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Economy

Keiichiro Kobayashi: The struggle for intergenerational cooperation

Policy issues that cannot be addressed in a single generation -- fiscal reconstruction, global warming, nuclear power generation -- are on the rise, and tackling these ultralong-term challenges may require a fundamental rethinking of society.

     According to calculations by a group of economists including R. Anton Braun of the U.S. Federal Reserve Bank of Atlanta, even if Japan introduced aggressive tax hikes and spending cuts right now, it would take close to 150 years to stabilize the ratio of public debt to gross domestic product. It will also be more than 100 years down the road before we find out what effect restrictions on greenhouse gas emissions will have on the environment. And when it comes to radioactive waste, it is technically possible to build a disposal facility right away once the site has been determined. Politically speaking, however, deciding on that location is nearly impossible, as it would come at enormous political cost and would only benefit generations living decades from now.

     Economic studies are underway to investigate these issues. Research into the nature of intergenerational equity, an emerging branch of welfare economics, is key to evaluating ultralong-term policies, according to a 2006 book edited by Waseda University professor Kotaro Suzumura.

      Professor Laurence J. Kotlikoff at Boston University and his co-authors proposed in a 1992 paper the concept of "generational accounting," under which the difference between payments to and benefits from the government is calculated for each generation. Generational accounting, which has come into widespread use, makes it possible to quantitatively compare gaps in financial burdens stemming from income transfers between generations.

     In a 1986 paper, Paul Demeny, fellow of the American Association for the Advancement of Science, proposed the so-called Demeny voting system. He called for giving voting rights to children and having parents cast these votes on their behalf with the purpose of reflecting the rights of the future generation in politics. Shigeki Kunieda, associate professor at Hitotsubashi University, also proposed a law designed to secure generational equity in a 2004 working paper at Japan's Research Institute of Economy, Trade and Industry.

      However, none of these papers theoretically analyze the feasibility of ultralong-term policies. Here, I'd like to discuss whether intergenerational policies can work in the first place.

Fundamental conundrum

Imagine, for example, that the current generation undertakes fiscal reconstruction by paying a certain cost in the form of increased taxes and the like. The future generation, their children, will reap the benefit once they themselves become adults. If the cost is, say, 10 and the return is 20, then the difference is a gain of 10. If a portion of this gain can be distributed to the parents, then that generation would voluntarily pursue fiscal reconstruction. The question is whether the two different generations can cooperate to make such an income transfer work.

      Consider a plan calling on the parents' generation to implement fiscal reconstruction at the cost of 10 so that the children's generation, using its gain of 20, will provide them with an income of 15 in the near future. If things go as planned, each generation pockets a gain of 5. But what would the younger generation actually decide to do in such a situation?

      By the time the "near future" arrives, fiscal reconstruction will have been completed and the return for the children's generation will be fixed at 20. If the children transfer 15 of that to their parents, their own gain would decrease to 5. But if the children break their promise and do not give back anything to their parents, the gain for their generation would remain at 20. If this generation is self-serving and rational, it would naturally choose the latter option. In other words, it would only make sense for the children's generation to change the rules.

     This is a typical "time inconsistency problem," where a behavior that is rational before an event does not match the behavior that is rational after the event. Because the parent's generation rationally predicts that even if they carry out fiscal reconstruction, they will receive nothing in return, they naturally choose not to implement fiscal reconstruction. Accordingly, intergenerational fiscal reconstruction is impossible from the beginning.

     This conundrum is nothing new. In fact, it is identical to the intergenerational income transfer problem that Paul Samuelson presented in a 1958 paper. He considered the issue of whether children will take care of aging parents. Using the same logic as the foregoing discussion, he argued that, if the issue is a one-time consideration, rational children would not care for their parents.

      But because this issue is played out in each generation, Samuelson argued, it is possible to create a system where caring for aging parents is the rational choice for children.

     As Samuelson indicated, intergenerational cooperation can be realized relatively easily when the issue is one that recurs over time. Most of the intergenerational issues human society has faced throughout its history have been of this recurring kind.

     The problem now is that new systems and technology have led to the emergence of nonrepeating policy issues. Fiscal reconstruction is one example, as fiscal deterioration is blamed on the spread of generous social security for the first time in history. Global warming and nuclear waste were both caused by modern technologies, meaning these, too, are one-time problems. In all of these issues, the impossibility of intergenerational cooperation arises.

     This is something that we have brought about, without realizing it, through the modernization process over the past 200 years. Believing that advances in modern rationalism would secure intergenerational commitment, Japan built fiscal and social security systems on the presumption that they would be sustained over the ultralong term. However, because each generation is self-serving and rational, intergenerational cooperation is impossible, even if a society develops.

     To successfully implement one-time, ultralong-term policies, each generation must behave in a way that goes beyond self-serving rationality. In order to do so, it is necessary to tap into religion and tradition. But that is difficult in modern society, where rationality is highly respected. In this light, Japan's outlook for realizing fiscal construction is extremely murky.

     Japan needs to design a system to avert these issues. For instance, the ultralong-term pension system provides great benefits to pensioners. But once the population structure changes, drastic reform is necessary to maintain the system, and the problem of the impossibility of intergenerational cooperation arises.

     Perhaps, systems and new technology that threaten intergenerational cooperation need to be restricted. This is different from irrationalism, which would seek to limit the rational development of technology and social systems. It simply means that, when determining whether to spread a technology or system, we need to take into consideration the limitations of society and seek an even higher level of rationalism.

Keiichiro Kobayashi is a professor of economics at Keio University in Tokyo.

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