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Idiosyncratic risk, aggregate risk, and the welfare effects of social security

Daniel Harenberg and Alexander Ludwig

No 18-016, ZEW Discussion Papers from ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research

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 (search for similar items in EconPapers)
JEL-codes: C68 E27 E62 G12 H55 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-age, nep-dge, nep-ias, nep-mac and nep-pub
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:zewdip:18016

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