Social Security, demographics and budget crises

This dissertation studies the impact of a social security system on the economy. It is divided in three chapters. The first one develops a general equilibrium model to analyze the effects of social security and demographic changes on fiscal policy sustainability, capital stock accumulation, and wealth distribution between workers and retirees. The second chapter presents quantitative results obtained through simulations of a calibrated version of the model presented in the first chapter. Finally, the third chapter presents a reform proposal for the Mexican social security system. The model developed in Chapter 1 departs from the traditional large-scale Overlapping Generations models that have been used to analyze social security issues. Instead, we extend the model developed by Yaari (1965), Blanchard (1985) and Weil (1989) to add a simple demographic structure that allows us to analyze these issues. In the case of an economy without social security there are two steady states, an autarkic one in which government debt is zero, and the golden rule steady state in which the interest rate is equal to growth rate of output. The latter is a rational expectations equilibrium only if the economy starts at the steady state. Implementing a pay-as-you-go social security scheme has a negative impact on the economy's capital stock. Also it has important redistributive effects from workers to retirees. These effects are stronger if the social security system runs a budget deficit. Chapter 2 shows that there is a limit to the size of the budget deficit. For a calibrated version of the model the critical budget deficit is 0.274 of one percent of GDP. The second chapter also shows that demographic changes have important effects on macroeconomic variables. An aging population increases the maximum sustainable deficit and the steady state capital stock. In terms of wealth redistribution, retirees' shares in both types of wealth (human and financial) increase. On the other hand, an increase in the fertility rate of the economy (baby boom) increases the maximum sustainable budget deficit but lowers the capital stock. A decrease in fertility rate (baby bust) has the opposite effects. This chapter also shows that demographic dynamics have an important impact on the dynamics of economic variables. Finally, Chapter 3 presents a suggested reform of Mexico's social security system. The proposal aims at a gradual shift from the current pay-as-you-go system to one that is fully-funded. The paper comprises: a review of the pension system; estimates of the implicit social security system debt; and simulations of five alternative repayment profiles.