Economic Well-Being

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ECONOMIC WELL-BEING

This entry provides information on the economic circumstances of older Americans by looking at differences in both the economic well-being among older adults and differences in economic well-being between older adults and others. Traditionally, policymakers have been interested in the economic well-being of groups that are particularly vulnerable—those individuals in society that theoretically cannot improve their own economic well-being. In addition to children and the disabled, elderly adults usually fall into this category, mainly because it is assumed that they have little access to labor markets. Older adults are defined as those past the traditional retirement age of sixty-five, although there is an emerging body of work looking at the economic status of the "oldest old," usually defined as those over eighty-five.

Consumption as a measure of economic well-being

The most common way to measure economic well-being is to determine the market value of goods that are consumed by an economic "agent" over a period of time. This raises a host of questions. First, what determines an agent? In general, there is a problem with determining individual well-being from household data. Second, what is the appropriate length of time to measure well-being? Economic well-being can be examined in the short term ("what is my economic well-being right now?") or a longer time horizon ("will my grandchild be able to afford college?"). Third, goods and services are not all that make up economic well-being. Leisure, or free time is a good example of a resource that presumably generates economic well-being on its own. Although it should not be assumed that households do not derive economic well-being from commodities besides goods and services, this discussion will focus on access to goods and services, which will be measured in monetary terms. This is because the proverbial slope could become quite slippery if we attempt to measure all nonpecuniary aspects of economic well-being. Nevertheless, our imperfect measure of well-being should be duly noted. Fourth, availability of resources can generate well-being even if they are not consumed. Having an abundance of savings that one never plans to consume, or that one gives to one's heirs, will no doubt provide economic well-being even though no consumption is observed. This fourth point suggests that instead of looking at consumption, we should measure well-being in terms of access to consumption. Fifth, measuring only flows of goods and services ignores our ability to increase that flow. Assuming that leisure time is a choice, the amount of goods you purchase is determined to a certain extent by your preferences. This means if we measure goods and services flows, we will underestimate the well-being of people who choose to purchase more free time. Furthermore, if people who consume more tend to work less (consume more leisure) we will underestimate inequality of economic well-being, but if people who consume more also tend to work harder for it, we will end up overestimating inequality.

Access to resources as a measure of economic well-being

Perhaps the most popular measures of economic well-being are household income and household net worth. Income measures the amount of money that enters a household over a period of time (usually measured over a one-year period), and net worth measures the amount of resources a household owns at a particular point in time, less any debts the household owes. These measures are useful for several reasons. First, they are both relative and absolute measures. You can make comparisons between households (although you still have to account for family size and structure) and the absolute values—they are usually measured in currency— also have meaning. Also, these measures reflect access to goods and services (dollars), regardless of whether or not funds are actually spent.

Although economists are usually careful not to attempt to make comparisons of economic satisfaction or "utility" between households, there is an implicit assumption, when using monetary measures of well-being, that we are doing exactly that. Before we go on, we must spend some time considering the relative pros and cons of different measures. It should be noted that for this entry, we will not consider measures that attempt to determine whether individuals have enough to meet the most basic necessities.

Measurement problems

One problem with comparing well-being is that it is difficult to define the unit of analysis. Although our goal might be to define the economic well-being of individuals, most individuals live in families or households, and most of our measures of economic well-being are either conceptualized or measured at the household level. Household measures of well-being make it impossible, for example, to compare the economic well-being of wives with that of their husbands. Very little has been done to examine differences in individual well-being within households, and it is usually assumed that resources within the household are shared. Therefore, when comparing differences in economic well-being among the aged, one must account for relationships that exist between economic well-being and the size and structure of households in which older householders exist. Furthermore, we will have to account for the fact that older households live in different "types" of households that the nonaged, making comparisons between the economic well-being of the aged and the non-aged difficult.

Table 1 shows the changes that have taken place with respect to the living arrangements of the aged over the last forty years. The fact that more of the aged live as heads of households than forty years ago (i.e., fewer of them living with relatives that are not their spouse or nonrelatives) indicates an improvement in the economic well-being of the aged. This is because moving in with relatives is often a signal, for an individual of any age, that one's economic well-being is not sufficient to maintain a household of one's -own. When comparing the well-being of the aged to the nonaged with household data, the aged will seem better off than they really are, because such an analysis fails to account for older Americans who choose not to be household heads. These older Americans, whose economic well-being has driven them to live with relatives, for example, are not picked up in the data. However, the data from Table 1 also suggest that this sort of bias decreased over time, so that any comparison of the aged and nonaged over time will underestimate any relative advances the aged make and underestimate any relative declines.

Individual versus household differences aside, one could argue that measuring household consumption, and using that as a measure of economic well-being, addresses both the limitations of the two more common measures while at the same time preserving their benefits. Aside from the problem of accounting for family size and structure, how much a household spends, one could argue, is a good measure of both how they are doing now, and how they expect to be doing in the future, which captures the essence of economic well-being. The problem is that households may have different measures of necessities. The health care example is relevant here—is John better off than Jeff if he spends twice as much on health care, but the same as Jeff on all other goods? Answering "no" to this question condemns consumption as a measure of economic well-being, and is obviously relevant when examining the economic well-being of the aged.

Looking at average measures of well-being does not account for the fact that there is inequality in economic well-being, that is, wide dispersion in the incomes of households, both for the aged and the nonaged. In general, inequality can be measured by comparing the values of certain households in a population. For example, one measure of inequality would be to compare the income level at which 20 percent of American households have less income and 80 percent have greater income (the lower quintile) with that of the income at which 80 percent of households have less income and 20 percent have more (the upper quintile). A distribution where the difference between those two numbers is greater, then, would be the one where income is distributed less equally. Another measure of inequality, where these comparisons are taken to their most extreme, is the Gini Coefficient, which compares not just two households, but all households in describing inequality. The Gini coefficient is calculated by taking the differences between the incomes of every household (this would be n times (n-1) differences for a sample of n households), averaging them, and dividing by two times the average household income. Again, a larger Gini coefficient means that inequality is larger. One of the benefits of the Gini coefficient is that it standardizes inequality to the absolute amount of the variable in question (in the case of the example, income).

Another way to measure the economic well-being of the aged is to compare any measures to those of the nonaged. There are a number of reasons why it is difficult to compare the well-being of older individuals and those who are not old. Economic vulnerability aside, issues of economic necessity need to be considered. In particular, the propensity of older Americans to consume health care services must be considered. Also problematic is the fact that most of our measures are monetary, that is, the ability of the household to purchase goods. Differences in leisure time between the aged and the nonaged are ignored in the tables below.

When thinking about comparing the economic well-being of people at different ages, both income and net worth are incomplete measures. Income underestimates the well-being of older Americans relative to younger Americans, since older Americans tend to have larger asset values to protect them from periods of low income. On the other hand, net worth overestimates the well-being of older Americans relative to younger Americans, because older households must draw a larger portion of their income from net worth.

Income is probably the measure of economic well-being that treats the old and the young "fairest." Ideally, both the old and young will have income—resources flowing into their households over a period of time. For the old, this will be made up mostly of return on investment capital—interest, capital gains, Social Security (which can be viewed as return on past savings, even though it does not really work that way in practice)—while the young are generating income from human capital—earnings. In this way, the life course can be seen as transforming your wealth from human capital into investment capital. For this reason, net worth seems to underestimate the economic well-being of the young— their wealth is still in the form of human capital. Nevertheless, both income and net worth can be used to show inequality within the two groups, and we will also use net worth to show how differences in well-being between the young and old have changed over time.

Changes in economic well-being over time

Table 2 shows the Census Bureau estimates of income in 1975, 1987, and 1999 for households headed by someone over sixty-five versus all households, adjusted for changes in the prices of goods and services between those years (they are comparable to 1999 prices). According to the Census, mean income for households headed by someone age sixty-five and over in 1999 was $34,671. This was 63 percent of the mean for all U.S. households ($54,842). This percentage is up from thirty years ago, when it was 54 percent, but it has remained stable since its peak of 65 percent in 1985. It is also important to note that there are some older individuals that live in households where the head is not over sixty-five (i.e., the older individual is not the head). Since these individuals are more likely to have fewer resources, the ratios in Table 2 probably underestimate the actual differences in income between older adults and the young. On the other hand, any improvement in economic well-being by the older relative to the young is probably underestimated by this Table, since more older Americans are living independently now relative to thirty years ago.

Table 3 gives the changes that have occurred over time in the sources of income of the aged. In general, Social Security is the most important source of income for the aged, and is of greater importance for individuals with low incomes. The proportions have remained relatively stable over time, except that in recent years, a declining proportion of total income has come from earnings, while more has come from assets and pensions. This trend exists even in the face of more opportunities in the labor market for older workers and more strict regulations in employment procedures. What is no doubt offsetting these opportunities are more incentives provided by employers in the form of pension benefits, and the tendency for increases in economic well-being to cause earlier retirement for many older Americans.

One statement that is commonly used to implicitly compare the economic well-being of older adults to that of the young—that older people are more vulnerable to inflation—is largely mythical. For low-income households, the majority of retirement income comes from Social Security retirement benefits, which, since 1975, are automatically indexed to the Consumer Price Index to account for price changes over time. For high-income households, most income comes from savings, where rates of return are generally correlated with inflation. Defined Benefit Pensions are not necessarily indexed to inflation. Nevertheless, it is a misrepresentation to talk about the aged as a group of citizens that generally have "fixed" incomes.

According to the U.S. Census, the distribution of income of older Americans is more equal than the distribution of nonaged, although the distribution has become more dispersed for both groups. While the Gini coefficient for the distribution of younger Americans' income went from .44 to .47 from 1973-1999, it went from .36 to .42 for the over-sixty-five population. Social Security and defined benefits, and entitlement programs such as Supplementary Security Income and the Social Security Earnings Test work to make the distribution of income more equal for both groups. This seems to be true, even though one might expect differences in financial planning and financial preparation for retirement, earnings inequality, and varying investment performance between households to skew the incomes of older Americans more than those of the young.

Table 4 shows the wealth differences between older households and all households in 1995 and 1998 (not included in the wealth measures are pension and social security wealth). It is not surprising that the net worth of the average older American is greater than that of the population in general. In 1998, households headed by someone sixty-five and over had a mean net worth of $392,187, compared to $282,979 for the entire U.S. population. Older households own more of just about every type of asset—monetary (highly liquid assets such as savings accounts, checking accounts, and money market accounts), investment assets (stocks, bonds, mutual funds, etc.) housing assets, and nonhousing real property. Furthermore, older households have much less debt. This latter fact should not surprise, given that older households have less earnings with which to guarantee future payment, and their higher asset levels make credit less necessary. Recall that we would expect older households to have more wealth ceteris paribus, since more of a younger household's economic well-being is made up of earnings ability. It should also be expected that the distribution of wealth among households over sixty-five is more equal than that of the population in general. For example, while the net worth of the household at the 25th percentile is only 4.7 percent of the wealth of the 75th percentile household for the population in general, the comparable statistic for over-sixty-five households is 16.9 percent, suggesting that the distribution of wealth is "tighter" for older households. Nevertheless, 10 percent of households over sixty-five have net worth of $4200 or less, not enough to generate significant levels of income.

Examining the changes that have occurred in the wealth characteristics of older households over the last few years reveals some cause for concern. From 1995 to 1998, the net worth of over-sixty-five households increased 31 percent, from $299,317 to $ 392,187 in 1998. The comparable increase for all U.S. households was 36 percent. This is surprising since the strong performance of investment markets implies that households with many assets would be the most fortunate. It seems that for some reason, older households were not able to take as much advantage of the unparalleled prosperity in the American economy as their younger counterparts, even when using an aged-biased criterion like net worth. This could be because of an inability to take advantage of labor markets the way younger individuals can. It might also suggest that the conservative investment habits of older Americans might prevent them from taking advantage of opportunities in capital markets.

Explaining differences in economic well-being

Among older Americans, health status and access to health care have a substantial effect on economic well-being. According to the Federal Reserve's Survey of Consumer Finances, health status definitely impacts economic well-being in old age, and inequality among the aged. For example, households where the head is aged seventy to seventy-nine and self-reports poor or fair health have a mean net worth of $225,462. This compares to $554,909 for heads aged seventy to seventy-nine that report good or excellent health, more than double their poor-health counterparts. The differences arise from two phenomena. One, health status has a significant impact on the number of hours worked during one's lifetime, which therefore affects past income, savings, and eventually net worth. Two, older households face higher out-of-pocket health costs, which deplete assets and, therefore, income from assets.

Aside from health status, often the same personal characteristics that are associated with low economic well-being in "young" households also contribute to low levels of economic well-being in old age. According to Census estimates, for both the older Americans and the young, the poor are overrepresented by female-headed households, households where the head did not attend any college, and households that are not white. The largest difference is the overrepresentation of minorities among the aged poor. While households headed by a non-white make up only 12.8 percent of older households, they make up nearly 29 percent of poor older households.

How could the economic well-being of older people be further improved? In the short run, such policies would involve either direct transfers, such as increased Social Security benefits, or policies that raise real interest rates, since the aged generate more of their income from returns on assets. These short-run policies would tend to come at the expense of the economic well-being of younger generations. In the long run, policies that insure stable incomes for older adults will serve to make their incomes more equal. The trend toward defined contribution pension plans and away from defined benefit plans (even Social Security may become a defined contribution plan) will likely add to inequality of outcomes, due to varying performances by households in investment markets, even if their effect on the overall well-being of older Americans as a group is unclear. Policies and programs that improve the physical health of the older adults would also lead to an improvement in financial health. Since so much of an individual's economic well-being in old age is determined by their financial preparation, policies that help promote sound financial planning for retirement, including policies encouraging workers to save, should increase overall well-being. It is unclear whether these types of policies increase inequality, however, since it is the members of society at the top of the distribution more likely to take advantage of such policies.

Charles B. Hatcher

See also Assets and Wealth; Bequests and Inheritances; Estate Planning; Pensions, Plan Types and Policy Approaches; Poverty; Social Security.