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Idiosyncratic risk, aggregate risk, and the welfare effects of social security

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  • Harenberg, Daniel
  • Ludwig, Alexander

Abstract

We ask whether a pay-as-you-go financed social security system is welfare improving in an economy with idiosyncratic productivity and aggregate business cycle risk. We show analytically that the whole welfare benefit from joint insurance against both risks is greater than the sum of benefits from insurance against the isolated risk components. One reason is the convexity of the welfare gain in total risk. The other reason is a direct risk interaction which amplifies the utility losses from consumption risk. We proceed with a quantitative evaluation of social security's welfare effects. We find that introducing an unconditional minimum pension leads to substantial welfare gains in expectation, even net of the welfare losses from crowding out. About 60% of the welfare gains would be missing when simply summing up the isolated benefits.

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  • Harenberg, Daniel & Ludwig, Alexander, 2018. "Idiosyncratic risk, aggregate risk, and the welfare effects of social security," ZEW Discussion Papers 18-016, ZEW - Leibniz Centre for European Economic Research.
    • Handle: RePEc:zbw:zewdip:18016
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    3. Antoine Bommier & Daniel Harenberg & François Le Grand & Cormac O'Dea, 2020. "Recursive Preferences, the Value of Life, and Household Finance," Cowles Foundation Discussion Papers 2231, Cowles Foundation for Research in Economics, Yale University.
    4. Geppert, Christian & Ludwig, Alexander & Abiry, Raphael, 1970. "Secular Stagnation? Growth, Asset Returns and Welfare in the Next Decades: First Results," MEA discussion paper series 201605, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    5. Erin Cottle Hunt & Frank N. Caliendo, 2022. "Social security and risk sharing: A survey of four decades of economic analysis," Journal of Economic Surveys, Wiley Blackwell, vol. 36(5), pages 1591-1609, December.
    6. Daniel Harenberg & Alexander Ludwig, 2015. "Social security in an analytically tractable overlapping generations model with aggregate and idiosyncratic risks," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(4), pages 579-603, August.
    7. Xu, Shaofeng, 2016. "On the welfare cost of rare housing disasters," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 301-318.
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    More about this item

    Keywords

    social security; idiosyncratic risk; aggregate risk; welfare;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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