Social security as Markov equilibrium in OLG models

Abstract

This paper studies the characteristics of intergenerational transfers in a standard overlapping generations model with short lived governments that care about the welfare of young generations only. A number of authors have shown that simple intergenerational games, in which in each period the current young generation plays as a dictator, are able to deliver political equilibria with social security even if the underlying competitive equilibrium is not dynamically inefficient. These authors have either derived pure steady state results or have relied on subgame-perfectness. This paper extends these results deriving Markov subgame perfect equilibria (i.e. that depend only upon the period t state variable, which is the stock of capital). Non-Markov subgame perfect equilibria assume agents know all the past history of the game; they cannot predict when the social security system will emerge and whether or not it will eventually emerge; they prescribe that generations that never deviated may be punished. Markov equilibria, placing more restrictions on the structure of the game, are able to deliver solutions that do not suffer from these drawbacks. As the paper shows, however, Markov strategies may produce unstable dynamics.