Idiosyncratic Risk, Aggregate Risk, and the Welfare Effects of Social Security

SAFE Working Paper No. 59

80 Pages Posted: 11 Jul 2014 Last revised: 5 Dec 2017

See all articles by Daniel Harenberg

Daniel Harenberg

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Alexander Ludwig

Goethe University Frankfurt - Research Center SAFE; University of Cologne - Faculty of Management, Economics and Social Sciences

Multiple version iconThere are 4 versions of this paper

Date Written: December 1, 2017

Abstract

We ask whether a pay-as-you-go financed social security system is welfare improving in an economy with idiosyncratic productivity and aggregate business cycle risk. We show analytically that the whole welfare benefit from joint insurance against both risks is greater than the sum of benefits from insurance against the isolated risk components. One reason is the convexity of the welfare gain in total risk. The other reason is a direct risk interaction which amplifies the utility losses from consumption risk. We proceed with a quantitative evaluation of social security’s welfare effects. We find that introducing an unconditional minimum pension leads to substantial welfare gains in expectation, even net of the welfare losses from crowding out. About 60% of the welfare gains would be missing when simply summing up the isolated benefits.

Keywords: social security; idiosyncratic risk; aggregate risk; welfare

JEL Classification: C68; E27; E62; G12; H55

Suggested Citation

Harenberg, Daniel and Ludwig, Alexander, Idiosyncratic Risk, Aggregate Risk, and the Welfare Effects of Social Security (December 1, 2017). SAFE Working Paper No. 59. Available at SSRN: https://ssrn.com/abstract=2464170 or http://dx.doi.org/10.2139/ssrn.2464170

Daniel Harenberg

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Alexander Ludwig (Contact Author)

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

University of Cologne - Faculty of Management, Economics and Social Sciences ( email )

Albertus-Magnus-Platz
Cologne, D-50923
Germany

HOME PAGE: http://www.wiso.uni-koeln.de/cmr/alexludwig

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