The Extension of Social Security Coverage in Developing Countries

We investigate the effects of extending the coverage of social security to uncovered elderly individuals in the informal sector in developing countries. We use a stochastic overlapping generations framework and incorporate important characteristics of developing countries including family transfers and a sizeable informal sector. Our calibrated model predicts that the introduction of a moderately sized social assistance program decreases steady state output by up to 3.25% and labor supply by up to 2.5%. In contrast to literature focusing on developed countries, the model predicts that extending the coverage of the social security system results in welfare gains for low income households. This result indicates that the insurance function and the redistribution function of the social assistance program dominate the distortionary effects in an environment without adequate risk sharing mechanisms and high inequality.