Optimal public policy à la Ramsey in an endogenous growth model

Abstract

We use an overlapping generations model with physical and human capital to ascertain the consequences for optimality of a social planner adopting a welfare criterion that treats all generations alike and is respectful of individual preferences. In particular, we consider a social planner who maximizes a non-discounted sum of individual utilities à la Ramsey, with consumption levels expressed in terms of output per unit of efficient labour. We show that the optimal growth path does not depend on the precise cardinalization of preferences (i.e., the degree of homogeneity of the utility function) and that it converges to the “Golden Rule” defined in this endogenous growth framework. The instruments available to the social planner are subsidies to the investment in education by the younger generation and lump-sum taxes on the middle-aged and the retirees. Decentralizing the optimum trajectory requires that subsidies to investment in education be negative (i.e., taxes), and that pensions to the elderly be positive along the entire optimal growth path. These results hold regardless of the initial conditions.