Overlapping generations: Kicking the can down an endless road
The final brief in our series on big economic ideas looks at the costs (and benefits) of passing on the bill to the next generation.
In the spring of 1899 William Miller persuaded three members of his Brooklyn prayer group to invest their money with him, promising them unearthly returns.
He would pay a dividend of 10% per week, plus a commission for each new investor they could recruit.
Soon, William “520%” Miller was drawing throngs of depositors to his door.
So “great was the crush”, by one account, his staircase eventually gave way.
Miller attributed his success to “inside information”.
But his real method was made famous 20 years later by the man who perfected it, Charles Ponzi.
Ponzi schemes like Miller's pay a return to early investors with money raised from later ones.
When they run short of new contributions, they collapse.
A scheme as generous as Miller's cannot last long.
But what if the promises were less extravagant and the repayment intervals less tight?
What if, for example, a scheme asked investors for money in their younger years in return for a payout in their dotage?
Over that time scale, a Ponzi scheme need not limit its recruitment efforts to the people alive when it begins.
It can repay today's contributors with money from future participants not yet born.
And since the next generation is never likely to be the last, the chain could, in principle, continue indefinitely.
Barring a catastrophe, new marks will be born every day.
This intergenerational logic lies behind the “pay-as-you-go” (PAYG) pensions common in many countries.
People contribute to the scheme during their working lives, and receive a payout in retirement.
Many people fondly imagine that their contributions are saved or invested on their behalf, until they reach pensionable age.
But that is not the case.
The contributions of today's workers pay the pensions of today's retirees.
The money is transferred between generations, not across time.