Quantifying the effects of socialsecurity reform

Abstract

This paper quantifies the efficiency, inequality and welfare consequences of alternative social security systems. In the context of an overlapping generations model, with ex-ante heterogeneity in productivity, we consider three alternative social security schemes. A funded defined contribution (FDC) system, based on individual capitalization. A notional defined contribution scheme (NDC) with collective capitalization and a non-contributory targeted pension (NTP)

scheme, financed with taxes. Our main findings are as follows. First, a collec- tive capitalization system, NDC, reduces pension inequality, without efficiency

losses and with overall welfare gains. Second, an FDC scheme, combined with a

non-contributory targeted pension, is Pareto efficient: it increases the replace- ment rate of a low-productivity individual, without reducing the replacement

rate of high-productivity workers. However, it implies efficiency and welfare losses as a consequence of distortionary taxes. Third, calibrating for Chile, we find that it is possible to increase the replacement rate of all individuals as well as the aggregate capital in the economy. This is possible with a suitable combination of the three systems previously described.