A Dynamic Politico-Economic Model of Intergenerational Contracts

Lancia, Francesco and Russo, Alessia (2010): A Dynamic Politico-Economic Model of Intergenerational Contracts.

Abstract

This paper investigates the conditions for the emergence of implicit intergenerational contracts without assuming reputation mechanisms, commitment technology and altruism. We present a tractable dynamic politico-economic model in OLG environment where politicians play Markovian strategies in a probabilistic voting environment, setting multidimensional political agenda. Both backward and forward intergenerational transfers, respectively in the form of pension benefits and higher education investments, are simultaneously considered in an endogenous human capital setting with labor income taxation. On the one hand, social security sustains investment in public education; on the other hand investment in education creates a dynamic linkage across periods through both human and physical capital driving the economy toward different Welfare State Regimes. Embedding a repeated-voting setup of electoral competition, we find that in a dynamic efficient economy both forward and backward intergenerational transfers simultaneously arise. The equilibrium allocation is education efficient, but, due to political overrepresentation of elderly agents, the electoral competition process induces overtaxation compared with a Benevolent Government solution with balanced welfare weights.

• Item Type: MPRA Paper
• Language: English
• Keywords: aging, Benevolent Government allocation, intergenerational redistribution, Markovian equilibria, repeated voting.
• Subjects: E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; D - Microeconomics > D7 - Analysis of Collective Decision-Making > D71 - Social Choice ; Clubs ; Committees ; Associations; H - Public Economics > H1 - Structure and Scope of Government > H11 - Structure, Scope, and Performance of Government; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis

References

Abel, A. B., Mankiw ,N. G., Summers, L. H. and Zeckhauser, R. J., 1989, Assessing Dynamic Efficiency: Theory and Evidence, Review of Economic Studies, 56 (1), 1-19.

Azariadis, C., and Galasso, V., 2002, Fiscal Constitutions, Journal of Economic Theory, 103, 255-281.

Azzimonti Renzo, M., Sarte, P. D., and Soares, J., 2009, Discretionary Taxes and Public Investment when Government Promises are not Enforceable, Journal of Economic Dynamics and Control, forthcoming.

Bassetto, M., 2008, Political Economy of Taxation in an Overlapping-Generations Economy, Review of Economic Dynamics, 11, 18-43.

Baron, D., and Ferejohn, J., 1989, Bargaining in Legislatures, American Political Science Review, 83, 1181-1206.

Battaglini, M., and Coate, S., 2007, Inefficiency in Leglislative Policy-Making: A Dynamic Analysis, American Economic Review, 97, 118-149.

Becker, G. S., Tomes, N., 1986, Human Capital and the Rise and Fall of Families, Journal of Labor Economics, 4.

Bellettini, G., and Berti Ceroni, C., 1999, Is Social Security Really Bad for Growth?, Review of Economic Dynamics, 2 (4), 796-819.

Boldrin, M. and Montes, A., 2005, The Intergenerational State Education and Pension, Review of Economic Studies, 72, 651-664.

Conde-Ruiz, J., and Galasso, V., 2005, Positive Arithmetic of the Welfare State, Journal of Public Economics, 89, 933-955.

Ehrlich, L., and Lui, F., 1998, Social Security, the Family, and the Economic Growth, Economic Inquiry, 36, 390-409.

Feldstein, M., 1974, Social Security, Induced Retirement and Aggregate Capital Accumulation, Journal of Political Economy, 82 (5).

Forni, L., 2005, Social Security as Markov Equilibrium in OLG Models, Review of Economic Dynamics, 8, 178-194.

Galasso, V., and Profeta, P., 2002, The Political Economy of Social Security: A Survey, European Journal of Political Economy, 18, 1-29.

Galasso, V., and Profeta, P., 2004, Politics, Ageing and Pensions, Economic Policy, 63-115.

Grossman, G. M., and Helpman, E., 1998, Intergenerational Redistribution with Short-lived Government, Economic Journal, 108, 1299-1329.

Hassler, J., Krusell, P., Storesletten, K. and Zilibotti, F., 2005, The Dynamics of Government, Journal of Monetary Economics, 52, 1331-1358.

Hassler, J., Storesletten, K. and Zilibotti, F., 2007, Democratic Public Good Provision, Journal of Economic Theory, 133, 127-151.

Kaganovich, M., and Zilcha, I., 1999,Education, Social Security and Growth, Journal of Public Economics, 71, 289-309.

Kehoe, T. J., and Levine, D. K., 2000, Liquidity Constrained Markets versus Debt Constrained Markets, Econometrica, 69, 575-598.

Klein, P., Krusell, P., and Rìos-Rull, J., 2008, Time-Consistent Public Policy, Review of Economic Studies, 75, 789-808.

Krusell, P., Quadrini, V. and Rìos-Rull, J. V., 1997, Politico-Economic Equilibrium and Economic Growth, Journal of Economic Dynamics and Control, 21, 243-272.

Lindbeck, A. and J. Weibull, 1987, Balanced-budget Redistribution as the Outcome of Political Competition, Public Choice, 52, 273-297.

Lizzeri, A., Persico, N., 2001, The Provision of Public Goods under Alternative Electoral Incentives, American Economic Review, 91, 225-239.

Maskin, E., and Tirole, J., 2001, Markov Perfect Equilibrium: I. Observable Actions, Journal of Economic Theory, 100, 191-219.

Mulligan, C. B. , and Xala-i-Martin, X., 1999. "Gerontocracy, Retirement, and Social Security, NBER Working Papers 7117.

OECD, 2007, Social Expenditure Database 1980-2003, OECD Press.

OECD, 2008, Education at a Glance - OECD Indicators 2008, OECD Press.

Persson, T. and Tabellini, G., 2000, "Political Economy-Explaining Economy Policy, MIT Press.

Plott, C., 1967, A Notion of Equilibrium and its Possibility under Majority Rule, American Economic Review, 57 (4), 787-806.

Rangel, A., 2003, Forward and Backward Intergenerational Goods: Why is Social Security Good for Environment?, American Economic Review, 93, 813-834.

Razin, A., Sadka, E. and Swagel, P., 2002, The Ageing Population and the Size of the Welfare State, Journal of Political Economy, 110 (4), 900-918.

Shepsle, K. A., 1979, Institutional Arrangements and Equilibrium in Multidimensional Voting Models, American Journal of Political Science, 23, 27-59.

Tabellini, G., 1991, The Politics of Intergenerational Redistribution, Journal of Political Economy, 99, 335-57.