Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 728: The Welfare Gains of Improving Risk Sharing in Social Security

Conny Olovsson ()
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Conny Olovsson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden

Abstract: This paper shows that improved intergenerational risk sharing in social security may imply very large welfare gains, amounting to up to 15 percent of the per-period consumption relative to the current U.S. consumption. Improved risk sharing raises welfare through a direct effect, i.e., by correcting an initially inefficient allocation of risk, and through a general equilibrium (GE) effect. The GE effect is due to the fact that the allocation of risk in the pay-as-you-go system influences the demand for capital. As a result, with an efficient risk sharing arrangement, the crowding out effect associated with an unfunded system can actually be completely eliminated. Efficient risk sharing in social security implies highly volatile and pro-cyclical benefits, i.e., that retirees' exposure to productivity risk is increased. Consequently, a policy involving completely safe benefits will unambiguously be welfare reducing.

Keywords: Social security; Risk sharing

JEL-codes: E21; H21; H55

29 pages, March 10, 2004

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