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Optimal Social Security with Moral Hazard

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Author Info
Tongwook Park (Korea Information Society Development Institute)
Abstract

Social security is a form of insurance that protects individuals against interruption or loss of earning power. However, in virtually every developed country, employees are leaving the labor force at younger and younger ages and such early retirement trend compounds the financial pressure on social security system. Some analyses suggest that the current structures of social security benefits biased to the early retiree lead people to seek early retirement.
To consider this incentive problem and to design the optimal benefit structures, a model of dynamic insurance against the risk of permanent shocks is developed by modifying Atkeson and Lucas' (1995) model of repeated principal agent problem. The existence and the characteristics of the optimal contract are established. The characteristics of the optimal contract established in this paper exactly confirm Diamond and Mirrlees (1978); this contract involves a decreasing social security tax and an increasing annuity with tenure. And it is optimal for people to retire after a finite period of work even if they are still able to work. In addition to the characterization, we establish that there also exists an optimal contract that balances the budget in every period.
Usually, the possibility of hidden saving is assumed away in repeated principal agent models. We consider the effect of hidden saving on the model and show that the presence of hidden saving does not completely upset the efficiency of the optimal contract over autarky with saving. An example of simulation is presented that suggests that the benefit structure of the current system might be biased to the early retirees and thus the gains could be made by changing the current systems to the optimal program.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1265.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1265

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  1. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
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  2. Feldstein, Martin S, 1985. "The Optimal Level of Social Security Benefits," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 303-20, May. [Downloadable!] (restricted)
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  3. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-32, May. [Downloadable!] (restricted)
  4. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Blackwell Publishing, vol. 54(4), pages 599-617, October. [Downloadable!] (restricted)
  5. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January. [Downloadable!] (restricted)
  6. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-38, April.
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  7. Harold L. Cole & Narayana R. Kocherlakota, 1999. "Efficient allocations with hidden income and hidden storage," Staff Report 238, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  8. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31. [Downloadable!] (restricted)
  9. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-67, June. [Downloadable!] (restricted)
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  10. Axel Borsch-Supan & Reinhold Schnabel, 1997. "Social Security and Retirement in Germany," NBER Working Papers 6153, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Diamond, P. A. & Mirrlees, J. A., 1978. "A model of social insurance with variable retirement," Journal of Public Economics, Elsevier, vol. 10(3), pages 295-336, December. [Downloadable!] (restricted)
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  12. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Blackwell Publishing, vol. 59(3), pages 427-53, July. [Downloadable!] (restricted)
  13. Atkeson Andrew & Lucas Jr. , Robert E., 1995. "Efficiency and Equality in a Simple Model of Efficient Unemployment Insurance," Journal of Economic Theory, Elsevier, vol. 66(1), pages 64-88, June. [Downloadable!] (restricted)
  14. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August. [Downloadable!] (restricted)
  15. Peter Diamond & Jonathan Gruber, 1997. "Social Security and Retirement in the U.S," NBER Working Papers 6097, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Takashi Oshio & Naohiro Yashiro, 1997. "Social Security and Retirement in Japan," NBER Working Papers 6156, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Green, Edward J & Oh, Soo-Nam, 1991. "Contracts, Constraints and Consumption," Review of Economic Studies, Blackwell Publishing, vol. 58(5), pages 883-99, October. [Downloadable!] (restricted)
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  18. Imrohoroglu, Ayse & Imrohoroglu, Selahattin & Joines, Douglas H, 1995. "A Life Cycle Analysis of Social Security," Economic Theory, Springer, vol. 6(1), pages 83-114, June.
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