Welfare-Enhancing Social Security Reform

Abstract

The last two decades have witnessed the complete or parital privatization of public pension systems in several countries, and many proposals have been made to privatize the U.S. Social Security system either completely or partially. The motivation behind such proposals is that privatization will lead to substantial long-run welfare gains due to an increase in the economy's steady-state capital stock and a reduction in labor market distortions. This buildup of capital requires lower consumption during the short run, however, so that transition generations might su¤er welfare losses. Previous analyses of the transition to privatized social security using large-scale, computable, overlapping generations models have generally confirmed both large long-run welfare gains and substantial welfare losses during the transition. This paper uses such a model to explore the characteristics that a reform proposal must have if it is to avoid welfare losses in the short run. Using reasonable parameter values, it demonstrates that a Pareto-improving transition to privatized social security is feasible.