Generational conflict, fiscal policy, and economic growth

Abstract

Worldwide, dependency ratios are forecast to increase dramatically in the next 50 years. A great deal of attention has been devoted to understanding the changes in fiscal policies that “must” take place to accommodate these changes and maintain desirable rates of economic growth. In contrast, less effort has been concentrated on studying the fiscal shifts that will endogenously result from demographic pressures. In particular, will a more elderly population support spending for those programs (e.g., education) that most directly augment the earnings of the young? If not, will this reduce economic growth? We investigate the effect of demographic transition on the endogenous determination of productive public spending. A demographic transition alters the identity of the median voter, leading to a preference for less spending. While this may reduce productive spending, it may also reduce tax rates and raise capital per worker. Simulations, calibrated to empirical estimates of the economic return to education, suggest that demographic transition will reduce output, despite a larger capital stock, unless education services become more productive in raising human capital.