Essays on political economy of public intergenerational transfers

Low fertility and mortality rates combined with the retirement of the generation of “baby boomers” bring about dramatic population ageing and are projected to reverse the demographic pyramid in many advanced economies. The main implication derived from the population ageing concerns the public finance of the major public intergenerational transfers (i.e., pensions and education). Ageing makes the political clout of the elderly stronger and more inclined to support transfers towards their retirement, intensifying the intergenerational conflict between young and old. In parallel, an increasing income inequality constitutes another major trend in developed countries. This trend aggravates the intragenerational conflict between rich and poor over the redistribution and the size of the welfare state. This Ph.D. thesis investigates the interplay between the public finance of intergenerational transfers (i.e., pensions and education), population ageing and income inequality within a political economy framework. The main purpose of the second chapter is to conduct an empirical investigation on the effect of current and future population ageing on education spending taking into account the strategic intergenerational link that exists in a system with a pay-as-you-go (PAYG) pension structure. The design of the PAYG pension system provides the appropriate incentives for the working age generation to invest in public education of young “today” in order to “reap” future benefits “tomorrow” in terms of higher taxable income, social security contributions and returns on savings. We conduct a panel analysis on OECD countries over an extended period in order to test the effect of ageing on education spending in total and per educational level. Findings suggest that the intergenerational conflict is present however it depends on the level of total level of pension spending, indicating that in times of limited fiscal resources ageing has a negative effect on education spending. Furthermore, when we consider the intergenerational link projected (future) population ageing has a positive effect on education spending that seems to be driven by non-mandatory educational levels (pre-primary and tertiary). Better quality pre-primary schooling can increase the participation rate and liberate parents from a time intensive task of raising children, and hence can generate a substantial boost in parental productivity that is directly linked to the current pensions. Second, an increase in the quality of early-education for children could have a significant effect on their future productivity and therefore on future taxable income. In the same vein, higher quality tertiary education would lead to higher future productivity, and thereby higher taxable income that is linked with the pensions of current middle-aged workers. In the third chapter, taking into account the aforementioned intergenerational link between working age and young we aim to evaluate whether a system of public intergenerational transfers – both to the elderly and to the young – can be politically sustained. In other words, we investigate whether the electorate would choose to provide publicly intergenerational transfers (pensions and education) if this decision per se was put under voting? To examine this question we employ the unique dataset taken from the National Transfers Accounts project -that provides a coherent accounting framework of economic flows from one age group to another- and a theoretical framework for the political viability of public intergenerational transfers developed in the literature. We find that most of the developed countries meet the conditions to have a politically sustained system of pensions and education and that ageing contributes positively to the political viability of such a system. In the fourth chapter, we develop an overlapping generations model with heterogeneous agents with respect to their position in the income distribution, endogenous fertility and probabilistic voting to investigate how the size of public pensions and education is decided and how it is affected by population ageing and income inequality. The contribution is to include in a model with private and public education the dimension of pensions that are linked to the general level of education of the previous generation. This allows us to consider simultaneously both intragenerational and intergenerational conflicts as well as the intergenerational link. The model predicts that an increase in income inequality increases the income of the agent indifferent between public and private education, and thus decreases the participation in public education. This reduces the share of voters caring for public education through altruism for their children, which reduces the total public education spending (which in turn decreases taxes and increases pensions). However, the number of children attending public education decreases faster than the total spending, which leads to an increase in per student spending on public education. The mechanism in the case of an increase in the number of retirees works in a similar fashion: The increase in the number of pensioners increases the political weight of the retirees, increasing total pension spending (which increases taxes and decreases per student public education spending). The number of pensioners increases faster than the total pension spending, thus the per pensioner pension is decreasing. In both cases we find a positive relationship between per student public education spending and pensions through the budget constraint. Empirical evidences derived from a panel analysis of OECD countries seem to support our theoretical predictions. To sum up, this thesis reviews the existing literature on the effect of population ageing on pensions and on education, and explores empirically and theoretically the intergenerational link between these intergenerational transfers. This link between the adults and the young generation plays a crucial role in the analysis of both the effect of population ageing and the effect of income inequality on public finance of pensions and education. As we observe, ageing pressure in financial health of the PAYG pensions system indicates a conflict between financial and political sustainability. Nevertheless, if population ageing fosters political support for both public pensions and education, this can create some positive feedback improving future financial prospects of the PAYG system. Using the findings from this thesis and previous theoretical research we can suggest that it might be a useful reform to require legislation to vote on pensions and education as a unique social policy package in order to boost the sustainability of both public intergenerational transfers. The main policy conclusion is that the debate on pension reform should be widen to consider the comprehensive action of public policy along the life cycle, i.e. the joint role of forward (from parents to children) and backward (from adults to elderly parents) intergenerational transfers. This will offer a more complete view of the incentives given to agents in decisions like savings, fertility and education.