Monday, October 17, 2022

A WONKY COMMENT ON A PAPER BY NOBEL LAUEATE EDMUND PHELPS

At some point, I cannot recall just when, I was invited to write a comment on a paper by the famous American economist Edmund Phelps which he was delivering at a philosophy conference. I no longer have his paper, but here is my comment


Socialist Planning and the Life-Cycle Model of Saving[1]

by Robert Paul Wolff

 

Professor Phelps addresses the very difficult problem of intergenerational justice in taxation. For the most part, philosophers concerned with questions of distributive justice have confined themselves to the relatively less complex case of a timeless present in which the members of a social and economic order confront one another and seek to arrive, in some way, at suitable principles of just distribution. So long as the only additions to, or subtractions from, the community occur as a result of voluntary entries or withdrawals by adult men and women, such principles as are fixed upon can, without special difficulty, be extended to new members. But troubles arise as soon as we attempt to take account of the actual human condition, with its endless overlapping life-cycle of birth, childhood, adulthood, old age, and death.

The temporal, generational structure of a human community poses three questions of just distribution which have no natural analogues in the timeless case. First, what share of the social product shall be allotted to those who are not yet able to engage in productive work, and according to what principles shall it be allotted? Which is to say, what shall the children get? Second, what share of the social product shall be allotted to those who are no longer able to engage in productive work, and according to what principles shall it be allotted? Which is to say, what shall the old get? And third, to what extent shall any given generation of productive workers curtail its present consumption so that future generations will find it economically possible to engage in productive work and hence to consume? Which is to say, what is a just rate of social savings? Professor Phelps' paper deals with one aspect of this complex of problems, namely the role of taxation in inducing the participants in a capitalist economy to behave as though they were guided by principles of intergenerational distributive justice that meet certain criteria of acceptability. The criterion which Professor Phelps explicitly invokes is efficiency, in the familiar form of the rule that no principle of intergenerational distribution will be embodied in a society's fiscal policy to which some alternative principle is Pareto-preferred. I shall suggest that, contrary to what would appear to be his intentions, the model employed by Professor Phelps, and the conclusions which he draws from it, have a readier and more natural application to the central planning decisions of a socialist society than to the fiscal decisions of the state apparatus of a capitalist society. Understood in this way, it seems to me, they constitute an extremely useful prolegomenon to the determination of the correct socialist principles of intergenerational distributive justice.

Professor Phelps employs a two-period model of a capitalist economy. Workers work in the first period of their life-cycle, consuming part of their income in period one and saving the rest toward their non-working old age in period two. Their aggregate savings constitute the capital available to the new generation of workers, who are in their first, or working period during the first generation’s second, or old-age period. Thus, the savings policies adopted out of rational self-interest by the first generation constitute the precondition for the investment policies adopted by the second generation out of their rational self-interest. The model assumes that each generation, in the aggregate, consumes its entire first-period savings (suitably augmented by some social rate of return) in its second period. Hence, it leaves nothing to its posterity in the form of bequests.

Intuitively, it is clear that consumption foregone by worker-savers in their working period will result both in an increase in the consumption available to them in their retirement period and also in an increase in the capital available to the next generation of worker-savers in their working period. Starting with a given level of aggregate saving by worker-savers in some base period, we may discover that the utility functions of those worker-savers and of the next generation of worker-savers are such that some different, lower rate of savings would leave nobody worse off and someone better off. There may, however, be no rationally self-interested reason for any individual worker-saver of the present generation of worker-savers to shift to that lower level of saving. The aim of Phelpsian fiscal policy is to alter the objective situation, through appropriate taxation, so that the move to the Pareto-preferred state comes to be the outcome of rational savings choices.

There are several rather nice features of the two-generation life-cycle model, if we look at it from the point of view of the three questions about intergenerational distributive justice mentioned above. First of all, the elimination of bequests solves at least one problem of allocation to children. If there is no inherited wealth, then we need not trouble ourselves over the vexing issue of the limits on, or justification for, inheritance. Secondly, the model explicitly answers the question of what the old shall get. In the aggregate, they will get what they paid for, in the form of savings or pension plans. Finally, the model offers an answer to the question of a just rate of savings--or at least it offers a partial answer, since Pareto-preference yields only a partial ordering.

To be sure, the model does not, in and of itself, offer any but the slenderest guide to redistribution, which one might have thought was the heart and soul of the issue of distributive justice (always remembering that the null redistribution is a case of redistribution). But as Professor Phelps makes clear in this and other papers, the model is compatible with whatever redistributive arrangements we might wish to impose, so it is at least a first step in the direction of a theory of intergenerational justice.

Nevertheless, the model employed by Professor Phelps seems to me to suffer from a number of drawbacks which make it, at one and the same time, an unsatisfactory tool for the analysis of capitalist fiscal policy and yet a promising tool for the analysis of socialist long-term planning.

The first problem is that the human life-cycle consists of three generations or periods, not two. The work period is preceded by childhood. Now the fact is that so long as they are charged with the social task of rearing their children, parents will seek to give those children a competitive advantage in a capitalist society by buying them better food and clothing, better education, specialized skill training, and anything else that will offer an edge in the job market. Some of the consumption in both periods of a worker-saver's life, therefore, will actually take the form of investment in human capital, with his/her children being the "firm" in which the capital is invested. The only way to transform Professor Phelps' model into a true no-bequests model would be to raise the children in the society communally and deny to natural parents (or anyone else) the right to spend extra money on the young. That may indeed be the socially just policy (although even I, from a socialist perspective, doubt it), but it is certainly not the policy ordinarily associated with the principles of capitalism. In the absence of such extreme egalitarian child-rearing procedures, the Phelps model very quickly turns into what he refers to as a "Barro and Bailey world of dynastic families."

It might be thought that the no-bequests assumption makes the life-cycle model irrelevant to capitalism even without the problem of child-rearing, for inherited wealth manifestly plays a major role in capitalism as we know it. However, Professor Phelps could get around that problem by positing a capitalism consisting entirely of joint-stock corporations in which worker-savers purchased shares as part of their pension arrangements. A worker-saver could then consume his or her savings in the second period simply by steadily cashing in his or her portfolio. If there were a one-hundred percent tax on estates, the result would very shortly be a system of actuarially sound life-trusts which would produce, as an aggregate result, a net estate of zero for each generation.

The problem of child-rearing remains, however. To preserve the structure of the life-cycle no-bequests model, the state would have to pursue a policy of active, continual intervention, in order to rectify what would otherwise be a series of de facto bequests by each generation to its children.

The second difficulty with the Phelps model is that it has the rather peculiar consequence of making workers the savers and capitalists the consumers in the economy.[2] The classical assumption on which most economic theory has been built is that capital accumulation in a capitalist economy takes the form of investment of a portion of profits. Most of the assumptions about capitalists' propensity to save are based on this conception, and make sense only in terms of it. In the life-cycle model, however, capital accumulation is essentially a by-product of old-age savings by workers. It is actually a bit difficult to see, in this model, who the capitalists are, or why financial institutions would consent to lend them money for investment purposes. Once again, the model is actually more appropriate to a socialist economy. If capitalists, as a class, are eliminated from the model, and capital accumulation is carried on by the state, then in some sense workers' savings will be the source of investment capital, although there would be no particular reason to go through the complicated process of distributing the social surplus ticketed for investment to the workers in the form of wages and then taking it back in the form of taxes.

The third difficulty with the Phelps model is that, in keeping with the assumptions of a private enterprise economy, it limits state direction of the economy to fiscal policies designed to make it self- interestedly rational for individual worker-savers to behave in a manner that will produce the outcome independently conceived as desirable by the authors of the fiscal legislation. Now, the experience of recent decades very strongly suggests that it is difficult to shape economic behavior by such indirect means. The effort, as the old saying has it, is rather like pushing on a string. In the absence of perfect information and consequent perfect certainty, worker-savers may persist in objectively irrational savings behavior because of doubts about the aggregate outcome of their, and their fellow worker-savers', choices. Professor Phelps' fiscal planners may find themselves reduced to ineffectual jaw-boning, along the lines of the subway and bus ads during the Eisenhower era that urged Americans to show their faith in America by buying on credit and going into debt. In a socialist economy, however, the target vectors of capital and consumption that are, in Professor Phelps' model, to be the unintended outcomes of individual choices, could become the values of objective planning functions. Through democratic methods of collective decision-making, real worker- savers could choose their collective future, reallocate resources to equalize the opportunities available to the next generation, and place themselves on the optimal growth path compatible with their collectively agreed-upon principles of distributive justice. In such a society, economic planners would, I imagine, have to engage in calculations very like those which Professor Phelps has shown us how to carry out.

 



[1] I should like to thank my colleague, Professor Robert Costrell of the University of Massachusetts Economics Department, for his very considerable assistance in the preparation of this Comment. 

[2] I owe this point to Costrell, who develops it in an unpublished paper entitled “The Destabilizing Distribution Effect in Life-Cycle Savings.”


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