WORKING PAPERS A Dynamic Politico-Economic Model of Intergenerational Contracts

This paper proposes a dynamic politico-economic theory of intergenerational contracts, whose driving force is the intergenerational conflict over government spending. Embedding a repeated probabilistic voting setup in a standard OLG model with human capital accumulation, we find that the empowerment of elderly constituencies is key in order to enforce productive policies. The paper characterizes the Markov-perfect equilibrium of the voting game, as well as the welfare properties. The main results are: (i) the existence of a Markov-perfect equilibrium which attains a growthenhancing intergenerational contract does not require pre-commitment through the establishment of long-lasting institutions; (ii) the political sustainability of the intergenerational contract relies solely on the politico-economic fundamentals that are payoff-relevant for future constituents; (iii) the implementation of pork-barrel transfers does not necessarily crowd out productive public investment; and, (iv) the greater the degree of intergenerational conflicts over the government spending, the lower the ineffi ciency. JEL Classification: D72, E62, H23, H30, H53