncratic)

Affects only one specific household/person

2 Generational (cohort)

Affects similarly every household/person born at the same date

3 Societal (time)

Affects every household/person same way at same time

For aggregate questions (‘national saving rate’), (2) and (3) are key

3 Societal (time)

Growth Decomposition

Friedman-definition “permanent income”: Avg for “similar” people

For person age 25 in 1992:

ppp1992,25 = Date1992 + GenerationY + Wrinkles1992

ppp2007,25 = Date2007 + GenerationZ + Wrinkles2007

For person age 40 in 2007

Data are cross-section, both date and wrinkles have changed:

same person︷︸︸︷ppp2007,40 − ppp1992,25 = ∆Date +

=0︷︸︸︷∆Generation +∆Wrinkles

Why It Matters for Consumption

LC/PIH says C is based on expectations about lifetime income

Perfect foresight infinite horizon constant growth:

Ct = (r − ρ−1(r − ϑ))(Bt + Ht)

Ht =Pt

r − γ

Summers (1981)/Tobin (1967): Human Wealth effect is huge(n.b.: If r < γ, Ht =∞)

Ct = (r − ρ−1(r − ϑ))(Bt + Ht)

Ht =Pt

r − γ

Ct = (r − ρ−1(r − ϑ))(Bt + Ht)

Ht =Pt

r − γ

Big Problem: G ↑⇒ S ↑

Cross-section: Modigliani (1970s, 1986)

Granger-causality: Carroll and Weil (1994), Attanasio et al(2000), Rodrik (2000)

Lots of other papers now (cf. Gourinchas and Jeanne (2007))

More convincing: ‘Narrative approach’

Japan, Korea, Hong Kong, Taiwan, Singapore, ....

OECD countries post-1974

Japan post-1990

Escape? Modigliani

Suppose aggregate growth has no effect on individual growth

Compare two countries:

A has zero pty growth

C has 8 percent pty growth

Compare two individuals in those countries:

Age 60 in 2010

60-year-olds in both have same income they did at age 25

25-year-olds in both countries expect same growth that25-year-olds expected in 1975

Agg growth all comes from higher level of initial income uponentry at 25

Escape? Modigliani

Age 60 in 2010

Escape? Modigliani

Age 60 in 2010

Escape? Modigliani

Age 60 in 2010

Escape? Modigliani

Age 60 in 2010

Escape? Modigliani

Age 60 in 2010

Escape? Modigliani

Age 60 in 2010

Implied Cross-Section of (Lifetime) Income By Age

25 30 35 40 45 50 55 60Age

1.0Income

Cross Section Age�Earnings Profile

Problem: Modigliani/Friedman ⇒ C = P

Simplest Alternative: It’s all date effects⇒ similar cross-section age-income across countries

Empirically, roughly true (certainly better than Modigliani)

Does Precautionary Saving Change Things?

No. Carroll and Toche (2009):

a ≈(

(γ − r) + ϑ(1 + (γ/f)(1− (γ/f)ω))

and staring at this (or solving models) convinces you thatγ ↑⇒ a ↓ (Summers was right)

... but if growth increases are always accompanied by increases inf, then maybe ...

Carroll and Jeanne (2009)

Sandri (2009)

a ≈(

(γ − r) + ϑ(1 + (γ/f)(1− (γ/f)ω))

Sandri (2009)

a ≈(

(γ − r) + ϑ(1 + (γ/f)(1− (γ/f)ω))

Sandri (2009)

Authors’ story: China is Modigliani on Steriods!

Show clockwise rotation in cross-section profile in ChinaCurrent 25-year-olds

Much higher income level than their parents hadSimilar income at 25 to current 55-year-oldsBut expect worse income growth than their parents expectedShould show implied beliefs about absolute income growthover lifetime, not cross-section

Pension system phase-outHealth care system privatizedNo kids to take care of youPeople just look to older HHs, don’t think about growth

Assessment

I don’t buy it

Unexplained: Why does this always happen?

Japan, Korea, Hong Kong, Taiwan, Singapore, ... now ChinaAge/income profile always rotates? Not likely ...

Leaves high absolute level of Chinese saving rates unexplained

Assessment

I don’t buy it

Assessment

I don’t buy it

Assessment

I don’t buy it

Assessment

I don’t buy it

Patrick Henry, Thomas Sargent, and Economic Man

“I know no way of predicting the future but by the past” – PatrickHenrySargent: Model expectations as coming from regression analysis ofpast dataLaibson et al (current JEP): “Natural Expectations”Authors: “Myopic expectations” – need to go further

Precautionary Saving?

Carroll and Jeanne (2009) Chamon, Prasad, and Liu (2010):

Big increase in precautionary saving

Effective phasing out of pensionsEffective privatization of health careUncertain political/economic future

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Even so:

ρ ≈ 5

β ≈ 1

Habits (Carroll, Overland, and Weil (2000))

Habits + Precautionary

Political economy (?)

Corporate governance (?)

A Big Question

Very valuable new data

Much work remains to be done

A Big Question

Very valuable new data

Much work remains to be done

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