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


  • Virginia Sanchez-Marcos & Alfonso Sanchez Martin


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%.

Suggested Citation

  • Virginia Sanchez-Marcos & Alfonso Sanchez Martin, 2004. "Can Social Security be welfare improving when there is demographic uncertainty?," Computing in Economics and Finance 2004 163, Society for Computational Economics.
  • Handle: RePEc:sce:scecf4:163

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    References listed on IDEAS

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    Cited by:

    1. Oliwia Komada & Krzysztof Makarski & Joanna Tyrowicz, 2017. "Welfare effects of fiscal policy in reforming the pension system," GRAPE Working Papers 11, GRAPE Group for Research in Applied Economics.
    2. 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.
    3. Alexander Ludwig & Michael Reiter, 2010. "Sharing Demographic Risk--Who Is Afraid of the Baby Bust?," American Economic Journal: Economic Policy, American Economic Association, vol. 2(4), pages 83-118, November.
    4. Boldrin, Michele & Montes, Ana, 2015. "Modeling an immigration shock," European Economic Review, Elsevier, vol. 74(C), pages 190-206.
    5. Alexander Ludwig & Michael Reiter, 2008. "Sharing Demographic Risk – Who is Afraid of the Baby Bust?," MEA discussion paper series 08166, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    6. 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.
    7. Peter Broer, 2012. "Social Security and Macroeconomic Risk in General Equilibrium," CPB Discussion Paper 221, CPB Netherlands Bureau for Economic Policy Analysis.
    8. 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.
    9. repec:eee:hapoch:v1_311 is not listed on IDEAS
    10. Roel Beetsma & Ward Romp, 2013. "Participation Constraints in Pension Systems," Tinbergen Institute Discussion Papers 13-149/VI, Tinbergen Institute.
    11. Clara Isabel González & J. Ignacio Conde-Ruiz & Michele Boldrin, 2008. "Immigration and Social Security in Spain," Working Papers 2008-36, FEDEA.
    12. 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.
    13. Shin, Inyong, 2012. "The Effect of Pension on the Optimized Life Expectancy and Lifetime Utility Level," MPRA Paper 41374, University Library of Munich, Germany.
    14. Shin, Inyong, 2015. "Could pension system make us happier?," MPRA Paper 65116, University Library of Munich, Germany.

    More about this item


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

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • J10 - Labor and Demographic Economics - - Demographic Economics - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy


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