Political (In)Stability of Social Security Reform

We analyze the political stability social security reforms which introduce a funded pillar (a.k.a. privatizations). We consider an economy populated by overlapping generations and intra-cohort heterogeneity, which introduces a funded pillar. This reform is efficient in Kaldor-Hicks sense and has political support. Subsequently, agents vote on abolishing the funded system, capturing the accumulated pension wealth, and replacing it with the pay-as-you-go scheme, i.e. “unprivatizing” the pension system. We show that even if such reform reduces welfare in the long run, the distribution of benefits across cohorts along the transition path implies that “unprivatizing” social security is always politically favored. We conclude that property rights definition over retirement savings may be of crucial importance for determining the stability of retirement systems with a funded pillar. 

This paper was originally started as a part of MODELLING project, but with the time, it evolved into a heterogeneous agents framework with ex ante heterogeneity in terms of endowments and preferences.