Dynamic Efficiency in the Gifts Economy

In the standard analysis of an overlapping generations economy with gifts from children to parents, each generation takes the actions of all other generations as given. The resulting "simultaneous moves" equilibrium is dynamically inefficient. In reality, however, parents precede children in time and realize that children will respond to higher parental saving by reducing their gifts. Incorporating this feature lowers the effective return to saving, resulting in lower steady state capital accumulation. For a broad class of gift economies, we show that the steady state capital stock in the gifts model must be on the efficient side of the golden rule. The analysis therefore overturns the standard presumption of dynamic inefficiency in the gift economy. This result reestablishes the potential relevance of the gift model to the U.S. economy, renders moot an important part of the debate on Ricardian Equivalence, extends the recent literature on the effects of implicit taxation on capital accumulation, and provides a motivation for the presence of a Social Security type system that unconditionally transfers resources from young to old.