Creating a ‘Generational Contract’ to Improve Young People’s Life Outcomes

Nargiz Mammadova is a Master’s student of the Economics: Research Programme and a finalist of the St. Gallen Global Essay Competition. She took part in this year’s St. Gallen symposium in Switzerland, where the theme was intergenerational interaction.

‘Together Everyone Achieves More: The Generational Contract in the Daf-Galor-Zeira Model’

There are two ways of being selected for the 51st St. Gallen Symposium: either be invited by the organisers or submit an essay relevant to the set topic. This year’s topic was ‘Collaborative Advantage: What Should Be Written into a New Intergenerational Contract?’. My essay was entitled ‘Together Everyone Achieves More: The Generational Contract in the Daf-Galor-Zeira Model’ and it was among the top 100 essays out of the 400 submitted.

In analysing the function of wealth distribution through investment in human capital, Galor and Zeira (1993) found that the primary distribution of wealth influences output. The existence of imperfections in the credit market and the indivisibilities of human capital when it comes to investment mean that economic growth is predominantly shaped by the distribution of wealth. However, there is limited literature devoted to the role of generational contracts in economics, especially for overlapping generations.

The main objective of my essay was to extend the Galor-Zeira Model by adding the concept of a ‘generational contract’ to ease financial market immobility and contribute to the sustainable welfare state through optimal consumption smoothing.

In the prevailing literature, the concept of a generational contract plays a crucial role in achieving an optimal welfare distribution and consumption smoothing for future generations. In view of this, there was a need to include a generational contract in the macroeconomic modelling of welfare and income distribution, which I tried to address in the Daf-Galor-Zeira model.

The main assumptions of the paper were as follows:

First, that one good should be replaced with n goods that provide more flexibility for economic agents to smooth their consumption
Individuals differ not only in the wealth they inherit, but also in their abilities and preferences that affect their decision to invest in human capital. If an individual’s ability is less than the average needed for a certain occupation, then their investment in human capital will either be a sunk cost or inefficient. In this case, not all of their descendants will be part of the skilled labour force
The assumption that individuals consume only during the second period of life is not consistent with the reality that there is an autonomous consumption which asserts that even with zero income, individuals should consume to satisfy their basic needs. I revise this assumption
In terms of having parents, individuals are classified into three groups: those who have two parents, those who have one parent, and those with none. When considering the wealth distribution, it can be postulated that individuals who have a parent are more likely to be part of the skilled labour force than orphans
Production function includes capital, technology, skilled and unskilled labour, and unpaid work by parents for their children. The Galor-Zeira model does not account for the savings rate, which plays a crucial role in investment in human capital. In the Daf-Galor-Zeira model, I assert that saving smooths consumption more efficiently than inherited wealth does. Saving can also enable individuals who are not initially endowed with an inheritance to buy insurance again in the future to smooth consumption
The Galor-Zeira model does not consider taxes and pensions. I propose that the government use tax revenue to invest in human capital for individuals who are financially vulnerable. Regarding pensions, the older generation can invest some percentage of their pensions in human capital for individuals with no inherited wealth
The Daf-Galor-Zeira model also asserts that unpaid work by parents for their children also contributes to the probability of joining the skilled labour force, and that the amount of unpaid work decays over time as children grow. Unpaid work done by parents for their children is proportional to the amount of time parents spent on their children

How did you learn about the 51st St. Gallen Symposium?

During the first year of my Master’s studies, I had an opportunity to work with Prof. Veronika Belousova. She was aware of my interests in research, and always told me about essay competitions. She forwarded me an email from Prof. Fuad Aleskerov with information about the 51st St. Gallen Symposium. That’s how this magnificent journey started.

How will the model work?

Starting with the role of government in the implementation and development of generational contracts, a certain percentage of the wage of a parent who dies should be transferred to the child if the family belongs to the low or middle-income group. This will increase the chances of a child from a poor family to join the skilled labour force, and the same goes for his or her descendants. Additionally, by taxing the income of rich families, the government can transfer some money to children who are orphans or belong to low and middle-income families. This way, the older generation will contribute to future ones, which will also improve the sustainable welfare state.

To eliminate the financial market immobility, the government can implement two policies. One of them is offering grants to individuals experiencing financial difficulties. Governments can do this by transferring part of the savings of wealthy people to orphans and individuals from low and middle-income families.
What is more, the government can establish mobility programmes where members of the experienced middle-aged and older generations train talented individuals who have been tested based on their analytical, quantitative, and verbal skills. A similar programme has been adopted in Azerbaijan to identify and promote promising and intelligent people with good management skills. This, in turn, serves to establish a human resource bank in the country comprised of promising leaders with intelligence and managerial qualities.

What are your impressions of the 51st St. Gallen Symposium?

First and foremost, I would like to express my immense gratitude to the dream team of Cosima von Wackerbarth, Livia Mühlheim, Fabio Heini, and Svenja Bossard, who spent the entire academic year organising this unforgettable event. Many thanks to my host Kelsey Maurer for her hospitality and for devoting her precious time to make her apartment feel like home. It would also be unfair not to mention the volunteers, who were humble and did everything to ensure that those four crazy, busy days went smoothly.

The breathtaking view of St. Gallen, the mesmerising Basel, the chocolates and cheese, the cute black-and-white cows, and the friendly and helpful locals are only a few of the things that blew my mind during my time in Switzerland. Words can’t convey how proud I am to join of the Leaders of Tomorrow community, meet amazing people from all walks of life, and share our cultural values. In a short period of time, we became a family of around 200 students for whom geography and distance are no barrier to reconnecting again.

Finally, I would like to thank my supervisor, Veronika Belousova, for everything she has done for me since October 2020. Participating in the 51st St. Gallen Symposium was an unforgettable experience—and for that, I owe her oceans of appreciation.

June 06, 2022

Education