Investment in children, social security, and intragenerational risk sharing

Abstract

We analyze the role of pay-as-you-go social security in intragenerational risk sharing in an overlapping-generations model with individual heterogeneity. Parents invest in their children’s education in state schools in exchange for old-age financial support. Due to random factors such as luck in the job market, children may have different earning capacities despite that they receive the same education. Without social security, a parent gets a transfer payment from her own child, so the received amount is uncertain as it depends on the child’s earnings. The social security scheme, which essentially serves to pool transfer contributions from all children and then redistribute them equally to each parent, insures parents against the risk of educational investments. Our model shows that social security stimulates educational spending, enhances labor earnings, and increases ex ante individual utility. However, it may worsen ex post intragenerational inequality of lifetime income.