The Review of Economic Studies, Ltd.

On the Optimal Transfer and Income Distribution in a Growing Economy

Author(s): K. Hamada
Source: The Review of Economic Studies, Vol. 34, No. 3 (Jul., 1967), pp. 295-299
Published by: Oxford University Press
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On

the

Optimal

Distribution in

Transfer

a Growing

and

Income

Economyn

1. One of the possible objections to income transfers from the capitalists to the
workers would be that it reduces the over-all saving ratio of an economy and retardscapital
accumulation. If the average propensity to save of the capitalists is larger than that of
the workers, transfer payments from the former to the latter, say by social security or
collective bargaining, reduce the over-all saving ratio of the economy, which in turn results
in a smaller capital-labour ratio and a smaller income-labour ratio in the equilibrium
growth path. Transfer payments will increase the labour share but may reduce the total
income to be distributed between labour and capital.
Then, is there any optimal amount of transfers from the standpoint of the workers in
the long run? The purpose of this note is to show that, in a neoclassical growth model
where saving ratios are different, no transfer is the best policy for the workers so far as the
comparison of balanced paths is concerned.
2. The growth model to be considered is a neoclassical one with different saving ratios
between capitalists and workers. We follow Pasinetti [1] in assuming that the workers
receive not only wages but also interest payments on their own accumulated savings.
Let n be growth rate of labour, and k, kl, k2 (k1 +k2 = k) be per capita capital,
that owned by the capitalists and that owned by the workers respectively. f(k), r(= f '(k))
and w(= f- rk) are concave per capita production function, interest rate and wage rate
respectively. The average propensity to save (consume) of the capitalists and of the
workers are denoted as s1 and s2 (c1 and c2), and they satisfy the relationship 1 >_ Sl>s2 ?0.2
If we introduce per capita transfer x from the capitalists to the workers, the income of the
capitalists is equal to (rk1- x) and that of the workers (w + rk2+x). Accordingly on the
equilibrium growth path, the following relations hold:
sl(rk1-x)
s2(w+ rk2+x)

= nk,
=

nk2.

...(1)

...(2)

Here we shall prove that the workers cannot be better off by a positive or negative
transfer.3
Assume the contrary, that the workers are made better off by a positive transfer.
When we take x away from the capitalists their as well as the economy's stock of capital
per man must be lower, Suppose x is taken away by such an amount as to reduce per
capita capital stock by " one unit ". Then at x = 0, reducing the capital stock by one
unit reduces output per man by r and investment per man by n so that available consumption
The change in consumption
Since n = slr, it is equal to -(re,).
changes -(r-n).
demand, on the other hand, comes from the following sources:
(i) the changes in k1 and k2, (ii) change in r, (iii) change in w, and (iv) the addition or
subtraction of x. If the workers are better off by the transfer, dk2> 0 by (2). Then clearly
1 The author would like to thank Profs. F. H. Hahn, R. Komiya, S. Kumon, S. Nishibe and K. Sato
for helpful commentson an earlierdraft of this note. This study is partly supportedby the Tokyo Centre
for Economic Research and the Research Institute for the Japanese Economy, Faculty of Economics,
University of Tokyo. None of them, of course, are responsiblefor any errors remainingor any views
expressedhere.
2 More preciselyspr _ s2 where 7 = rk/f. See Sato [4].
3 I owe this method of proof to Prof. Hahn.
295

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296

REVIEW OF ECONOMIC STUDIES

dklrcl + dk2rc2> rc,(dkl + dk2)= - rc. So consumption demand from source (i) falls
by less than does available consumption. Differentiating (1) and noting the relation
slr = n at x = 0, one can easily obtain k,dr = x, whence there is an increase of capitalist
consumption due to the higher interest rate just equal to the reduction from the direct
transfer. Similarly,
dw = -kdr = -kldr-k2dr = -x-k2dr.
Therefore the reduced consumption demand of the workers due to the reduction of wages
is just offset by the increase from the transfer and the higher interest rate. On the whole
there will be excess consumption demand from the first source. Hence workers cannot be
better off.
Similarly we can show that they cannot be better off by a negative transfer. Since
per capita income of the workers takes a local maximum at x = 0, concavity of production
and linearity of the objective function makes it a global maximum.
This result might seem surprising. But it does not necessarily mean that transfer
payments in the actual world are useless or even harmful to the workers' welfare. First,
there is no assurance that the actual wage rate is equal to labour's marginal productivity.
Social security or trade unionism may be necessary to realize the equality of wage rate to
marginal productivity. Secondly, the discussion above concerns only the comparison of
balanced paths. In the next section this strict restriction is relaxed and it will be shown
that positive transfer payments eventually become the best policy so long as the workers
have some time preference or impatience.
3. Since there is no assurance that the capital-labour ratio initially given to the economy
equals the optimal capital-labour ratio derived above, it is necessary to compare not only
balanced paths but also unbalanced ones. It requires, however, rather complicated analysis
to consider the optimality of these dynamic paths in general. Here we consider only a
simple case where the workers do not save at all, and where the policy objective is to
maximize the discounted sum of the workers' income through time.
If the workers do not save, all the capital is owned by the capitalists, namely k = k
and k2 = 0. Thus we have the following dynamic equation for capital accumulation:

k = sl(rk-x)-nk

... (3)

where k is variable through time and k its time derivative. x is our control variable and
is subject to the constraint below that the transfer should at most exhaust the capitalists'
total income and at least leave the minimum subsistence wages (denoted as z) to the
workers:
< x < rk.
z-(f-rk)
...(4)
Then our problem is to maximize the discounted sum of the workers' income. namely

u=

(f-rk+x)e-Ptdt,

...(5)

where p is the rate of discount or the time preference of the workers,' with respect to x
subject to (4) and the initial per capita capital ko. By using Pontryagin's Maximum
Principle, one can obtain the optimal path. Let H be the Hamiltonian.
H = (f-rk+

x) + 0(sl(rk-x)-nk)

+ u(rk-x) + v(x-z +f-rk)

where u and v are nonnegative auxiliary variables such that

u = 0 if rk>x; v = 0 if x>z-(f-rk).
1 It would be reasonableto assume p is small enough to satisfy p<slr.

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OPTIMAL TRANSFER AND INCOME DISTRIBUTION

297

Then in order that the time path of x be optimal, there exists a continuous 0 as a function
of t, satisfying
f- p0=

kf"-

= 0,

1-S1q-U+V

lim

betP=

t-+ooo

b(s1(r+kf")-n)-u(r+kf")-v(-kf"),

0,

along with equation (4) (see Pontryagin et al, [2], Chapter VI). Since at least one of u
and v is zero, we have the following three phases:
Phase I: u

v = 0 (interior solution)
1
SI

x-=

s1r=n+p,

k.
Si

Phase II: u

0, v>0 (wages kept to the subsistence minimum)

=
x --(f-rk)

1+v

0 = >+
S1

=-

Phase III: u >0, v

k=s1(f-f)-nk

Si

b{s1r-(n+p)}.

0 (all profit transferredto the workers)

x=

rk
1-u

Sl

Sl

k=

-nk

4=

-r+k(n+p).

Phase diagrams of Phase II and III are shown in Figures 1 and 2.

In order that we have a continuous 4 which is at the same time bounded if time goes
to infinity, b must be decreasing in Phase II and increasing in Phase III (optimal paths
are indicated by solid curves in Figure 1 and 2). Therefore we can have the following
optimal transfer programme:
(a) If ko = k* such that s1f '(k*) = n + p, then remain in Phase I,
(b) If ko <k*, start from Phase II and move to I.
(c) If ko > k*, start from Phase III and move to I.
The optimal path of x is illustrated by Figure 3. If the initial endowment of capital is
smaller than k*, the optimal policy for the workers is that they give up their income for
accumulation just leaving the subsistence minimum (if ko is very small, it may be necessary
to receive transfer payments at the start to keep the subsistence minimum) for some length
of time, and after a while they enjoy the fruit of capital accumulation by positive transfer
payments from the capitalists.' If the initial endowment of capital is larger than k*, the

I Precisely,komust satisfy the condition ko>k where k is the smallersolution of

sl( f-z)-nk

0.

Otherwise,the economy cannot sustain itself at the start without outside help, say, foreign aid or lending.
U

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REVIEW OF ECONOMIC STUDIES

298

optimal policy for them is to receive all the capitalists income by transfers until capital
decumulates to the value of k*. Anyway, eventually positive transfer from the capitalists
to the workers becomes the best policy.
Incidentally, case (b) above where initial capital is scarce draws our attention in a
development context. For instance, if we assume that all capital is owned by the state,

k= 0

k-

1~~~~~~~~~~~~~~~~~~~~~0

S1

S < ?

?e

>K
9,

X<
S

o0
o

FIGURE

I~~~~~

Ik
1

<-o

'

''

k <

Fk < ?0

k*
FIGURE

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OPTIMAL TRANSFER AND INCOME DISTRIBUTION

299

our model may be interpretedas a capitalaccumulationmodel of a plannedeconomy. If

the state were interestedonly in the maximizationof the discountedsum of wages, the
workersshould be satisfiedwith the subsistencewage level at an earlystage of economic
development.'
x

_-~~
---| ~

~~

rlC

rk)
FIGURE

3
K. HAMADA.

Universityof Tokyo

REFERENCES
[1] Pasinetti,L. L. " Rate of Profit and Income Distributionin Relation to the Rate
of Economic Growth ", Review of Economic Studies, 29 (1962).

[2] Pontryagin,L. S., Boltyanskii,V. G., Gamkrelidze,R. V., and Mishchenko,E. F.

The Mathematical Theory of OptimalProcesses, New York and London, 1962.

[3] Preobrazhenskii,E. " On Primary Socialist Accumulation" in N. Spulber ed.

Foundations of Soviet Strategy for Economic Growth: Selected Soviet Essays 1924-

1930,Indiana,1964.
[4] Sato, K. " The NeoclassicalTheoremand Distributionof Income and Wealth",
Review of Economic Studies, 33 (1966).
1 In the so-called " primarysocialist accumulation" debate in the USSR (see Preobrazhenskii[3),
the " exploitation" of other sectors than state industrywas proposed to acceleratecapital accumulation.
Though the crux of the matterwas essentiallyanalogousto the discussionhere, the discussionthere mostly
dealt with the transferof saving betweensectors or regionsratherthan betweenthe classes of the economy.
The discussion in this paper might be more relevant to the economic developmentof that country after
1930 when most of its capital was owned by the state.

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