Social security with rational and hyperbolic consumers

Abstract

The present paper simulates the privatization of social security in an economy populated by overlapping generations of individuals that have time-consistent or time-inconsistent preferences, face mortality and individual income risk as well as borrowing constraints. We compute the transition path and compensate households in order to isolate the efficiency effects of the reforms. The model is calibrated to the German economy where the social security system offers little income insurance. Nevertheless, we find a positive role for social security due to the insurance provision against mortality risk and the provision of a commitment technology for present-biased consumers. In economies with rational consumers the elimination of social security yields an efficiency loss of roughly 0.6 percent of initial resources, while in economies with hyperbolic consumers the efficiency loss increases to 1.8 percent.