Efiiciency versus insurance

The role for fiscal policy in social security privatization

Pension system reforms imply substantial redistribution between cohorts and within cohorts. They also implicitly aect the scope of risk sharing in societies. Linking pensions to individual incomes increases efficiency but reduces the insurance motive implicit in Beveridgean systems. The existing view in the literature argues that the insurance motive dominates the efficiency gains when evaluating the welfare effects. We show that this result is not universal: there exist ways to increase efficiency or compensate the loss of insurance, assuring welfare gains from pension system reform even in economies with uninsurable idiosyncratic income shocks. The scal closure, which necessarily accompanies the changes in the pension system, may boost efficiency and/or make up for lower insurance in the pension system. Indeed, scal closures inherently interact with the effects of pension system reform, counteracting or reinforcing the original effects. By analyzing a variety of scal closures, we reconcile our result with the earlier literature. We also study the political economy context and show that political support is feasible depending on the scal closure.

Key words: pension system reform, scal policy, welfare effects
JEL Codes: C68, D72, E62, H55, J26