Thursday, July 7, 2016

The power of math wielded by economists: Germans just doubled their wealth/net worth

Germans have seen their wealth grow rapidly a couple of times over the last century. The blogster remembers a story about a poor German child aged eight or ten rushing into the living room waving a banknote that said 50 million Reichsmark and proclaiming "look, we are rich".

Yes, that was fake wealth, a reminder of hyperinflation that did a number on Germany in the 1920s, and after World War II, the situation was deteriorating quite rapidly, too.

But with an official inflation rate near zero percent, 2016 is so different. The good news just keeps piling on.

The German Institute for Economic Research (DIW Berlin) has released a study showing the wealth of Germans doubles if you factor in future pension/social security entitlements, says this article in Frankfurter Allgemeine (FAZ). Future entitlements.

How did that 100% increase happen?

It has to do with how you define wealth. Which is not clear cut - unless you have nothing at all. In which case we can all agree: your wealth is zero.

Statistics generally defines wealth, or net worth, as the value of property and investments plus cash.

But every now and then, some boneheaded economist comes and says this is not comprehensive, not the full picture, or - ideological trigger - not the truth. The DIW folks must have felt the same and set out to calculate how much richer Germans get if you factor future pension/social security benefits into the wealth equations.

The results are wonderful. Average wealth goes up from 85,348 Euros to 176,789 Euros. The median shows an increase otherwise seen only in Ponzi schemes before collapse from 18,000 Euros to 107,392 Euros.

Now, you could pause and ask: the median net worth of Germans is only 18,000 Euros? And that's the fourth largest economy in the world? 

Luckily, neither the authors of the study nor the newspaper ask this question.

The problem with including future pension/social security income into the net worth calculation is simple: you die, it is gone. Poof. Real wealth, barring hyperinflation, nuclear war and the presidency of <insert name of your most vilified candidate here>, continues to exist.
The other stuff, barring hyperinflation, nuclear war and the presidency of <insert name of your most vilified candidate here>, continues to exist.

The flimsy justification for including pension/social security benefits in the net worth is that "you can see contributions as a kind of savings".
This argument is advanced by the same economists who point out that social security is not a savings system but one in which current contributions pay for the benefits of current retirees. While some countries make an effort to have a certain amount of reserves for pay out over the next decade or two, others - like Germany - boast privileged groups that contribute zero to their future pension.
Based on the "a kind of savings" argument, why not call everyone who plays the lotto a millionaire? I know, the TV ads already do, but that's not my point.
The odds for the jackpot are a little bit higher than surviving to 67, but for three correct numbers, they are not all that different. At least for black Americans.

The advantage of adding future pension/social security income to your current net worth is that the inequality coefficient, the Gini coefficient drops nicely from awfully bad 0.79 to plain awful 0.59.

A couple of years ago, another economist used the same funky maths to prove once and for all that German recipients of basic means tested social benefits were not poor at all. That guy said that a recipient would receive some 200 000 Euros of benefits over a period of 20 years.

How could you dare to call this person poor?

To which the blogster replied: in reality, basic means tested benefits are a subsidy for businesses and the public sector because all the money paid to the benefit recipient is spent within the following month.

If you disagree with this view, we refer you to the standards applied in defining "financing terrorism" or money laundering, where the first hop retains none or very little of the money, and the law considers the second hop the real beneficiary.

Sorry for the digression.

Be it as it may, adding potential future pension/social security benefits to your net worth is unacceptable.

If you own the median 18.000 Euros and die before pension kicks in, you are still worth only 18.000 Euros.

[Update] Clarified "future" entitlements, i.e. not current social security or retirement income. Added text "The flimsy justification..." to "for black Americans".

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