Quasi-hyperbolic discounting and social security systems

Hyperbolic discounting has become a common assumption for modeling bounded rationality with respect to individual savings decisions. We examine the effects of hyperbolic discounting on the comparison of alternative social security systems. We show that this form of bounded rationality breaks the equivalence between funded and pay-as-you-go (PAYG) systems established in Sheshinski and Weiss [Sheshinski, E., Weiss, Y., 1981. Uncertainty and optimal social security. Quarterly Journal of Economics 95, 189-206]. Intergenerational transfers within a PAYG economy are usually secured by the social security system and independent of longevity, whereas this is not the case for the funded economy. The savings level under hyperbolic discounting is lower than under exponential discounting [Laibson et al., 1998], but the ratio between the savings level under hyperbolic discounting within a funded economy and a PAYG economy depends on the effectiveness of the commitment devices. It is shown that if individuals are hyperbolic discounters, then in a PAYG economy any change in the mandated level of intergenerational transfers is neutralized by individuals’ voluntary bequests. This does not apply to a funded system.     

Nonseparable preferences and optimal social security systems

In this paper, we consider economies in which agents are privately informed about their skills, which evolve stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. In this environment, we derive a generalized version of the Inverse Euler Equation and use it to show that intertemporal wedges characterizing optimal allocations of consumption can be strictly negative. We also show that preference nonseparabilities imply that optimal differentiable asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.     

Designing social security - a portfolio choice approach

Public social security systems may provide diversification of risks to individuals’ life-time income. Capturing that a pay-as-you-go system (paygo) may be considered as a “quasi-asset”, we study the optimal size of the paygo system as well as the optimal split between funded and unfunded pension saving by means of a theoretical portfolio choice framework. A low-yielding paygo system can benefit individuals if it contributes to hedge other risks to their lifetime resources. Numerical calculations indicate that optimal social security systems should be at least partly paygo financed in many economies. The optimal magnitude of the paygo system depends on the specified risk concept as well as the stochastic properties of stock market returns and implicit paygo-returns.     

Filtral preorders and opportunity inequality

We compare profiles of opportunity sets by means of set-inclusion filtral preorders (SIFPs). Some significant results of the classic theory of income inequality are reproduced in the SIFP-framework.     

Integration, social distress, and policy formation

I study the integration of regions in the form of a merger of populations, which I interpret as a revision of people’s social space and their comparison set; I illustrate the way in which a merger can aggravate social distress; and I consider policy responses. Specifically, I view the merger of populations as a merger of income vectors; I measure social distress by aggregate relative deprivation; I demonstrate that a merger increases aggregate relative deprivation; and I show that a social planner is able to reverse this increase by means of least-cost, post-merger increases in individual incomes, but is unable to counter it by relying exclusively on a self-contained income redistribution that retains individual levels of wellbeing at their pre-merger levels.     

Social security, retirement age and optimal income taxation

It is often argued that implicit taxation on continued activity of elderly workers is responsible for the widely observed trend towards early retirement. In a world of laissez-faire or of first-best efficiency, there would be no such implicit taxation. The point of this paper is that, when first-best redistributive instruments are not available, because some variables are not observable, the optimal policy does imply a distortion of the retirement decision. Consequently, the inducement of early retirement may be part of the optimal tax-transfer policy. We consider a model in which individuals differ in their productivity and their capacity to work long and choose both their weekly labor supply and their age of retirement. We characterize the optimal non-linear tax-transfer that maximizes a utilitarian welfare function when weekly earnings and the length of active life are observable while individuals' productivity and health status are not observable.     

Funded social security and economic growth

This paper investigates the relationship between economic growth and a fully funded social security system in an overlapping generations model with family altruism. It is shown that funded social security may harm growth if there are operative bequests within the family.     

An experimental study on individual choice, social welfare, and social preferences

We experimentally study subjects’ compliance with dominance relationships of income distributions in a ranking task. The experiment consisted of four different treatments: Lottery, individual choice, social preferences, and social planner. Our results suggest that people's risk attitudes do not adequately reflect their inequality attitudes. Uninvolved social planners exhibit randomization preferences, while self-interested social planners are generally more inequality averse and try to avoid extreme outcomes.     

A second chance at success: A political economy perspective

This paper characterizes a stationary Markov-perfect political equilibrium where agents vote over income taxation that distorts educational investment. Agents become rich or poor through educational investment, and the poor have a second chance at success. The results show the following concerning the cost of a second chance. First, when the cost is low, the economy is characterized by high levels of upward mobility and inequality, and a low tax burden supported by the poor with prospects for upward mobility. Second, when the cost is high, there are multiple equilibria with various patterns of upward mobility, inequality and redistribution. Numerical examples show that the shift from a high-cost economy to a low-cost economy may reduce social welfare.     

The extension of social security coverage in developing countries

We study the dynamic general equilibrium effects of introducing a social pension program to elderly informal sector workers in developing countries who lack formal risk sharing mechanisms against income and longevity risks. To this end, we formulate a stochastic dynamic general equilibrium model that incorporates defining features of developing countries: a large informal sector, private transfers as an informal safety net, and a non-universal social security system. We find that the extension of retirement benefits to informal sector workers results in efficiency losses due to adverse effects on capital accumulation and the allocation of resources across formal and informal sectors. Despite these losses recipients of social pensions experience welfare gains as the positive insurance effects attributed to the extension of a social insurance system dominate. The welfare gains crucially depend on the skill distribution, private intra-family transfers and the specific tax used to finance the expansion.     

Poverty growth in Scandinavian countries: A Sen multi-decomposition

We show in this paper that the growth rate of the Sen index is multi-decomposable, that is, decomposable simultaneously by subgroups and income sources. The multi-decomposition of the poverty growth yields respectively: the growth rate of the poverty incidence (poverty rate) decomposed by subgroups, the growth rate of the poverty depth (poverty gap ratios) decomposed by sources and subgroups, and the growth rate of inequality decomposed by sources and subgroups. We demonstrate that the multi-decomposition is not unique. It is mainly dependent on poverty lines defined on the space of income sources. An application to Scandinavian countries shows that poverty lines based on non-correlation between the income sources imply serious risks of underestimation of the contribution levels of the different components of the global poverty growth. The main contribution of our paper is to pay particular attention to the poverty growth and its source components in order to avoid underestimation of poverty growth.     

Redistributive effects of minimal equal sacrifice taxation

We examine the circumstances under which minimal equal sacrifice taxation reduces income inequality. Focusing on absolute sacrifice and relative inequality, we show that after tax incomes are more equally distributed than before tax incomes and that after tax inequality decreases with the revenue to be raised if and only if the elasticity of the marginal utility of income is decreasing. However, other things equal, after tax inequality is shown to decline as the utility function becomes more concave. We investigate next how these conclusions extend when one takes the absolute inequality view and considers that it is the relative loss in utility that has to be equalized across individuals.     

Distributional preference in Japan

Using experiments developed by Engelmann and Strobel ( 2004 ), this study investigates distributional preference in Japan. We find that just over half the people in the study have a maximin preference, approximately 7 to 19% have an efficiency preference, approximately 8% have a self‐interest preference, and approximately 18% chose the allocation that would reduce the payoff to the rich and the poor, given that her/his payoff would remain constant. The last preference could be interpreted as what is referred to as “malice”, “deep envy” or a “feeling of vulnerability” in behavioural economics and cross‐cultural psychology.     

Innis Lecture: Equity and equality

Abstract Is horizontal equity (HE) the ‘most widely accepted principle of equity’? Or does it stand in ‘opposition to the advancement of human welfare’? This paper argues that the case for the HE principle is not as straightforward as is usually thought and that it requires advanced notions of justice and well‐being. The most likely ethical basis for HE appears to combine a Rawlsian maximin principle and a view of well‐being that allows for relative local comparison effects. The paper also explores some of the dimensions of equality and well‐being along which the HE principle can be applied and presents a number of examples showing how HE considerations can provide an important input into policy analysis.     

Social security and risk sharing

In this paper we identify conditions under which the introduction of a pay-as-you-go social security system is ex ante Pareto-improving in a stochastic OLG economy with capital accumulation and land. We argue that these conditions are consistent with realistic specifications of the parameters of the economy. In our model financial markets are complete and competitive equilibria interim Pareto efficient. Therefore, a welfare improvement can only be obtained if agents? welfare is evaluated ex ante, and arises from an improvement in intergenerational risk sharing. We also examine the optimal size of a given social security system as well as its optimal reform.     

The Covariance Structure of East and West German Incomes and its Implications for the Persistence of Poverty and Inequality

Abstract. Based on data from the German Socio-Economic Panel (GSOEP), this paper analyzes the dynamics of equivalent income in East and West Germany in the years following reunification. Special emphasis is given to the separation of permanent and transitory components, the persistence of transitory shocks and their implications for the persistence of poverty and inequality. The results suggest that in West Germany, between 52 and 69 per cent of cross-sectional income inequality was permanent, and that poor individuals stayed in poverty for two years on average. In East Germany, the share of the permanent component in overall income inequality rose continuously from 20 per cent in 1990 to 72 per cent in 1998, reaching a level near the one that prevailed in West Germany during the same period. The rising importance of time-invariant components in East German incomes was also reflected in expected poverty durations which slightly increased from 1.47 years in 1990 to 1.67 years in 1998.     

Redistribution as a selection device

This paper studies the role of the wealth distribution for the market selection of entrepreneurs when agents differ in talent. It argues that the redistribution of initial endowments can increase an economy's surplus because more talented individuals get credit for their risky investment projects. Moreover, the redistribution of initial endowments may lead to a Pareto-improvement although all agents are non-satiable. An agent's entrepreneurial ability is his private information and there is moral hazard in production. I find conditions such that unproductive rich entrepreneurs crowd out productive poor ones on the capital market. Then redistribution of initial endowments may lead to a new equilibrium where market participants are better informed about the entrepreneurs’ ability. The new equilibrium is characterized by (i) the selection of better entrepreneurs, (ii) a higher riskless rate of return on capital, (iii) lower repayments of successful entrepreneurs to their creditors and (iv) the fact that all agents are better off.     

Chronic and transient poverty: Measurement and estimation, with evidence from China

The paper contributes to the measurement of poverty and vulnerability in three ways. First, it proposes a new approach to separating poverty into chronic and transient components. Second, it provides corrections for the statistical biases introduced when using a small number of periods to estimate the importance of vulnerability and transient poverty. Third, it applies these tools to the measurement of chronic and transient poverty in China using a rich panel data set that extends over 17 years. Alternative measurement techniques are found to yield significantly different estimates of the relative importance of chronic and transient poverty. The precision of the estimates is also considerably enhanced by simple statistical corrections.     

Inequality in democracies: Testing the classic democratic theory of redistribution

The classic democratic theory of redistribution claims that an increase in the mean-to-median (MM) income ratio causes a majority coalition in the electorate to collectively demand more redistribution. The functional dependence of redistribution on the MM income ratio is tested in parametric and nonparametric regression frameworks using an OECD panel dataset. While the parametric regression model is found to be misspecified rendering subsequent inference invalid, the robust nonparametric regression model fails to uncover evidence that the MM income ratio is relevant for predicting redistribution.