Diamond has made fundamental contributions to a variety of areas, including
government debt and
capital accumulation,
capital markets and risk sharing,
optimal taxation, search and matching in
labor markets, and
social insurance.
Dynamic inefficiency Diamond (1965) extended the
Ramsey–Cass–Koopmans model, from a representative infinitely-lived
agent to a setup where new individuals are continually being born and old individuals are continually dying. He built on a framework developed by
Paul Samuelson, who had termed it "an exact consumption-loan model." Since individuals born at different times attain different utility levels, it is not clear how to evaluate
social welfare. One of the main results of this paper is that the decentralized equilibrium might not be dynamically
Pareto efficient, even though markets are competitive and externalities are absent. In particular, depending on the preferences and technology, the economy might find itself saving too much, pushing the capital stock above what Edmund Phelps called the
Golden Rule level. In this situation, government debt can crowd out capital and, in doing so, increase welfare.
Diamond–Mirrlees production efficiency result The
Diamond–Mirrlees production efficiency result follows from a set of assumptions which characterise what can be called a 'DM world'. It is characterised by 7 assumptions: i) perfect competition ii) constant returns to scale to production iii) lump sum taxation is not possible iv) there is a revenue requirement i.e. the government has to raise revenue to fund its expenditures v) full instrument set: the government has the flexibility to levy taxes on all commodities and all factors of production in the economy vi) non-satiation in at least one good vii) individualistic social welfare function. Under these assumptions, it can be shown that the second best allocation requires
production efficiency to be preserved throughout the economy. This result arises from the assumptions that characterise the DM world: • The production side of the economy is independent from the consumption side of the economy (assumption i and ii): perfect competition and constant returns to scale implies no profits (if not producers would increase production infinitely and thus profits). This means that the income of consumers do not depend on the producer prices. In addition, this also means that the incidence of the tax would fall 100% on consumers. Again, this is an application of the
theory of the second best: Pareto efficiency should be restored in independent markets. • The economy is not able to operate in a first-best world (assumption iii and iv): the government must raise revenue but is not able to raise this through lump sum taxation, thus a Pareto optimal allocation of resources is not possible. Note, this is the only irremovable distortion in the DM world. • The government has a full instrument set that allows any configuration of prices to be achieved, which allows the government to bring about any configuration of relative consumer prices that is consistent with the revenue requirement. The key idea is that when the government can control all consumer prices, the producer prices are independent from the consumer prices and the consumption decision part of the optimal taxation problem becomes independent of the production decision. The implication of the result is that there should be no taxes on intermediate goods and imports. Another implication is that public and private sector production should be based on the same relative prices. In practice, one needs to consider if the assumptions of the DM world are likely to apply; nevertheless, the efficiency result is a useful benchmark against which to judge whether any policy violation of production efficiency is justified.
Labor market search and match Diamond (1982) is one of the first papers which explicitly models the
search process involved in making trades and hiring workers, which results in equilibrium unemployment.
Social Security policy Diamond has focused much of his professional career on the analysis of U.S.
Social Security policy as well as its analogs in other countries, such as China. In numerous journal articles and books, he has presented analyses of social welfare programs in general and the American Social Security Administration in particular. He has frequently proposed policy adjustments, such as incremental but small increases in social security contributions using
actuarial tables to adjust for changes in
life expectancy and an increase in the proportion of earnings that are subject to taxation. == See also ==