Explaining the Wealth Holdings of Different Cohorts: Productivity Growth and Social Security

Abstract

It is well-known that individuals born in different periods of time (cohorts or generations) exhibit different wealth accumulation paths. While previous studies have used cohort dummies to proxy for this fact, research in this area suffers from a serious identification problem, i.e., how to disentangle age, time, and cohort effects from a simple cross-section or a time series of cross-sections. Furthermore, the use of cohort dummies leaves unexplained the reasons for the differences across cohorts. In this paper, we go beyond the simple use of cohort dummies to capture the differences in wealth holdings across generations. We use basic economic theory to propose two indicators of the economic conditions under which households accumulate wealth. The first one represents productivity differences across cohorts: the aggregate level of gross national product per capita around the time the head of the household entered the labor market. The second measure summarizes the changes in Social Security during the head of household’s working life. Using panel data from the Dutch Socio-Economic Panel, we show that productivity growth can explain all the cohort effects present in income data, while productivity growth and the generosity of Social Security can explain all the cohort effects present in household net worth. Thus, cohort effects can be traced back to past economic conditions and we do not need to resort to differences in preferences or other reasons to explain the differences in wealth holdings across generations.