(This essay was published in Hong Kong Economic Journal on 6 April 2016.)


There is strong agreement among most economists that the lives of young people from lower and lower middle-income families will be worse than their parents’ generation. But those that come from the upper and upper middle-income families will be better off than their parents’ generation. Society is becoming more divided and it is passing this onto the next generation. But economists differ in their interpretation of what is driving the difference. And this has important implications for how society and government should be responding to intergenerational differences.


Professor Joseph Stiglitz, Nobel economist at Columbia and a left-leaning Democrat, recently claimed that the voting patterns of the young generation are markedly different from their parents’ generation on both sides of the Atlantic. This is also noticeable in Hong Kong.


He attributes the difference to a growing divide between two generations whose past and current lives are so different from each other and whose prospects are so different.


I believe he generalizes far too much. Let me consider the intergenerational differences identified by Stiglitz in turn. These concern jobs, security, and homeownership.


First, Stiglitz claims the parents’ generation had well paying jobs that were waiting for them. Today’s youths will have to search for many months to find a job, including some college graduates, and are unable to move out of their parents’ household.


To claim there are fewer well paying jobs now than in the past is simply another way of saying inequality is rising over time. It happens when individuals with higher incomes experience faster income growth, and those with lower incomes have slower income growth.  There is plenty of evidence from many countries that this has indeed become the case in the past three to four decades. But why has this happened?


My explanation for rising income inequality is the changing effects of human capital investment. Technological advances have increasingly rewarded the better educated with higher incomes. The rate of return to schooling is higher for the young generation today than it was for their parents’ generation in the past.


This problem can be remedied if more individuals become better educated. Investing in human capital would directly raise the incomes of more individuals by making them more productive. It would also indirectly increase the incomes of the less well educated in the population by reducing their relative supply. The rising income inequality is therefore a failure of society and government’s human capital investment policy.


But the problem is made more difficult because many born into lower and lower middle-income families have made too little human capital investments because their parents are often divorced. They have been raised in single parent households and in bad neighborhoods, where there are no good role models to learn from and to emulate. Assortative mating擇偶通婚further strengthens these effects as women have become better educated over time. Better-educated men are now more likely to marry better-educated women, and this is further worsening the human capital investment opportunities of the young generation in less well-educated families. They have fallen behind long before they could come to college. So despite subsequent efforts to catch up, they are still disadvantaged. The race today starts on day one.


Their fate is in sharp contrast with the young generation from upper and upper middle-income classes whose parents are much less likely to be divorced. They have made massive amounts of human capital investments from early childhood.


Stiglitz claims the young generation thinks they are getting a worse deal than their parents’ generation. He asserts that this is not because the young generation are not studying and working hard enough. But they are incensed that the economic game is rigged as they see bankers, who brought on the financial crisis, walk away with mega-bonuses, with few being held accountable for their wrongdoing.


As a consequence, they have lost trust in the political elites that promised unprecedented prosperity for many. They see free market capitalism as benefitting only the top 1%, who became incredibly well off. Stiglitz asserts “we won’t be able to fix the problem if we don’t recognize it.” He claims, “Our young do. They perceive the absence of intergenerational justice, and they are right to be angry.


Stiglitz’s point may be correct if he is referring to a fraction of the young generation. But the rise of angry politics is not restricted to voices from the political left; it also comes from the political right. In the U.S. you have supporters of the Tea Party who advocate religious awakening, family values, individual responsibility, pro-life, and less government. There is also the Trump phenomenon whose support comes from the failing White lower and lower middle-income classes.


Stiglitz is also wrong to identify the political problems of the growing economic divide with only the top 1% of the income distribution. They are not the only group who have benefitted from making more investment in human capital. The income of the top 1% is rising faster than the top 5%, the top 5% is rising faster than the top 10%, the top 10% is rising faster than the top 25%, and so on. The effect is happening across the entire income distribution. This is fundamentally a deep social and economic problem, and not a political one.


Second, Stiglitz claims that the parents’ generation have attained job security, married young, bought a home, can expect to retire with reasonable security and even in comfort, and have lived generally better than their parents. The young generation will face job insecurity throughout their lives and are frightened by how much they will need to save to live a decent life, including for retirement.


There are a host of problems here. But the central issues are the ailing social pension systems, and the rising cost of medical care and urban housing.


The insolvency of social pension systems is one basic reason why the young generation now has to save a frightening amount for their old age and why they are so concerned about well-paying jobs and job security, which sadly some of them are unlikely to find for lack of human capital. In this respect the young generation are right to be unhappy with their parents’ generation who voted in generous social pensions that are now insolvent because their life expectancies are so much higher.


Each generation has a responsibility to the next. In the rich nations the contract between the parents’ generation and the next has been violated. To restore the generational balance, two things will have to be done.


First, immediately and permanently cut all government outlays by X%, and second, immediately and permanently raise all government taxes by Y%. The amount of X and Y will differ from nation to nation but in each they will be in the double-digit levels.


The problem is that if these measures are not implemented immediately, the percentages required to restore the generational balance will rise each and every year. While this is what is required to achieve generational balances, the individuals responsible for such decisions are pursuing the opposite path – spend more and tax less. So hardly anyone in the young generation is convinced that any of the political elites will make this happen and that is why they are naturally angry, and prey to populist demagoguery.


The rising cost of medical care is a product of technological advances. The strange case of medical advancement is that as it delivers new services that can bring down medical costs, its demand also increases because of highly elastic income and price elasticities of demand. Spending on medical care increases both absolutely and as a share of income.


While one can view medical expenditure as the cost of leading a secure and comfortable life today, one must also remember that it is an intergenerational benefit – it will also help today’s young to live better and longer. So it is not at all obvious that this cost will make the young worse off than their parents, even among the disadvantaged.


Third, Stiglitz notes that the parents’ generation has, to their pleasant surprise, earned more from the capital gains on their homes than from working. The children of the upper middle class will therefore do well, because they will inherit housing wealth from their parents. But for most others the cards are stacked against them attaining anything approaching what was once viewed as a basic middle-class lifestyle. Buying a home is a distant dream.


But the rising cost of housing is now increasingly well understood. Contrary to Stiglitz’s insinuation that it is a windfall from speculative activities, rising housing prices is a universal phenomenon common to all urban centers and it has been ongoing since the end of the last world war. The more thriving the city, the more people will flock to the city. Urban high-density living is the primary reason why housing is expensive and rising in cities, and why it is a source of urban poverty and inequality.


A voluminous body of recent research in the U.S. and Europe has shown that regulatory rigidities in land use development and building construction have further reduced the supply of housing. It is the most important driver of rising housing prices in major metropolitan areas.


Professors Chang-Tai Hsieh of the University of Chicago and Enrico Moretti of the University of California, Berkeley studied 220 US metropolitan areas from 1964 to 2009 and found that high housing prices had reduced labor flows across cities and lowered aggregate U.S. GDP by 13.5%. The primary cause was regulatory rigidities in housing supply in high productivity cities like New York, San Francisco and San Jose.


Professors Hsieh and Moretti concluded that lowering regulatory constraints on housing supply in these cities to the level of a median city would expand their work force and increase U.S. GDP by 9.5%. The problem of high and rising housing prices that is the woe of the young generation is not a result of the failure of free market capitalism, but of regulatory constraints that prevent markets from functioning properly.


Stiglitz concludes that “three realities – social injustice on an unprecedented scale, massive inequities, and a loss of trust in elites – define our political moment, and rightly so…that is why the center-left and center-right parties are losing.” He does not think more free market capitalism is the answer. “[I]f socialism means creating a society where shared concerns are not given short shrift – where people care about other people and the environment in which they live – so be it.”


It is understandable that almost eight years into a financial crisis, a deep recession, lethargic growth, unaffordable housing, rising income inequality, poverty and lack of mobility among the disadvantaged, people are frustrated. This is not limited to the young generation. But is Stiglitz presenting a correct explanation? I don’t think so, at least not from the large amount of research that has been done on these issues. We have a good idea about why there is an intergenerational divide. And we also know enough about what has to be done to close it.


The strongest evidence we have of why Stiglitz’s view is problematic comes from the angry voices we hear. They come not only from those who want more government, but also from those who want less. The young generation that is discontented speaks with many different voices: some embrace socialism and others capitalism. Even more significantly, they embrace a whole spectrum of other views that cannot be reduced to socialism versus capitalism.


I think the pessimism of the young generation is not only rooted in the intergenerational socioeconomic divide, but also in the cultural mood of the postmodern era they grew up in.


The term postmodern first appeared in the 1930s. But postmodernism as the description for a broad cultural phenomenon only gained widespread attention in the 1970s; and that is why their parents’ generation was less affected by it. It was a quest to move beyond modernism – the human intellectual quest to unlock the secrets of the universe in order to master nature for human benefit and create a better world.


The modern mind has faith that progress is inevitable, and knowledge will eventually free us from our vulnerability to nature, as well as from all social bondage. In the postmodern world, people are no longer convinced that knowledge is inherently good. In eschewing the modern myth of inevitable progress, postmodernism replaces the optimism of the last century with a gnawing pessimism. Gone is the belief that every day, in every way, we are getting better and better.


Members of the emerging young generation are no longer confident that humanity will be able to solve the world’s great problems or even that their economic situation will surpass that of their parents. They view life on earth as fragile and believe that the existence of humankind is dependent on a new attitude of community cooperation rather than individual competition.


Eighteen months ago in Hong Kong, many people found delightful community cooperation in Admiralty when they appeared there in the evening, and were glad to be able to escape from their daily work – a form of individual competition. They have become influenced by the postmodernist mindset.

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