Laurence Kotlikoff

Laurence J. Kotlikoff
Nationality	United States
Academic career
Field	Public Finance
Institution	Boston University
Alma mater	Harvard University University of Pennsylvania
Influences	Martin Feldstein
Awards	Fellow of the American Academy of Arts and Sciences, a William Warren Fairfield Professor at Boston University, Fellow of the Econometric Society
Information at IDEAS / RePEc

Laurence Jacob Kotlikoff (born January 30, 1951) is a William Warren FairField Professor at Boston University, a Professor of Economics at Boston University, Fellow of the American Academy of Arts and Sciences, Research Associate of the National Bureau of Economic Research, Fellow of the Econometric Society, former Senior Economist, President’s Council of Economic Advisers, and President of Economic Security Planning, Inc., a company that markets ESPlanner - an economics-based personal financial planning software program, a simplified version of which is available for free use by the public.

Research

Kotlikoff's thesis examined, in a life-cycle simulation model, the impact of intergenerational redistribution on the long-run position of the economy. He also studied whether the rich spend a larger or smaller share of their lifetime resources than do the poor. And he provided a new empirical approach to understanding the impact of Social Security on saving.

At UCLA, Kotlikoff wrote (with Avia Spivak) a seminal paper on intra-family risk-sharing entitled "The Family as an Incomplete Annuities Market." He also wrote (with Lawrence Summers) a widely cited paper questioning the importance of saving for retirement in determining total U.S. wealth accumulation. This paper, entitled "The Role of Bequests in Aggregate Capital Formation," suggested that most of U.S. wealth accumulation was not attributed to life-cycle saving, but rather to private intergenerational transfers (whether intended or unintended) and was the subject of a lively exchange between Kotlikoff and Nobel Laureate Franco Modigliani, who argued the opposite.

The Auerbach-Kotlikoff Model

Together with Alan Auerbach, a Professor of Economics at the University of California Berkeley, Professor Kotlikoff developed, beginning in 1979, the first computable general equilibrium model of dynamic life-cycle economies. Their model (summarized in their 1987 Cambridge University Press book, Dynamic Fiscal Policy) is being used by economists to compute the perfect foresight transition paths of closed and open economies experiencing complexity demographic and fiscal policy changes in settings with multiple goods and different worker skill groups. Overlapping generations models, in which agents can live upwards to 100 years, are very complicated mathematical structures. Agents who are young will, if they are rational, consider all future interest rates and wage rates in deciding how much to save and work in the present. These interest rates and wage rate paths will depend on the course of the economy's relative supplies of capital and labor, since these relative supplies determine whether capital or labor is relatively scarce and, therefore, what these factors of production will get paid in the competitive market.

The paths of capital and labor will be determined by the aggregation of the saving and labor supply decisions of the individual agents alive through time. Thus a young person's decision about consuming and working today depends, in part, on what he believes will be the interest and wage rates when he's middle age and old, for example, age 90. But the value of these factor prices when he's age 90 depend on how much capital and labor will be around in that year. But this depends, in part, on the saving and labor supply of unborn generations who will be around when he reaches old age.

Mathematically, this problem devolves into a 200-plus order non-linear difference equation in the ratio of capital to labor. There are no mathematical techniques for calculation the exact solution of high order non-linear difference equations. Auerbach and Kotlikoff devised an iterative solution method that entails guessing how the economy's ratio of capital to labor will evolve and then updating the guesses based on deviations of capital and labor supplies from their respective demands and continuing in this manner until the economy's capital-labor transition path converges. Prior to their work, economists had no means of assessing how a realistic life-cycle economy would evolve, including the timing of its responses to a wide range of fiscal and demographic changes. For example, economists had no means of saying how much less capital would be available to the economy in each future year were the government to increase its consumption on a permanent basis and finance that higher level of consumption by raising income tax rates.

Deficit Delusion

In 1984 Kotlikoff wrote a fundamental paper entitled "Deficit Delusion," which appeared in the The Public Interest. This was the first of a series of papers showing that in economic models featuring rational agents, "the" deficit is a figment of language, not economics. I.e., the deficit is not economically well defined. Instead, what governments measure as "the" deficit is entirely a result of the language they use to label government receipts and payments. If the government calls a receipt a "tax," this lowers the reported deficit. If, instead, it calls the receipt "borrowing," it raises the reported deficit. Thus, if you give the government, say, $1,000 this year, it can say it is taxing you $1,000 this year. Alternatively, it can say it is borrowing $1,000 from you this year and will be taxing you in, say, five years the $1,000 plus accrued interest and using this future tax to pay you the principal plus interest due on the current borrowing. With one set of words the deficit is $1,000 larger this year than with the other set of words. If it so chose, the government could say it was taxing you $1,000 this year and also, this year, borrowing $1 trillion from you for, say, five years, making a transfer payment to you this year of $1 trillion, and taxing you in five years an amount equal to principal plus interest on the $1 trillion and using it to pay principal plus interest on the $1 trillion it is now borrowing. With this alternative choice of words, the reported deficit is $1 trillion larger than with the first set of words. But in all three examples, you hand over $1,000 this year and receive and pay zero on net in the future.

Einstein taught us that neither time, nor distance are well-defined physical concepts. Instead, their measurement is relative to our frame of reference -- how fast we were traveling in the universe and in what direction. Our physical frame of reference can be viewed as our language or labeling convention. Einstein showed that neither time and distance were well-defined concepts, but could be measured in an infinite number of ways. The same is true of the deficit. It is a economic measure with no meaning.

In what may be Kotlikoff's most important work, he (together with Harvard's Jerry Green) wrote (see articles at [http:www.kotlikoff.net]) "On the General Relativity of Fiscal Language," which shows that the deficit is devoid of economic meaning in all economic models involving rational agents. These models can feature uncertainty, incomplete markets, distortionary fiscal policy, asymmetric information, borrowing constraints, time-inconsistent government policy, and a host of other problems, yet "the" deficit will still bear no theoretical connection to real policy-induced economic outcomes. The reason, again, is that there is no single deficit, but rather an infinity of deficit or surplus policy paths that can be announced (by the government or any private agent) simply by choosing the "right" fiscal labels.

In Kotlikoff's words, using the deficit as a guide to fiscal policy is like driving in LA with a map of NY. For unlike in our physical world in which we are all using the same language (have the same frame of reference), in the world of economics, we are each free to adopt our own frame of reference -- our own labeling convention. Thus, if Joe wants to claim that the U.S. federal government ran enormous surpluses for the last 50 years, he can simply choose appropriate words to label historic receipts and payments to produce that time series. If Sally wishes to claim the opposite, there are words she can find to "justify" her view of the past stance of fiscal policy. The fact, as shown by Kotlikoff and Green, that the fiscal variables in all mathematical economic models involving rational agents can be labeled freely and tell us nothing about the models themselves (no more than does choosing to discuss the models in French or English), means that the multitudinous econometric studies relating well-defined economic variables, such as interest rates or aggregate personal consumption, to "the" deficit are, economically-speaking, content free.

The deficit is not the only variable that is not well defined. An economy's aggegate tax revenue, its aggregate transfer payments, it disposable income, its personal and private saving rates, and its level of private wealth -- all are non-economic concepts that have no more purchase on reality than the emperor's clothes in Hans Christian Anderson's famous "children's" story.

Generational Accounting

Kotlikoff's realization that conventional fiscal measures were incapable of measuring economic policy fundamentals prompted him to call in the mid 1980s for the development of generational accounting to measure directly the concern underlying "the" deficit, namely the fiscal burden being placed on today's and tomorrow's children. Together with Alan Auerbach and Jagadeesh Gokhale, Kotlikoff produced the first set of generational accounts for the U.S. in the late 1980s. This analysis produced a label-free (language-free) measure of the burdens facing young and future generations. Generational accounting quickly spread to other countries and, to date, has been applied to the fiscal policies of over 35 countries in both developed and developing countries.

Studies of Intergenerational Altruism

Kotlikoff has done pioneering work testing intergenerational altruism -- the proposition that current generations care about their descendants enough to ensure that government redistribution from their descendants to themselves will be offset by private redistribution back to the descendants either in the form of bequests or intervivos gifts. This proposition dates to David Ricardo, who raised it as a theoretical, but empirically irrelevant proposition. In 1974, in a famous article, Robert Barro revived "Ricardian Equivalence" by showing in a simple, elegant framework that each generation's caring about its children leads current generations to be altruistically linked to all future their future descendants. Hence, a government policy of transferring resources to current older generations at a cost to generations born, say, in 100 years would induce the current elderly to simply increase their gifts and bequests to their children who would pass the resources onward until it reached those born in 100 years. This inter-linkage of current and future generations devolves into a mathematical model which is isomorphic to one in which all agents are infinitely lived (i.e., they act as if they live for ever in so far as their progeny are front and center in their preferences). The infinitely-lived model was originally posited by Frank Ramsey in the 1920s. It's aggregation properties make it very convenient for teaching macro economics because one does not have to deal with the messiness of upwards of 100 overlapping generations acting independently, but also interdependently. Consequently, it has become a mainstay in graduate macroeconomics training and underlies the work by Economics Nobel Laureate Ed Prescott and other economists on Real Business Cycle models.

Kotlikoff's singly and jointly authored work in the 1980s and 1990 called this model into question on both theoretical and empirical grounds. In a paper entitled "Altruistic Linkages within the Extended Family: A Note (1983)," which appears in Kotlikoff's 1989 MIT Press book What Determines Savings?Kotlikoff showed that when agents take each other's transfers as given, marriage generates intergenerational linkages between unrelated individuals. I.e., if you, Steve, are altruistic toward your daughter, Sue, and your daughter marries John, who is altruistically linked to his father Ed, who has a daughter Sara who is altruistic toward her husband David, who cares about his sister Ida, who's cares about her father-in-law Frank, you Steve are altrusitically linked to Frank. Furthermore, if Steve loses a dollar and you gain a dollar, Barro's model implies that you Steve will take your new found dollar and hand it to Frank. Kyle Bagwell and Douglas Bernheim independently reached Kotlikoff's conclusion, namely that the Barro model had patently absurd implications.

Together with Assaf Razin and Robert Rosenthal, Kotlikoff showed in [1] that dropping the unrealistic assumption that transfers are taken as given and permitting individuals to refuse transfers (e.g., refusing your mother's offer of an extra helping of cabbage) invalidates Barro's proposition of Ricardian Equivalence. I.e., they showed that Barro's model was a combination of a plausible set of preferences (altruism toward one's children) and an implausible assumption about the game being played by donors and donees.

In a series of empirical papers with Stanford economist Michael Boskin, University of Pennsylvania economist Andrew Abel, Yale economist Joseph Altonji, and Tokyo University economist Fumio Hayashi, Kotlikoff and his co-authored showed that there was little, if any, empirical support for Barro's very special model of intergenerational altruism.

National Saving In life-cycle models without operative intergenerational altruism, the young are the big savers because of every dollar they receive, they save a larger percentage than do the elderly for the simple reason that the elderly are closer to the ends of their lives and want to use it before they lose it. The unborn are, of course, the biggest savers because giving them an extra dollar (that they will be able to collect with interest when they arrive) leads them to consume nothing more in the present because they aren't yet alive. So taking from the young and unborn and giving to the elderly should lead to a decline in national saving. In a 1996 paper (see [2]) with Jagadeesh Gokhale and John Sablehaus, Kotlikoff showed that the ongoing massive redistribution from young and future savers to old savers was responsible for the postwar decline in U.S. saving.

Notwithstanding his many studies overturning Ricardian Equivalence, on both theoretical and empirical grounds, Kotlikoff has a paper showing why intergenerational transfers may have no impact on the economy in a world of purely selfish life-cycle agents. The argument presented is simple. Once younger generations have been maximally exploited by older generations (who are assumed to have the ability to redistribute from the young to themselves), older generations can no longer extract resources for free, meaning they can no longer leave higher fiscal burdens for future generations without handing over a quid pro quo. At such an extreme, intergenerational transfers, per se, are no longer feasible because the young will refuse to accept them.

Policy Reform

Kotlikoff has written that the economic future is bleak for the United States without tax reform, health care reform, and Social Security reform in his book The Coming Generational Storm and other publications. Kotlikoff is a supporter of the FairTax proposal, contributing to research of plan's effects and the required rate for revenue neutrality. He was an economic adviser to formerly-Democratic candidate Mike Gravel during the 2008 Democratic Primary.

Publications

• Laurence J. Kotlikoff, 1987, “social security," The New Palgrave: A Dictionary of Economics, v. 4, pp. 413–18. Stockton Press
• Laurence J. Kotlikoff, 1992, Generational Accounting, The Free Press

• Laurence J. Kotlikoff, 2006, "Is the United States Bankrupt?," Federal Reserve Bank of St. Louis Review, July/August, 88(4), pp. 235–49.
• Laurence J. Kotlikoff, October 22, 2006. "Drifting to Future Bankruptcy." The Philadelphia Inquirer
• *Laurence J. Kotlikoff and Scott Burns (2004). The Coming Generational Storm: What You Need to Know about America's Economic Future'. MIT Press. ISBN 0-262-11286. Description and chapter-preview links, p. vii.
• Laurence J. Kotlikoff and Scott Burns, 2008. Spend 'til the End: The Revolutionary Guide to Raising Your Living Standard - Today and When You Retire', Simon & Schuster. Description and Preview link to chapter links, via right-arrow at top to pp. 11-12.

External links

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