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Can Social Security be welfare improving when there is demographic uncertainty?

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  • Virginia Sanchez-Marcos & Alfonso Sanchez Martin

Abstract

This paper studies the welfare implications of a PAYG pension system in a neoclassical growth model with overlapping generations, demographic uncertainty and sequentially incomplete markets. In absence of public pensions, small cohorts tend to be favored by the changes in relative prices implied by demographic shocks. As described in Bohn (1999), PAYG Define Benefit systems can help to share the financial risks created by demographic uncertainty across the generations. The overall welfare impact depends on the balance between this insurance effect and the well known crowding-out effect stemming from the unfunded character of the system. Therefore, the question about the total welfare impact of PAYG pensions is intrinsically quantitative. In this paper we use a four-periods OLG model calibrated to the US economy to provide a first quantitative assessment of the relative size of the different effects involved.The findings are unfavorable for PAYG pension systems: the size of the crowding-out effect is large enough to offset the benefits from risk sharing, making the introduction of public pensions a welfare decreasing process (even in ex-ante terms). In particular, with a marginal PAYG pension scheme (providing a 2\% replacement rate of the average wage) small cohorts lose the equivalent to a 1.9% of their consumption in the age interval 20/40, while larger cohorts loss is 1.5%.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 163.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:163

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Keywords: social security; demographic uncertainty; general equilibrium; life-cycle model;

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References

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Cited by:
  1. Willem Heeringa, 2008. "Optimal life cycle investment with pay-as-you-go pension schemes: a portfolio approach," DNB Working Papers 168, Netherlands Central Bank, Research Department.
  2. Michael Reiter & Alexander Ludwig, 2009. "Sharing Demographic Risk – Who is Afraid of the Baby Bust?," 2009 Meeting Papers 389, Society for Economic Dynamics.
  3. Roel Beetsma & Ward Romp, 2013. "Participation Constraints in Pension Systems," Tinbergen Institute Discussion Papers 13-149/VI, Tinbergen Institute.
  4. Shin, Inyong, 2012. "The Effect of Pension on the Optimized Life Expectancy and Lifetime Utility Level," MPRA Paper 41374, University Library of Munich, Germany.
  5. Hans Fehr, 2009. "Computable Stochastic Equilibrium Models and Their Use in Pension- and Ageing Research," De Economist, Springer, vol. 157(4), pages 359-416, December.
  6. Clara Isabel González & J. Ignacio Conde-Ruiz & Michele Boldrin, 2008. "Immigration and Social Security in Spain," Working Papers 2008-36, FEDEA.
  7. Peter Broer, 2012. "Social Security and Macroeconomic Risk in General Equilibrium," CPB Discussion Paper 221, CPB Netherlands Bureau for Economic Policy Analysis.
  8. Miyazato, Naomi, 2010. "The optimal size of Japan's public pensions: An analysis considering the risks of longevity and volatility of return on assets," Japan and the World Economy, Elsevier, vol. 22(1), pages 31-39, January.
  9. Jan Hagemejer & Krzysztof Makarski & Joanna Tyrowicz, 2013. "Efficiency of the pension reform: the welfare effects of various fiscal closures," Working Papers 2013-23, Faculty of Economic Sciences, University of Warsaw.

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