Working Paper: CEPR ID: DP3275
Authors: Michele Boldrin; Ana Montes
Abstract: When credit markets to finance investment in the human capital of young people are missing, the competitive equilibrium allocation is inefficient. When generations overlap, this failure can be mitigated by properly designed social institutions such as public education and public pensions. We show that, when established jointly, they implement an intergenerational transfer scheme supporting the complete market allocation. Through the public financing of education, the young borrow, from the middle age to invest in human capital. When employed, they pay back their debt via a social security tax, the proceedings of which finance pension payments to the now elderly lenders. We consider other, allocationally equivalent, financing schemes. In all cases, when the complete market allocation is achieved a certain equality should be observed among implicit rates of return and the market rate of return. We test this prediction by using micro and macro data from Spain. The results are, surprisingly, good. We also use the model to quantify the impact of undergoing demographic change on the implicit rates of return. The results point, unsurprisingly, to dramatic changes in generational rates of return. Contrary to what predicted by earlier studies in the generational accounting tradition, our findings suggest that future generations are not necessarily going to be worse than current ones.
Keywords: efficient intergenerational arrangements; public education; public pensions
JEL Codes: H11; H30; H42; I20; O11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credit markets absent (G19) | inefficient allocation of resources (D61) |
| public education financing (I22) | enables human capital investment (J24) |
| public pension system (H55) | allows middle-aged to repay loan (G51) |
| public education financing + public pension system (H75) | replicates complete market allocation (C59) |
| current arrangements (F33) | approximate predicted equality between rates of return (G17) |
| demographic changes (J11) | alter intergenerational equity and efficiency (D15) |