A Note on the Aging Population and the Size of the Welfare State
Central European University, Economics Working Paper No. WP4/2003
12 Pages Posted: 29 Jul 2003
Date Written: 2003
Razin et al. (2002) reported an empirical puzzle concerning certain OECD countries between 1965 and 1992: ceteris paribus, the higher the dependency ratio (implied by population aging), the smaller is the size of the welfare state. To explain the puzzle, they constructed a redistributive OLG model, assuming that (i) the workers receive the same benefits as the old; (ii) having static expectations on future tax rates, the workers maximize their current rather than lifetime incomes. This Note exposes a serious error in the empirical part, namely that population aging and increasing dependency are mixed up. The theoretical part replaces (i) by a more general assumption: The worker's benefit is proportional to old-age benefit and shows the oversensitivity of the model to the fictious value of the proportionality factor. Moreover, replacing static expectations in assumption (ii) by naive-rational expectations leads to a consistent but still imperfect model.
Keywords: social security, Government expenditure, population aging, median voter
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