Recent years have witnessed a rise in ultra-long-term, cross-generational policy issues such as fiscal reconstruction, climate change, and nuclear power generation.
Even if Japan implemented severe tax increases and spending cuts immediately, it would take nearly 150 years to stabilize its public debt to gross domestic product (GDP) ratio, according to estimates by R. Anton Braun of the U.S. Federal Reserve Bank of Atlanta. Likewise, whatever measures we take today to curb greenhouse gas emissions, it will be more than 100 years before their impact on the environment becomes apparent. Meanwhile, it is technically possible to construct a radioactive waste disposal facility, but the current political reality does not allow determination as to where to construct it. The beneficiaries of such a facility, which would have to be constructed at great political cost, are the future generations several decades from now, and it is difficult for the current generation to see the benefit of constructing it.
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Some progress has been made in economics research on those ultra-long-term policy issues. As noted in a 2006 book coauthored and edited by Waseda University Professor Kotaro Suzumura (Note 1), research into what constitutes intergenerational equality (or equity)—which must be clarified as a prerequisite for assessing ultra-long-term policies—is developing as a branch of welfare economics.
Proposed by Boston University Professor Laurence J. Kotlikoff and others in their 1992 paper, the concept of "generational accounting," which is to calculate the difference between the value of payments to the government and the value of receipts from the government on a generation-by-generation basis, has been adopted widely in economic analyses. This enables a quantitative comparison of inequalities resulting from intergenerational income transfers.
One notable policy proposal came from Paul Demeny, a fellow of the American Association for the Advancement of Science. In his 1986 paper, he called for giving children voting rights and enabling parents to exercise the rights on their behalf as a way to reflect the interests of the future generation in politics. Likewise, in a RIETI discussion paper published in 2004, Hitotsubashi University Associate Professor Shigeki Kunieda proposed a basic law that would ensure intergenerational equality.
However, those proposals are not based on a theoretical analysis on the viability of ultra-long-term policies. In what follows, I would like to explore whether a long-term, intergenerational policy indeed can be viable.
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As an example, let's examine the implications of fiscal consolidation by using an overlapping generations (OLG) model. Suppose that the current generation ("parents") initiates a fiscal consolidation program by bearing certain costs, for instance, in the form of increased taxes. In this case, the future generation ("children") would receive returns in the form of avoiding an economic crisis after their parents are deceased (see the figure). In the case illustrated in the figure, the cost of fiscal consolidation is 10 and the return is 20, which would generate a net gain of 10 (=20–10). Distributing a portion of the gain to the parents would cause them to implement fiscal consolidation voluntarily. The question is whether cooperation involving such an intergenerational income transfer is possible.
Consider a plan in which the parents implement fiscal consolidation by bearing 10 units of cost and the children promise to provide them with 15 units of income in the near future. If everything goes as planned, the parents and the children will obtain five (=20-15) units of net gain each. However, what would be the decision of the children in the near future if the parents have actually implemented fiscal consolidation today by bearing 10 units of cost? By that time, the fiscal consolidation program will have been completed and the return for the children will be fixed at 20 units. If the children transfer 15 units of income to the parents as promised, their gain will be reduced to five units. Meanwhile, if they break the promise, their gain will be 20 (=20-0) units. If the children are self-serving and rational, they would naturally choose to keep all 20 units of gain to themselves. In other words, the optimal choice for the children in the near future is to change the predetermined plan and make no income transfer to the parents.
This is a typical case of dynamic inconsistency, a situation where rational behavior prior to a certain event is not optimal after the event occurs. Here, the parents rationally expect not to receive anything in return from the children even if they implement fiscal consolidation today. As a result, they choose not to implement fiscal consolidation today. This means that fiscal consolidation involving intergenerational income transfers is impractical from the beginning. Let's call this "impossibility of intergenerational cooperation."
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This argument is nothing new and almost identical to what Paul A. Samuelson pointed out concerning income transfers across generations in his article published in 1958, in which he looked into the question of whether children will provide for their aging parents. Using the same logic discussed above, Samuelson showed that rational children would not provide for their aging parents if it were a one-shot game.
However, in the case where providing for aging parents is an infinitely repeated game that will be played by each generation, he argued that it is possible to create a system in which providing for aging parents would be a rational choice for children.
As shown by Samuelson, intergenerational cooperation can be achieved relatively easily where the structure of a repeated game is present. Indeed, most of those intergenerational policy issues that have been confronted by human society in the past have had the recursive nature of repeated games.
The problem is that a new set of policy issues—those that are of a non-repeating nature—are now arising as a result of the development of new technologies and regulatory systems. Actually, fiscal consolidation is not a repeated game but a one-off game because the primary cause of the fiscal problems we face today is the proliferation of very generous social security programs, an event that has occurred for the first time in history. Climate change and the disposal of spent nuclear fuel are problems caused by today's modern technology and thus both are one-shot games. Those policy issues give rise to the impossibility of intergenerational cooperation.
In a sense, those difficult challenges are unintended consequences of the modernization process over the past 200 years. Based on the naïve belief that the further rise of modern rationalism will assure the fulfillment of intergenerational commitments, we have created fiscal and social security systems presumed to be sustainable for generations. However, it is because each generation is self-serving and rational that intergenerational cooperation is impossible even in a highly developed society.
In order for one-time, ultra-long-term policies to be successful, each generation must act in a way that goes beyond self-serving rationality. That would require the help of religion or traditional norms, which is difficult in today's modern society where rationality is the guiding principle. And if so, we must say that the prospects for the successful implementation of fiscal consolidation in Japan are extremely bleak.
Regarding similar difficulties, Hitotsubashi University Professor Takashi Oshio proposed the concept of "biological limitations of democracy," which refers to the mutual amplification effect of a declining population and dysfunctional democracy, in his book published in 2014 (Note 2).
What is needed for the future is an institutional structure designed in a way to prevent such intractable problems from arising. For instance, Japan's public pension system, an ultra-long-term mechanism that has been blamed as a major cause of growing fiscal spending, has been providing significant gains to pensioners. Now that the structure of the Japanese population has changed, fundamental changes must be made to the pension system in order to prevent it from collapsing, hence giving rise to the problem of the impossibility of intergenerational cooperation. However, what if we have a pension system that consists of a funded pension scheme and an intergenerational income redistribution scheme under which the amount of payout is determined for each fiscal year as is the case for term insurance policies? The amount of pension benefits would change every year, but the impossibility of intergenerational cooperation would not pose a problem.
Probably, we need to refrain from developing institutions and technologies that would entail the impossibility of intergenerational cooperation. This is not meant to be irrationalism that would attempt to limit the rational development of technology and social systems. Rather, this is to point to the need to elevate rationalism to a more sophisticated level so as to ensure that decisions over whether or not to allow a certain technology or system to spread will be made by taking into consideration rational and scientifically sound judgment on the limitations of the capacity of human society as the operator of such a technology or system.
* Translated by RIETI.
June 23, 2014 Nihon Keizai Shimbun
