People care about the wellbeing of their children and typically try to leave them bequests. At the same time, children have aspirations to have a better standard of living than their parents. They also develop ‘habits’ by which they become accustomed to a certain standard of living and expect to consume more in the future.
The interaction of these basic human motivations are examined in new research by Jaime Alonso-Carrera, Jordi Caballé and Xavier Raurich, published in the April 2007 issue of the Economic Journal. They show that:
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An increase in habit intensity increases the amount of consumption in old age, since stronger habits reduce the overall benefits from consumption in youth. To consume too much when individuals are young is a form of addiction that will diminish the benefits associated with consumption when old.
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If individuals leave bequests, the amount of savings remains constant and a reduction in the amount of bequests occurs whereas, if individuals do not leave bequests, only the amount of saving increases. In both cases, the outcome is a reduction in the amount consumed at early stages of life.
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On the other hand, an increase in aspiration intensity makes individuals raise the amounts of both savings and bequests in order to outweigh the negative effect of stronger aspirations for their descendants' benefits when young.
In terms of the policy implications of intergenerational altruism, the researchers analyse whether the ‘neutrality proposition’ holds with habits and aspirations. This proposition says that altruistic individuals can outweigh at the family level all the effects of government deficits. Individuals internalise the fact that future generations will have to face a tax rise in order to pay for the principal and the interest of the government debt issued today as a consequence of the current deficit.
Therefore, altruistic parents raise the amount of bequests left to their descendants so as to neutralise the effect of those future tax payments. Moreover, the current reduction of taxes is not triggering more productive investment by the present generation since all the increase in disposable income is channelled towards increasing the amount of bequests.
But this argument relies on the critical assumption that generations must be effectively linked by means of positive bequests. If bequests were zero, then no adjustment in its amount would be possible. In other words, in order to obtain the neutrality of public deficits, individuals should exhibit a sufficiently high level of love towards their children.
This study shows that aspirations (based on the standard of living of parents) make the existence of positive bequests easier, whereas habits (based on own past consumption) make it difficult for the bequest to be positive. Therefore, introducing a realistic characteristic in individual preferences like habits could invalidate one of the main propositions of classical macroeconomics, namely, that fiscal deficits have no economic consequences.
There is a long-standing debate among economists about the relative importance of bequests and lifecycle saving on capital accumulation, wealth inequality and economic policy. More specifically, theoretical and empirical research has studied whether intergenerational transfers motivated by parental altruism play a crucial role in accounting for the observed saving patterns. For instance, some studies have shown that at least 80% of US capital stock is accumulated through intergenerational transfers and that 50% of individuals save in order to leave an estate.
Several alternative motives leading to intergenerational transfers have been proposed. Although there is still some controversy over the reasons why individuals make intergenerational transfers, some empirical research has found evidence that intergenerational altruism is one of the most likely. Altruism means that parents care about the wellbeing of their children and this makes them to try to leave bequests to their descendants.
In addition to altruism, preferences of individuals might display other characteristics, like habits or aspirations. Habits relate to the fact that the benefits associated with a given amount of current consumption depend on the past experience of consumption of the individual under consideration.
For example, two individuals owning the same luxury car could experience a different level of satisfaction depending on whether their previous car was also a luxury or a sub-compact one. The individual who previously owned a sub-compact car should be happier with his new car as he has not yet formed habits concerning luxury cars.
Meanwhile, aspirations relate to the fact that the benefits individuals get from consumption depend on the consumption experience of their predecessors. In other words, individuals inherit tastes from their parents and they use the standards of consumption of their parents as a reference for their future consumption.
In both cases, past consumption is used as a reference with which current consumption is compared. Under habits, the reference is own past consumption, while under aspirations, the reference is parents’ consumption.
ENDS
Notes for editors: ‘Aspirations, Habit Formation, and Bequest Motive’ by Jaime Alonso-Carrera, Jordi Caballé and Xavier Raurich is published in the April 2007 issue of the Economic Journal.
Jaime Alonso-Carrera is at the Universidade de Vigo. Jordi Caballé is at the Universitat Autònoma de Barcelona. Xavier Raurich is at the Universitat de Barcelona.
For further information: contact Jordi Caballé on +34-935-812-367 (email: Jordi.Caballe@uab.es; webpage: http://selene.uab.cat/jcaballe/); or Romesh Vaitilingam on 07768-661095 (email: romesh@compuserve.com).