Unfunded Social Security Research Articles

On the Implications of Two-Sided Altruism in Human-Capital-Based OLG Model

This article summarizes some propositions regarding economic dynamics and implications of two-sided altruism, on the basis of the human-capital-based OLG model of Ehrlich and Lui (1991), with application of a modified, fertility-endogenized definition of linearly separable two-sided altruism by Abel (1987) and Altig and Davis (1993). Some properties in both transition processes and steady states, the effects of unfunded social security on an equilibrium path, and the implications in the context of so called the Samaritan’s dilemma and the Recardian equivalence are also analyzed. Finally some policy implications are summarized. My calibration results and analyses show that (1) the combination of altruism toward parents and children is crucial for determining a threshold level of initial human capital and education technology in a transition process (stagnant to growth or growth to stagnant) with an irreversible hysteresis aspect, (2) in this human-capital-based OLG model, a regular recursive induction approach might still cause inefficiency in terms of an ex-post Pareto optimality criterion as of two periods later, even if strategic effects for after children (two generations later) are appropriately taken account of, and (3) unfunded social security, which involves actuarially fair insurance as well as certainty premium transfer, does not affect either saving or critical values for regime change so drastically, in this two-sided altruistic economy.

Demographic structure and growth: The effect of unfunded social security

This paper examines how demographics affect economic growth in an OLG model with unfunded social security. We derive two interesting results. First, the relationship between population growth and per capita output growth is hump shaped. Second, the relationship between life expectancy and per capita output growth is also hump shaped.

Consumption over the life cycle: The role of annuities

We explore the quantitative implications of uncertainty about the length of life and a lack of annuity markets for life cycle consumption in a general equilibrium overlapping generations model in which markets are otherwise complete. Empirical studies find that consumption displays a hump shape over the life cycle. Our model exhibits life cycle consumption that is consistent with this pattern. Our calibrated model, which includes an unfunded social security system, displays a hump shape but the peak occurs later in the life cycle than in the data. Adding a bequest motive causes this decline to begin at a younger age.

Why are more redistributive social security systems smaller? A median voter approach

One of the stylized facts of unfunded social security programs is that programs are larger in size, measured relative to the GDP, the tighter the link between pension claims and past earnings. We provide a political economy explanation of this stylized fact in a median voter model, where people vote on the social security tax rate. We compare pension systems with flat-rate and earnings-related benefit formulas. Only flat-rate benefits redistribute within a generation from high to low income groups. If labor supply is endogenous, they also imply larger efficiency costs than earnings-related schemes. Using data on eight European countries, we find that the median voter is typically middle-aged with high income. For these voters, earnings-related systems are more attractive both because of less intragenerational redistribution and lower distortions in labor supply. The median voter model is also able to account for a considerable degree of cross-country variation in contribution rates.

Social security and self control preferences

We analyze the welfare effects of an unfunded social security system. We do so using an overlapping generations economy wherein agents have self-control preferences, face mortality risk, individual income risk, and borrowing constraints. Given our specification of preferences, unfunded social security helps reduce the agents’ temptation to consume in every period; consequently, the welfare costs it otherwise entails are substantially mitigated. While both social security and self-control when considered separately reduce welfare, their combination renders this effect considerably less severe. Moreover, if the cost of resisting temptation is very high, the introduction of social security might even improve welfare.

Life expectancy, human capital, social security and growth

We analyze the effects of changes in the mortality rate upon life expectancy, education, retirement age, human capital and growth in the presence of social security. We build a vintage growth, overlapping generations model in which individuals choose the length of education and the age of retirement, and where unfunded social security pensions depend on workers' past contributions. Social security has a positive effect on education, but pension benefits favor reductions in retirement age. The net effect is that starting from a benchmark case, higher life expectancies give rise to lower per capita GDP growth in the presence of social security as the share of the active population is reduced. In addition, higher social security contribution rates reduce the growth rate of per capita GDP.

Health investment, saving, and public policy

Abstract. This paper develops an overlapping‐generations model in which agents invest in health to prolong life in both working and retirement periods. It explores how unfunded social security with or without health subsidies affects life expectancy, economic growth, and welfare. In particular, by extending life at a possible cost of capital accumulation, health subsidies and a pay‐as‐you‐go pension can improve welfare, especially in the short run. JEL classification: I12, J14, J18, O11

Elimination of Social Security in a Dynastic Framework

In this paper we study the welfare effects of eliminating social security in a model with two sided altruism where social security provides insurance against lifetime and individual income uncertainty. Our findings indicate that households are able to shift the efficiency gains, generated through privatization of social security, across parents and children quite successfully. Contrary to a pure life-cycle setup, our framework yields significant support for even an uncompensated elimination of unfunded social security.

A Note on Deficit, Implicit Debt, and Interest Rates

This short note revisits the long-standing issue of the relationship between government borrowings and interest rates using vector autoregression (VAR) models. In particular, we consider the dynamic impacts of both official deficit and implicit debt on the interest rates. Two measures of unfunded Social Security obligations (implicit debt) are examined. The recently developed generalized forecast error variance decompositions, which are invariant to the ordering of variables in VARs, are adopted. We find that temporary shocks to the official deficit do not cause real interest rate changes in the short term but do cause moderate changes in the long term. They have significant impact on nominal interest rates in both short and long horizons. The implicit debt also appears to have some moderate influence on real interest rates at long horizons.

A Note on Deficit, Implicit Debt, and Interest Rates

This short note revisits the long‐standing issue of the relationship between government borrowings and interest rates using vector autoregression (VAR) models. In particular, we consider the dynamic impacts of both official deficit and implicit debt on the interest rates. Two measures of unfunded Social Security obligations (implicit debt) are examined. The recently developed generalized forecast error variance decompositions, which are invariant to the ordering of variables in VARs, are adopted. We find that temporary shocks to the official deficit do not cause real interest rate changes in the short term but do cause moderate changes in the long term. They have significant impact on nominal interest rates in both short and long horizons. The implicit debt also appears to have some moderate influence on real interest rates at long horizons.

Positive arithmetic of the welfare state

This paper argues that social security enjoys wider political support than other welfare programs because: (i) retirees constitute the most homogeneous voting group, and (ii) the intragenerational redistribution component of social security induces low-income young to support this system. In a dynamically efficient overlapping generation economy with earnings heterogeneity, we show that, for sufficient income inequality and enough elderly in the population, a welfare system composed of a within-cohort redistribution scheme and an unfunded social security system represents the political equilibrium of a two-dimensional majoritarian election. Social security is sustained by retirees and low-income young; while intragenerational redistribution by low-income young. Unlike unidimensional voting model, our model suggests that to assess how changes in inequality affect the welfare state, the income distribution should be decomposed by age groups.

Lessons for an ageing society: the political sustainability of social security systems

What is the future of social systems in OECD countries ? In our view, the answer belongs to the realm of politics. We evaluate how political constraints shape the social security system in six countries - France, Germany, Italy, Spain, the UK and the US - under population aging. Two main aspects of the aging process are relevant to the analysis. First, the increase in the dependency ratio - the ratio of retirees of workers - reduces the average profitability of the unfunded social security system, thereby inducing the agents to reduce the size of the system by substituting their claims towards future pensions with more private savings. Second, an aging electorate leads to larger systems, since it increases the relevance of pension spending on the policy-makers' agenda. The overall assessment from our simulations is that the political aspect dominates in all countries, albeit with some differences. Spain, the fastest aging country, faces the largest increase in the social security contribution rate. When labor market considerations are introduced, the political effect still dominates, but it is less sizeable. Country specific characteristics (not accounted for in our simulations), such as the degree of redistribution in the pension system and the existence of family ties in the society, may also matter. Our simulations deliver a strong policy implication: an increase in the effective retirement age always decreases the size of the system chosen by the voters, while often increasing its generosity. Finally, delegation of pension policy to the EC may reduce political accountability and hence help to reform the systems.

Lessons for an Aging Society: The Political Sustainability of Social Security Systems

What is the future of social security systems in OECD countries? In our view, the answer belongs to the realm of politics. We evaluate how political constraints shape the social security system in six countries - France, Germany, Italy, Spain, the UK and the US - under population aging. Two main aspects of the aging process are relevant to the analysis. First, the increase in the dependency ratio - the ratio of retirees to workers - reduces the average profitability of the unfunded social security system, thereby inducing the agents to reduce the size of the system by substituting their claims towards future pensions with more private savings. Second, an aging electorate leads to larger systems, since it increases the relevance of pension spending on the policy-makers' agenda. The overall assessment from our simulations is that the political aspect dominates in all countries, albeit with some differences. Spain, the fastest aging country, faces the largest increase in the social security contribution rate. When labor market considerations are introduced, the political effect still dominates, but it is less sizeable. Country specific characteristics (not accounted for in our simulations), such as the degree of redistribution in the pension system and the existence of family ties in the society, may also matter. Our simulations deliver a strong policy implication: an increase in the effective retirement age always decreases the size of the system chosen by the voters, while often increasing its generosity. Finally, delegation of pension policy to the EC may reduce political accountability and hence help to reform the systems.

A welfare analysis of social security in a dynastic framework*

In this article, we study the welfare effects of unfunded social security in a general equilibrium model populated with overlapping generations of altruistic individuals that differ in lifetime expectancy and earnings ability. Contrary to previous research, our results indicate that steady‐state welfare increases with social security for most households, although by very different amounts. This result is mainly due to two factors. First, the presence of two‐sided altruism significantly mitigates the crowding out effect of unfunded social security. Second, ability shocks and uncertain lifetimes generate significant heterogeneity among households to yield different induced preferences for social security.

Pay-as-you-go Social Security and the Distribution of Altruistic Transfers

This paper studies the impact of an unfunded social security system on the distribution of altruistic transfers in a framework where savings are due to both life cycle and random altruistic motivations. We show that the effect of social security on the distribution of these transfers depends crucially on the strength of the bequest motive in explaining savings behaviour. We measure this strength by the expected weight that individuals attach to the utility of future generations. On the one hand, if the bequest motive is strong, then an increase in the social security tax raises the bequests left by altruistic parents. On the other hand, when the importance of altruism in motivating savings is sufficiently low, the increase in the social security tax could result in a reduction of the bequests left by altruistic parents under some conditions on the attitude of individuals toward risk and on the relative returns associated with private saving and social security. Some implications concerning the transitional effects of introducing an unfunded social security scheme are also discussed.

Time-Inconsistent Preferences and Social Security

In this paper we examine the role of social security in an economy populated by overlapping generations of individuals with time-inconsistent preferences who face mortality risk, individual income risk, and borrowing constraints. We find that unfunded social security lowers the capital stock, output, and consumption for consumers with time-consistent or time-inconsistent preferences. However, it may raise or lower welfare depending on the strength of time inconsistency.

Long-run effects of unfunded social security with earnings-dependent benefits

This paper examines the effects of unfunded social security with bequests, fertility and human capital by considering a mix of earnings-dependent and universal social security benefits. We show that social security is more likely to promote growth by reducing fertility and increasing human capital investment if its benefits are more dependent on individuals’ own earnings. Through simulations, we find that the differences in the effects of social security resulting from variations in the benefit formula can be too substantial to be ignored. We also investigate the welfare effect in calibrated economies.

Guaranteeing Individual Accounts

Global aging is prompting workers and taxpayers everywhere to recognize their vulnerability to the inherent uncertainty of unfunded social-security systems. This has generated an international wave of social-security reforms over the last two decades, prompting more than 20 countries to establish Individual Account (IA) plans. In the United States, the idea of Individual Accounts has attracted recent interest with the release of the Final Report of the President's Commission to Strengthen Social Security (CSSS): here, voluntary individual accounts were proposed as a key element of a reformed national old-age system (see Commission to Strengthen Social Security, 2001; John F. Cogan and Mitchell, 2003). Strengths of IA's include the fact that participants gain ownership in their accounts and diversify their pension investments; nevertheless, IA participants also must bear capital-market risk. Recent market volatility has reminded investors of the importance of capital-market fluctuations and their potential impact on retirement income. In response, some policymakers have suggested that be designed to help protect IA investments. Abroad, such guarantees have been adopted in several Latin American countries undergoing reform, and most recently, in Japan and Germany (Mitchell and Kent Smetters, 2003). Sensible public policy recommending the adoption of guarantees must identify their costs and who will pay for them. In this paper, we discuss how to evaluate such costs in the context of a social-security reform that includes IA's, along with ways to finance them.

Lessons for an Aging Society: the Political Sustainability of Social Security Systems'

What is the future of social security systems in OECD countries? In our view, the answer belongs to the realm of politics. We evaluate how political constraints shape the social security system in six countries – France, Germany, Italy, Spain, the UK and the US – under population aging. Two main aspects of the aging process are relevant to the analysis. First, the increase in the dependency ratio – the ratio of retirees to workers – reduces the average profitability of the unfunded social security system, thereby inducing the agents to reduce the size of the system by substituting their claims towards future pensions with more private savings. Second, an aging electorate leads to larger systems, since it increases the relevance of pension spending on the policy-makers’ agenda. The overall assessment from our simulations is that the political aspect dominates in all countries, albeit with some differences. Spain, the fastest aging country, faces the largest increase in the social security contribution rate. When labor market considerations are introduced, the political effect still dominates, but it is less sizeable. Country specific characteristics (not accounted for in our simulations), such as the degree of redistribution in the pension system and the existence of family ties in the society, may also matter. Our simulations deliver a strong policy implication: an increase in the effective retirement age always decreases the size of the system chosen by the voters, while often increasing its generosity. Finally, delegation of pension policy to the EC may reduce political accountability and hence help to reform the systems.

Pareto-Improving Social Security Reform when Financial Markets Are Incomplete!?

This paper studies an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system leads to a Pareto improvement. When returns to capital and wages are imperfectly correlated, a system that endows retired households with claims to labor income enhances the sharing of aggregate risk between generations. Our quantitative analysis shows that, abstracting from the capital crowding-out effect, the introduction of social security represents a Pareto-improving reform, even when the economy is dynamically efficient. However, the severity of the crowding-out effect in general equilibrium tends to overturn these gains.