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Can Market and Voting Institutions Generate Optimal Intergenerational Risk Sharing?

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  • Antonio Rangel
  • Richard Zeckhauser

Abstract

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 that 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 by 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6949.

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Date of creation: Feb 1999
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Publication status: published as Can Market and Voting Institutions Generate Optimal Intergenerational Risk Sharing? , Antonio Rangel, Richard Zeckhauser. in Risk Aspects of Investment-Based Social Security Reform , Campbell and Feldstein. 2001
Handle: RePEc:nbr:nberwo:6949

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  1. 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.
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  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. 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.
  9. James M. Poterba, 1996. "Demographic Structure and the Political Economy of Public Education," NBER Working Papers 5677, National Bureau of Economic Research, Inc.
  10. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  11. Jerry R. Green, 1977. "Mitigating Demographic Risk Through Social Insurance," NBER Working Papers 0215, National Bureau of Economic Research, Inc.
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