Uncertainty and the effects of a pay-as-you-go social security program on economic growth

Abstract

This paper examines the implications of a simplified social security program on future wages and interest rates in the context of uncertainty. Individual consumption-savings and portfolio decisions are integrated into stochastic growth models to find how a social security program alters intermediate and long-run equilibrium factor payments. Two forms of uncertainty are used, namely, production uncertainty and labor force participation.

In the first part of this paper recent arguments over how social security affects individual savings are presented and evaluated. Conclusions are made that Feldstein's tax and benefit effects represent the dominant influences on personal savings behavior. A neo-classical growth model is then built, that integrates the two period consumption savings decisions of individuals, and long-run equilibrium wages and interest rates are derived. A social security program is then introduced, causing wages to fall and interest rates to rise. Production uncertainty is then added to the model to find how social security impacts on factor payments via individual consumption and portfolio decisions.

Certain questions regarding a social security program are then examined within the production uncertainty model. They include: determining the optimal amount of social security; examining the implications of a fully funded program; studying the relationship between future labor force participation and private investment; examining if optimal social security varies, depending on the individual's wage income and introducing technological growth to see how it effects optimal savings.

An alternative form of uncertainty, labor force participation, is then substituted into the model to see if the implications of social security differ, depending on the form of uncertainty. The results are similar to those found in the production uncertainty model. In addition, it is shown that social security tends to increase the variance of future stochastic wages.