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Pareto Improving Social Security Reform when Financial Markets are Incomplete?

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Author Info
Dirk Krueger
Felix Kubler

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Abstract

This paper studies an Overlapping Generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system can lead to a Pareto improvement. When returns to capital and wages are imperfectly correlated, the consumption variance of all generations can be reduced if government policies enable them to pool labor and capital incomes. A social security system that endows retired households with a claim to labor income may serve as an effective tool to share aggregate risk between generations. Our quantitative analysis shows that, first, abstracting from the crowding-out effect of social security on the aggregate stock in general equilibrium, the introduction of social security does indeed represent a Pareto improving reform, if households are both fairly risk-averse and fairly willing to intertemporally substitute consumption. Second, the severity of the capital crowding-out effect in general equilibrium overturns these gains for degrees of risk aversion and intertemporal elasticity of substitution commonly used in the literature.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9410.

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Date of creation: Jan 2003
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Publication status: published as Krueger, Dirk and Felix Kubler. "Pareto-Improving Social Security Reform When Financial Markets Are Incomplete?," American Economic Review, 2006, v96(3,Jun), 737-755.
Handle: RePEc:nbr:nberwo:9410

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Find related papers by JEL classification:
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
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    Other versions:
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  14. Krueger, Dirk & Kubler, Felix, 2004. "Computing equilibrium in OLG models with stochastic production," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1411-1436, April. [Downloadable!] (restricted)
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  19. Robert C. Merton, 1983. "On the Role of Social Security as a Means for Efficient Risk Sharing in an Economy Where Human Capital Is Not Tradable," NBER Chapters, in: Financial Aspects of the United States Pension System, pages 325-358 National Bureau of Economic Research, Inc. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bovenberg, A Lans & Uhlig, Harald, 2006. "Pension Systems and the Allocation of Macroeconomic Risk," CEPR Discussion Papers 5949, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Marcello D'Amato & Vincenzo Galasso, 2009. "Political Intergenerational Risk Sharing," CSEF Working Papers 216, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  3. Alexander Ludwig & Michael Reiter, 2008. "Sharing Demographic Risk – Who is Afraid of the Baby Bust?," MEA discussion paper series 08166, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
    Other versions:
  4. Olovsson, Conny, 2004. "The Welfare Gains of Improving Risk Sharing in Social Security," Seminar Papers 728, Stockholm University, Institute for International Economic Studies. [Downloadable!]
  5. J. C. Parra & M. Huggett, 2005. "Quantifying the Inefficiency of the US Social Security System," Computing in Economics and Finance 2005 70, Society for Computational Economics. [Downloadable!]
  6. Dario Caldara & Jesús Fernández-Villaverde & Juan F. Rubio-Ramírez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," NBER Working Papers 15026, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Sydney Ludvigson, 2008. "The Research Agenda: Sydney Ludvigson on Empirical Evaluation of Economic Theories of Risk Premia," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 9(2), April. [Downloadable!]
  8. Hans Fehr & Christian Habermann, 2005. "Risk Sharing and Efficiency Implications of Progressive Pension Arrangements," DNB Working Papers 064, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  9. Dario Caldara & Jesus Fernandez-Villaverde & Juan F. Rubio-Ramirez & Wen Yao, 2009. "Computing DSGE Models with Recursive Preferences," PIER Working Paper Archive 09-018, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
  10. Andrew Mason & Ronald Lee & An-Chi Tung & Mun-Sim Lai & Tim Miller, 2006. "Population Aging and Intergenerational Transfers: Introducing Age into National Accounts," NBER Working Papers 12770, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Caucutt, Elizabeth M. & Cooley, Thomas F. & Guner, Nezih, 2008. "The Farm, the City, and the Emergence of Social Security," IZA Discussion Papers 3731, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  12. Falilou Fall, 2004. "Pension reform, assets returns and wealth distribution," Cahiers de la Maison des Sciences Economiques v04033, Université Panthéon-Sorbonne (Paris 1). [Downloadable!]
  13. Markus Knell, 2008. "The Optimal Mix Between Funded and Unfunded Pensions Systems When People Care About Relative Consumption," Working Papers 146, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
  14. Dirk Krueger & Fabrizio Perri, 2005. "The Research Agenda: Dirk Krueger and Fabrizio Perri on Risk Sharing across Households, Generations and Countries," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 6(2), April. [Downloadable!]
  15. Hans Fehr & Christian Habermann & Fabian Kindermann, 2008. "Social Security with Rational and Hyperbolic Consumers," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 884-903, October. [Downloadable!] (restricted)
    Other versions:
  16. Gomes, Francisco J & Michaelides, Alexander, 2007. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," CEPR Discussion Papers 6136, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  17. Ennio Bilancini & Massimo D'Antoni, 2008. "Pensions and Intergenerational Risk-Sharing When Relative Consumption Matters," Department of Economics University of Siena 541, Department of Economics, University of Siena. [Downloadable!]
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