تغییر ریسک میان نسل هااز طریق امنیت اجتماعی وسیاست های کمک مالی

This paper adopts a stochastic overlapping generations framework to analyze the allocation of aggregate financial risks under different social security systems and a majority voting rule. We study whether there will be switches between pay-as-you-go (PAYG) and fully funded (FF) systems in such an economy. We show that in case of a negative aggregate shock, low-income young individuals will form a political coalition with the elderly to implement a PAYG system. PAYG scheme is shown to persist even after a good aggregate shock if the system is redistributive enough.

The design of old age insurance through social security and, in particular, through a pay-as-you-go (PAYG) system has been widely discussed since the ‘Beveridge Report’ was written in Britain during the second World War period (Beveridge, 1942). Recently, reform proposals regarding the social security systems are at the heart of the public policy debates in all the major industrialized countries. In most of these countries, aging of the population has lead to higher costs associated with the PAYG systems. This financial burden has boosted the fraction of public opinion, policy makers, and economists that view a private alternative to the existing public arrangement not only as feasible but also as desirable. Currently, almost all of the publicly defined benefit systems follow a PAYG scheme, that is, current benefits paid to the elderly are financed by current contributions from workers (and employers). The private system alternative is based on the simple idea that workers, instead of contributing to the PAYG retirement scheme, could put their savings in individually owned private accounts and withdraw these funds from the account when they reach the retirement age. In the rest of the paper, we will refer to this ‘individually funded’ alternative as the fully funded (FF) system. In many privatization plans, workers would be free to decide how to invest their own savings. The clear economic advantage of such a system is that individual accounts would allow workers to tailor their investment and saving decisions concerning their retirement funds to their degree of risk aversion. In a PAYG scheme, instead, workers are forced to accept the ‘portfolio allocation’, so to speak, of the public system. A classic and recurrent argument in favor of the introduction of a private social security system claims that it could enhance the growth rate through the effect on the saving rate. In other words, a worker could obtain higher rates of return by managing his individual account and investing appropriately in securities. Geanakoplos et al. (1999), however, disagree with this ‘investment illusion’ and show that once the ‘legacy debt’ from the first generation of retirees is incorporated into the computations, a privatized system may not necessarily yield a higher rate of return in the U.S. Furthermore, higher rates of return would embed a higher risk. In fact, many of the central issues in the debate over reforms relate to uncertainty. Proposals to privatize Social Security in the U.S. and to invest a portion of the Social Security Trust Fund in equities have drawn attention to the risk aspects of a reform.1 Once uncertainty considerations are incorporated, the analysis of social security reforms becomes more complicated. This is because, even leaving aside the important efficiency considerations, risk-sharing issues naturally arise. A defined contribution system allocates risk in a very different way than a publicly financed defined benefit system does: a PAYG system has a fundamental advantage in this sense over a system of individual accounts. Its future benefits are backed by the government's power to tax, which will be exerted if this is what the majority of voters want. Consequently the public system can spread the risk across different cohorts of the population, including future (unborn) workers. The risks associated with holding capital assets, instead, can be shared with others alive at the same time, but they cannot be shared with future generations. Under an FF system, each worker's pension depends largely on how successful the individual investment decisions have been, and also on how lucky or skilled the worker was in choosing the timing of his retirement. Aaron (1999) argues that the investment risk implies not only intertemporal variation in yields, but also interpersonal variation in returns if workers were to choose their portfolio composition individually.2Shoven and Slavov (2006), on the other end, point out that PAYG is not immune by risk as well. ‘Political risk’ that is: future governments could implement different tax and benefits arrangements and this add a stochastic component to the rate of return of the PAYG system as well. We take this feature into consideration in our framework. Economic and policy analyses evaluating social security reform proposals have to take into account the extent and the nature of such risks as well as the implications of reforms on those who bear the risks. In this paper, we focus on this issue. The purpose of this paper is to study how political economy considerations regarding the social security system affect the outcomes in a stochastic economy confronted with aggregate ‘generational’ risk. The risk considered here, in particular, is a risk associated with the return on a financial asset. It is a burden for all members of one generation but does not affect other generations directly. We pose the following question: could the possibility that a generation may suffer ‘the risk of having a bear stock market during the years it saves for retirement’3 help explain the political persistence of the PAYG system? Our results indicate a positive answer. The point we would like to convey in this paper is quite simple but not yet addressed in all its aspects by the existing literature: this type of financial risk being unavoidable for agents, will it be shared or shifted within and especially between generations? If so, how and to what extent? How should social security reform proposals be evaluated on an ex-ante basis? Besides serving other purposes, a PAYG system can be a useful tool to shift financial risk across generations. In general, while the specifics of social security programs can vary considerably across countries, they always embed a social insurance element. Furthermore, as witnessed recently in several industrialized countries, once a PAYG system is in place, it is hard to dismantle. The arguments proposed here account also for this real-world stylized fact. The present work defines an FF social security system as a decentralized process for the saving decisions. The government does not play any role in this system. Under the PAYG system, instead, individuals are forced to contribute with a payroll tax in order to obtain publicly financed future benefits. Young individuals, who are heterogeneous in terms of their labor income and investment technologies, have to choose how much to save and what fraction of savings to invest in risky assets (e.g. stocks) or in risk free assets (e.g. inflation-indexed government bonds). There are two states of the world, a good one and a bad one, that determine the return on the risky asset. Once the aggregate uncertainty is resolved, voting on the payroll social security tax rate takes place. As a result, the preferred social security system (PAYG or FF) is implemented and consumption follows. There is a fundamental asymmetry in the economy we consider here. Abstracting completely from within cohort labor income differences, one generation may enjoy all the gains from a stock market boom but may also suffer all the losses from a downturn.4 We find that a PAYG system is always implemented in case of a negative shock. Therefore, government plays the role of a ‘bailout agent’. More interestingly, a PAYG system is likely to be in place even after the positive aggregate shock hits the economy depending on the redistributiveness of the system. Our framework can also be viewed as a modification of Casamatta et al., (2000). They show the political sustainability of a redistributive PAYG system in a two period overlapping generation economy with heterogeneous agents. In their model, a fraction of workers and retirees form a majority to vote for a positive level of social security. This is also the case in the present work, even though redistributive considerations play a key role in determining the winning coalition only in the good state of the world. In the bad state of the world, majority will always support the PAYG system independent of the benefit rule. The simple model introduced here is relevant for several reasons. The first one is a caveat for reforms regarding the social security design. For any reform proposal to be taken seriously, it must also consider financial market risk: agents prefer to spread the risk and the damages of the bear stock market across and within cohorts and they may use their vote for such a purpose.5 This issue must be taken into account when proposals for social security reforms are made and our model is a step in this direction. Furthermore, even though the main objective of the paper does not consist in being another positive theory of the welfare state, our model can clearly fit the stylized facts about the historical inception of the social security system in the U.S. and the strong resistance to its current reform proposals.6 Along these lines, another contribution of this paper is to show that a system that contains elements of privatization mixed with an unfunded component is politically preferred to an FF system once an aggregate financial shock is considered. Another contribution of this model is the analytical treatment of the descriptive statement made by Orszag and Stiglitz (2001) on bailout policies for social security. They explain why the often believed assertion that bailout politics will be more severe under public defined benefits plan than under private defined contribution plan is not necessarily true.7 In our model, the classical moral hazard problem could make bailout politics even worse if the system in place is an FF one to begin with: starting with an FF system agents rationally anticipate that a PAYG system will be implemented with certainty in case of a bad state and also in the good state with positive probability. The group voting for a PAYG is acting as a lender of last resort, thus young workers ‘over-risk’ when taking their saving and portfolio decisions. If a negative shock hits the economy, the adverse effect on the wealth of the individuals is magnified by this classical moral hazard problem. Finally, Kruger and Kubler (2006, p. 751) stated that: ‘Extensions of the work of Thomas Cooley and Jorge Soares (1999) and Michele Boldrin and Aldo Rustichini (2000)…… with aggregate uncertainty are needed to address the questions why, though not Pareto improving, the U.S. social security was introduced when it was introduced and who one would expect the major supports of this reform (and of its reversal) to be.’ The model presented here is a first step in this direction. The rest of the paper is organized as follows: in Section 2 we introduce the model and in Section 3 we study different economic frameworks under the FF and the PAYG systems. Section 4 presents the political–economic outcomes of the model. In Section 5, we check the robustness of the model under alternative timing scenarios and Section 6 concludes. The proofs are in the Appendix.

The discussion on social security reform involves many complicated issues. An exhaustive study of the subject requires analyzing several other economic factors such as transition costs of a reform and labor market policies. Demographic and actuarial aspects of a reform, as well as its impact on national savings and financial markets, together with overall growth effects should also be taken into account. Finally, the allocation of public resources into different types of social expenditures is part of a growing literature on the welfare state. Each of these topics have been, to various extent, examined by the existing literature on social security. A much less investigated aspect is differences in financial risk distribution over the life cycle under PAYG and FF schemes and the political support for a social security reform that introduces a switch between the two. This work is an attempt to fill the gap by investigating the allocation of aggregate risk in a stochastic overlapping generation model under a majority voting rule. We find that a PAYG system that incorporates a base pension equal for everyone, a supplementary pension related to wages, and a voluntary private component is politically preferred to an FF system where savings are completely decentralized. The conclusion is that this PAYG system is resilient in the presence of financial risk. The PAYG serves as a safe asset. A fraction of young voters choose to use their vote as a tool to insure their retirement income by supporting it. In order to protect themselves against the bad state of the world, they vote to shift their realized risk onto future generations and current wealth. Hence, they form a pro-PAYG coalition with the elderly. This finding is consistent with the result that Gale (1990) obtains on the risk sharing properties of government debt. He argues that if markets are incomplete, government could introduce new securities that expand risk sharing opportunities. By introducing these safe short dated securities, it would be possible to allow each cohort to transfer some risk across life periods. In his setting, government debt is an exogenously given security, whereas in our setting PAYG is endogenous. Our findings also match the observation earlier made by Bohn (2003) that fiscal institutions shift productivity risk onto future workers rather than current retirees. The observed fiscal policies around the world implicitly assume a higher degree of productivity risk tolerance on the workers side rather than the retirees side. We take a complementary approach to explain political motives behind this risk allocation. In our model, the size of the unfunded pension system is represented by the payroll tax rate ττ. It is positively related to the proportion of pensioners, but the median voter is always a young agent. The size of the PAYG system is possibly increasing with pre-tax labor income inequality and it also depends on the realized state of the world.20 We show that, under the good state of the world, a different political support mechanism is utilized by the elderly to establish a PAYG system. The intragenerational redistributive aspect of the PAYG system is the leverage old agents use to form a coalition with the young voters. The redistributive role of social security is important to explain the political sustainability of this intergenerational transfer scheme. Since the FF system guarantees higher returns in the good state relative to the PAYG, the within cohort redistributiveness of the public system is the appealing factor for young unskilled voters as it is the case in Casamatta et al. (2000). This argument could explain the political persistence of the PAYG system during the 90s and was first put forth by the seminal contribution of Tabellini (2000). This latter feature implies that the political support for the PAYG is inversely related with the return on private savings and thus that social security taxes are anticyclical. This model's prediction would vanish if we were to allow for government debt. In this case, the model would likely predict a classical tax smoothing role for government debt and constant social security taxes. The political part of the model, however, would become very complex since with multiple issues (i.e. social security and debt) to vote upon aggregation of preferences through majority voting presents several difficulties. Furthermore, Yared (2007), in a political economy model, shows that taxes and debt can persistently adjust to shocks and, specifically, that tax rates can display a persistent increase during a negative shock. This is analogous to the anti cyclical behavior of payroll taxes I found here. A moral hazard issue naturally arises: since in the bad state a PAYG system always gets implemented, agents will invest more in risky asset than they would otherwise do. The coalition voting for a PAYG is acting as a lender of last resort, and consequently young workers ‘over-risk’ when taking their saving and portfolio decisions. The adverse effect on income could be magnified by this moral hazard problem. This outcome is consistent with the informal argument presented in Orszag and Stiglitz (2001) on bailout policies for social security systems. They claim that these policies will be more severe under private defined contribution plan than under public defined benefits plan. The main results are pretty robust to repeated voting, and changing the timing of the model does not affect the main findings either. This study can be extended along several dimensions. First, a setting in which heterogeneous agents try to smooth their macroeconomic risk by choosing the size of the social security system and of the government debt in an alternative voting framework such as the one outlined by Battaglini and Coate (forthcoming) is certainly among the suggestions for future research. Second, an important source of risk has not been considered here, namely labor income uncertainty. For example, a productivity shock may lead to random variations in labor income. This work, however, abstracts from labor income uncertainty and focuses on financial market risk only. An interesting extension would be to incorporate labor market shocks correlated with returns to capital. Last but not least, a further extension of this work could be voting on the redistributiveness of the system. Whether voters prefer a Bismarckian or a Beveridgean system and why it is so deserves additional attention.