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Pareto-Improving Social Security Reform when Financial Markets are Incomplete!?

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Author Info
Dirk Krueger
Felix Kubler

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Abstract

This paper studies an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system leads to a Pareto improvement. When returns to capital and wages are imperfectly correlated, a system that endows retired households with claims to labor income enhances the sharing of aggregate risk between generations. Our quantitative analysis shows that, abstracting from the capital crowding-out effect, the introduction of social security represents a Pareto-improving reform, even when the economy is dynamically efficient. However, the severity of the crowding-out effect in general equilibrium tends to overturn these gains. (JEL D58, D91, E62, H31, H55)

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 96 (2006)
Issue (Month): 3 (June)
Pages: 737-755
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Handle: RePEc:aea:aecrev:v:96:y:2006:i:3:p:737-755

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hubbard, R Glenn & Judd, Kenneth L, 1987. "Social Security and Individual Welfare: Precautionary Saving, Borrowing Constraints, and the Payroll Tax," American Economic Review, American Economic Association, vol. 77(4), pages 630-46, September. [Downloadable!] (restricted)
  2. Attanasio, Orazio P & Weber, Guglielmo, 1993. "Consumption Growth, the Interest Rate and Aggregation," Review of Economic Studies, Blackwell Publishing, vol. 60(3), pages 631-49, July. [Downloadable!] (restricted)
  3. Robert C. Merton, 1981. "On the Role of Social Security as a Means for Efficient Risk-Bearing in an Economy Where Human Capital Is Not Tradeable," NBER Working Papers 0743, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249.
  5. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467. [Downloadable!] (restricted)
  6. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," NBER Working Papers 2097, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier. [Downloadable!] (restricted)
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  8. Thomas F. Cooley & Jorge Soares, 1999. "A Positive Theory of Social Security Based on Reputation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 135-160, February. [Downloadable!] (restricted)
  9. Robert J. Shiller, 1998. "Social Security and Institutions for Intergenerational, Intragenerational and International Risk Sharing," Cowles Foundation Discussion Papers 1185, Cowles Foundation, Yale University. [Downloadable!]
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  10. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887 Elsevier. [Downloadable!] (restricted)
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  11. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January. [Downloadable!] (restricted)
  12. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December. [Downloadable!] (restricted)
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  13. Kandel, Shmuel & Stambaugh, Robert F., 1991. "Asset returns and intertemporal preferences," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 39-71, February. [Downloadable!] (restricted)
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  14. Henning Bohn, 2004. "Intergenerational Risk Sharing and Fiscal Policy," 2004 Meeting Papers 22, Society for Economic Dynamics. [Downloadable!]
  15. Hansen, G D, 1993. "The Cyclical and Secular Behaviour of the Labour Input: Comparing Efficiency Units and Hours Worked," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(1), pages 71-80, Jan.-Marc. [Downloadable!] (restricted)
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  16. Krueger, Dirk & Kubler, Felix, 2004. "Computing equilibrium in OLG models with stochastic production," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1411-1436, April. [Downloadable!] (restricted)
  17. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, vol. 8(3), pages 275-298, December. [Downloadable!] (restricted)
  18. Henning Bohn, 1999. "Social Security and Demographic Uncertainty: The Risk Sharing Properties of Alternative Policies," NBER Working Papers 7030, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. Demange, G., 2000. "On Optimality of Intergenerational Risk Sharing," DELTA Working Papers 2000-05, DELTA (Ecole normale supérieure).
  20. Cecchetti, Stephen G. & Lam, Pok-sang & Mark, Nelson C., 1993. "The equity premium and the risk-free rate : Matching the moments," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 21-45, February. [Downloadable!] (restricted)
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  21. Robert C. Merton, 1983. "On the Role of Social Security as a Means for Efficient Risk Sharing in an Economy Where Human Capital Is Not Tradable," NBER Chapters, in: Financial Aspects of the United States Pension System, pages 325-358 National Bureau of Economic Research, Inc. [Downloadable!]
  22. Michele Boldrin & Aldo Rustichini, 2000. "Political Equilibria with Social Security," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 41-78, January. [Downloadable!] (restricted)
  23. Gary Burtless, 2000. "Social Security Privatization and Financial Market Risk: Lessons from U.S. Financial History," Discussion Papers of DIW Berlin 211, DIW Berlin, German Institute for Economic Research. [Downloadable!]
  24. Poterba, James M., 1998. "The rate of return to corporate capital and factor shares: new estimates using revised national income accounts and capital stock data," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 48(1), pages 211-246, June. [Downloadable!] (restricted)
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  25. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July. [Downloadable!] (restricted)
  26. Shiller, Robert J., 1999. "Social security and institutions for intergenerational, intragenerational, and international risk-sharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 50(1), pages 165-204, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bovenberg, A Lans & Uhlig, Harald, 2006. "Pension Systems and the Allocation of Macroeconomic Risk," CEPR Discussion Papers 5949, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Marcello D'Amato & Vincenzo Galasso, 2009. "Political Intergenerational Risk Sharing," CSEF Working Papers 216, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  3. Alexander Ludwig & Michael Reiter, 2008. "Sharing Demographic Risk – Who is Afraid of the Baby Bust?," MEA discussion paper series 08166, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
    Other versions:
  4. Olovsson, Conny, 2004. "The Welfare Gains of Improving Risk Sharing in Social Security," Seminar Papers 728, Stockholm University, Institute for International Economic Studies. [Downloadable!]
  5. J. C. Parra & M. Huggett, 2005. "Quantifying the Inefficiency of the US Social Security System," Computing in Economics and Finance 2005 70, Society for Computational Economics. [Downloadable!]
  6. Dario Caldara & Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," NBER Working Papers 15026, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  7. Sydney Ludvigson, 2008. "The Research Agenda: Sydney Ludvigson on Empirical Evaluation of Economic Theories of Risk Premia," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 9(2), April. [Downloadable!]
  8. Hans Fehr & Christian Habermann, 2005. "Risk Sharing and Efficiency Implications of Progressive Pension Arrangements," DNB Working Papers 064, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  9. Andrew Mason & Ronald Lee & An-Chi Tung & Mun-Sim Lai & Tim Miller, 2006. "Population Aging and Intergenerational Transfers: Introducing Age into National Accounts," NBER Working Papers 12770, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Caucutt, Elizabeth M. & Cooley, Thomas F. & Guner, Nezih, 2008. "The Farm, the City, and the Emergence of Social Security," IZA Discussion Papers 3731, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  11. Mark J. Kamstra & Robert J. Shiller, 2009. "The Case for Trills: Giving the People and Their Pension Funds a Stake in the Wealth of the Nation," Cowles Foundation Discussion Papers 1717, Cowles Foundation, Yale University. [Downloadable!]
  12. Falilou Fall, 2004. "Pension reform, assets returns and wealth distribution," Cahiers de la Maison des Sciences Economiques v04033, Université Panthéon-Sorbonne (Paris 1). [Downloadable!]
  13. Markus Knell, 2008. "The Optimal Mix Between Funded and Unfunded Pensions Systems When People Care About Relative Consumption," Working Papers 146, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
  14. Dirk Krueger & Fabrizio Perri, 2005. "The Research Agenda: Dirk Krueger and Fabrizio Perri on Risk Sharing across Households, Generations and Countries," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 6(2), April. [Downloadable!]
  15. Hans Fehr & Christian Habermann & Fabian Kindermann, 2008. "Social Security with Rational and Hyperbolic Consumers," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 884-903, October. [Downloadable!] (restricted)
    Other versions:
  16. Gomes, Francisco J & Michaelides, Alexander, 2007. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," CEPR Discussion Papers 6136, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  17. Ennio Bilancini & Massimo D'Antoni, 2008. "Pensions and Intergenerational Risk-Sharing When Relative Consumption Matters," Department of Economics University of Siena 541, Department of Economics, University of Siena. [Downloadable!]
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