Pareto Improving Social Security Reform When Financial Markets are Incomplete
34 Pages Posted: 13 Sep 2005
Date Written: May 2005
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.
Keywords: Social security reform, aggregate fluctuations, intergenerational risk sharing, incomplete markets
JEL Classification: D58, D91, E62, H31, H55
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