Can Market and Voting Institutions Generate Optimal Intergenerational Risk Sharing?
In: Risk Aspects of Investment-Based Social Security Reform
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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