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Can Market and Voting Institutions Generate Optimal Intergenerational Risk Sharing?

In: Risk Aspects of Investment-Based Social Security Reform

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  • Antonio Rangel
  • Richard Zeckhauser

Abstract

January 14, 1999 Are market and voting institutions capable of producing optimal intergenerational risk-sharing? To study this question we consider a simple endowment economy with uncertainty and overlapping generations. Endowments are stochastic; thus it is possible to increase the welfare of every generation using intergenerational transfers that might depend on the state of the world. We characterize the transfers that are necessary to restore efficiency and compare them to the transfers that take place in markets and voting institutions. Unlike most of the literature, we study both ex-ante and interim risk-sharing. Our main conclusion is that both types of institutions have serious problems. Markets cannot generate ex-ante risk-sharing because agents can trade only after they are born. Furthermore, markets generate interim efficient insurance in some, but not all economies because they cannot generate forward (old to young) intergenerational transfers. This market failure, in theory, could be corrected by government intervention. However, as long as government policy is determined by voting, intergenerational transfers might be driven more by redistributive politics than by risk-sharing considerations. Successful government intervention can arise, even though agents can only vote after they are born, but only if the young determine policy in every election.

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This chapter was published in:

  • John Y. Campbell & Martin Feldstein, 2001. "Risk Aspects of Investment-Based Social Security Reform," NBER Books, National Bureau of Economic Research, Inc, number camp01-1.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10593.

    Handle: RePEc:nbr:nberch:10593

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    1. Smith, Alasdair, 1982. "Intergenerational transfers as social insurance," Journal of Public Economics, Elsevier, vol. 19(1), pages 97-106, October.
    2. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
    3. Roger H. Gordon & Hal R. Varian, 1985. "Intergenerational Risk Sharing," NBER Working Papers 1730, National Bureau of Economic Research, Inc.
    4. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    5. James M. Poterba, 1996. "Demographic Structure and the Political Economy of Public Education," NBER Working Papers 5677, National Bureau of Economic Research, Inc.
    6. 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.
    7. Baxter, Marianne, 1989. "Money and market incompleteness in overlapping generations models," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 69-91, July.
    8. Enders, Walter & Lapan, Harvey E., 1982. "Social Security Taxation and Inter-Generational Risk Sharing," Staff General Research Papers 10822, Iowa State University, Department of Economics.
    9. Jerry R. Green, 1977. "Mitigating Demographic Risk Through Social Insurance," NBER Working Papers 0215, National Bureau of Economic Research, Inc.
    10. Manuelli, Rodolfo, 1990. "Existence and optimality of currency equilibrium in stochastic overlapping generations models: The pure endowment case," Journal of Economic Theory, Elsevier, vol. 51(2), pages 268-294, August.
    11. Peled, Dan, 1984. "Stationary pareto optimality of stochastic asset equilibria with overlapping generations," Journal of Economic Theory, Elsevier, vol. 34(2), pages 396-403, December.
    12. Peled, Dan, 1982. "Informational diversity over time and the optimality of monetary equilibria," Journal of Economic Theory, Elsevier, vol. 28(2), pages 255-274, December.
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