Does Social Security Privatization Produce Efficiency Gains

TLDR: In this article, the authors analyze a 50% privatization of social security using an overlapping-generations model where heterogeneous agents with elastic labor supply face idiosyncratic earnings shocks and longevity uncertainty and find that privatization performs better in a closed economy, where interest rates decline with capital accumulation, than in an open economy.

Abstract: While privatizing social security can improve labor supply incentives, it can also reduce risk sharing. We analyze a 50% privatization using an overlapping-generations model where heterogeneous agents with elastic labor supply face idiosyncratic earnings shocks and longevity uncertainty. When wage shocks are insurable, privatization produces about $18,100 of extra resources for each future household after all transitional losses have been compensated for with lump-sum taxes. When wages are not insurable, privatization reduces efficiency by about $2,400 per future household. We check the robustness of these results to different model specifications as well as policy reforms and arrive at several surprising conclusions. First, privatization performs better in a closed economy, where interest rates decline with capital accumulation, than in an open economy. Second, privatization also performs better when an actuarially fair private annuity market does not exist. Third, government matching of private contributions on a progressive basis is not very effective at restoring efficiency and can actually cause harm.