DP5039 Pareto Improving Social Security Reform when Financial Markets Are Incomplete

Author(s): Dirk Krueger, Felix Kübler
Publication Date: May 2005
Keyword(s): aggregate fluctuations, incomplete markets, intergenerational risk sharing, social security reform
JEL(s): D58, D91, E62, H31, H55
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5039

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 labour 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.