Roberto Calvo Macias, a Spanish author and thinker, once wrote that it is impossible to design a coherent philosophy of economics not founded on our mortality. The Grim Reaper permeates estate laws, retirement plans, annuities, life insurance and much more besides.
The Industrial Revolution taught us that humans are interchangeable by breaking the process of production down to minute -- and easily learned -- functional units. Only the most basic skills were required. This led to great alienation. Motion pictures of the period ("Metropolis," "Modern Times") portray the industrial worker as a nut in a machine, driven to the verge of insanity by the numbing repetitiveness of his work.
As technology evolved, training periods have lengthened, and human capital came to outweigh the physical or monetary kinds. This led to an ongoing revolution in economic relations. Ironically, dehumanizing totalitarian regimes, such as fascism and communism, were the first to grasp the emerging prominence of scarce and expensive human capital among other means of production. What makes humans a scarce natural resource is their mortality.
Though aware of their finitude, most people behave as though they are going to live forever. Economic and social institutions are formed to last. People embark on long-term projects and make enduring decisions -- for instance, to invest money in stocks or bonds -- even when they are very old.
Childless octogenarian inventors defend their fair share of royalties with youthful ferocity and tenacity. Businessmen amass superfluous wealth and collectors bid in auctions regardless of their age. We all -- particularly economists -- seem to deny the prospect of death.
Examples of this denial abound in the dismal science:
-- Consider the invention of the limited liability corporation. While its founders are mortals, the company itself is immortal. It is only one of a group of legal instruments -- the will and the estate, for instance -- that survive a person's demise. Economic theories assume that humans -- or maybe humanity -- are immortal and, thus, possessed of an infinite horizon.
-- Valuation models often discount an infinite stream of future dividends or interest payments to obtain the present value of a security. Even in the current bear market, the average multiple of the p/e (price to earnings) ratio is 45. This means that the average investor is willing to wait more than 60 years to recoup his investment (assuming capital gains tax of 35 percent).
Standard portfolio management theory explicitly states that the investment horizon is irrelevant. Both long-term and short-term magpies choose the same bundle of assets and, therefore, the same profile of risk and return. As John Campbell and Luis Viceira point in their "Strategic Asset Allocation," published this year by Oxford University Press, the model ignores future income from work which tends to dwindle with age. Another way to look at it is that income from labor is assumed to be constant -- forever.
To avoid being regarded as utterly inane, economists weigh time. The present and near future are given a greater weight than the far future. But the decrease in weight is a straight function of duration. This uniform decline in weight leads to conundrums. "The Economist" -- based on the introduction to the anthology "Discounting and Intergenerational Equity," published by the Resources for the Future think tank -- describes one such predicament: "Suppose a long-term discount rate of 7 percent (after inflation) is used, as it typically is in cost-benefit analysis. Suppose also that the project's benefits arrive 200 years from now, rather than in 30 years or less. If Gross World Product grew by 3 percent per annum during those two centuries, the value of the world's output in 2200 will be $8 quadrillion ... But in present value terms, that stupendous sum would be worth just $10 billion. In other words, it would not make sense ... to spend any more than $10 billion ... today on a measure that would prevent the loss of the planet's entire output 200 years from now."
Traditional cost-benefit analysis falters because it implicitly assumes that we possess perfect knowledge regarding the world 200 years hence -- and, insanely, that we will survive to enjoy ad infinitum the interest on capital we invest today. From our exalted and privileged position in the present, the dismal science appears to suggest, we judge the future distribution of income and wealth and the efficiency of various opportunity-cost calculations. In the above-mentioned example, we ask ourselves whether we prefer to spend $10 billion now -- due to our "pure impatience" to consume -- or to defer present expenditures so as to consume more 200 years hence.
Yet, though their behavior indicates a denial of imminent death, studies have demonstrated that people intuitively and unconsciously apply cost-benefit analyses to decisions with long-term outcomes. Moreover, contrary to current economic thinking, they use decreasing utility rates of discount for the longer periods in their calculations. They are not as time-consistent as economists would have them be. They value the present and near future more than they do the far future. In other words, they take their mortality into account.
This is supported by a paper titled "Doing it Now or Later," published in the March 1999 issue of the American Economic Review. In it the authors suggest that overindulgers and procrastinators alike indeed place undue emphasis on the near future. Self-awareness surprisingly only exacerbates the situation: "Why resist? I have a self-control problem. Better indulge a little now than a lot later."
But a closer look exposes an underlying conviction of perdurability.
The authors distinguish sophisticates from naifs. Both seem to subscribe to immortality. The sophisticate refrains from procrastinating because he believes that he will live to pay the price. Naifs procrastinate because they believe that they will live to perform the task later. They also try to delay overindulgence because they assume that they will live to enjoy the benefits. Similarly, sophisticated folk overindulge a little at present because they believe that, if they don't, they will overindulge a lot in future. Both types believe that they will survive to experience the outcomes of their misdeeds and decisions.
The denial of the inevitable extends to gifts and bequests. Many economists regard inheritance as an accident. Had people accepted their mortality, they would have consumed much more and saved much less. A series of working papers published by the National Bureau of Economic Research in the last 5 years reveals a counter-intuitive pattern of intergenerational shifting of wealth.
Parents gift their off-spring unequally. The richer the child, the larger his or her share of such largesse. The older the parent, the more pronounced the asymmetry. Post-mortem bequests, on the other hand, are usually divided equally among one's progeny.
The avoidance of estate taxes fails to account fully for these patterns of behavior. A parental assumption of immortality does a better job. The parent behaves as though deathless. Rich children are better able to care for ageing and burdensome parents. Hence the uneven distribution of munificence. Unequal gifts -- tantamount to insurance premiums -- safeguard the rich scions' sustained affection and treatment. Still, parents are supposed to love their issue equally. Hence the equal allotment of bequests.
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