Social security and risk sharing: the role of economic mobility across generations

How well does social security jointly insure lifetime earnings risk and longevity risk? We show that the answer to this fundamental question depends critically on the nature of economic mobility across generations. To show this result, we compare two economies. In our first economy, inheritances are uncorrelated with wage earnings, implying that an individual’s earnings are unrelated to the wages and asset holdings of their predecessors. In our second economy, there is no such economic mobility; instead, low-wage earners are stuck receiving small inheritances from their low-wage ancestral line, while high-wage earners enjoy large inheritances from their high-wage ancestral line. We make these comparisons in a variety of settings including both fixed and endogenous factor prices. Social security causes large welfare losses in the first economy but can generate large welfare gains in the second economy. Given the apparent limits to economic mobility in the USA, the welfare gains from collective risk sharing through social security are potentially large.