A Dynamic Politico-Economic Model of Intergenerational Contracts

Francesco Lancia, Alessia Russo
University of Bologna, Italy

In this paper we investigate 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 distortionary income taxation. On 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 regimes. Embedding a repeated-voting setup of electoral competition, we find that under the dynamic efficiency scenario 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 time-consistent Centra Planner solution with balanced welfare weights.

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