Social Security in Theory and Practice With Implications for Reform

166 countries have some kind of public old age pension. What economic forces create and sustain old-age Social Security as a public program? In the first part of the paper, we document some of the internationally and historically common features of Social Security programs including explicit and implicit taxes on labor supply, pay-as-you-go features, intergenerational redistribution, benefits which are increasing functions of lifetime earnings and not means-tested. The rest of the paper discusses various positive theories of Social Security and compares each of them with the empirical regularities uncovered in the first part. We partition theories into three groups: “political”, “efficiency” and “narrative” theories. We explore three political theories: the majority rational voting model (with its two versions: “the elderly as the leaders of a winning coalition with the poor” and the “once and for all election” model), the “time-intensive model of political competition” and the “taxpayer protection model”. We then discuss the “efficiency theories,” which view creation of the SS program as a full or partial solution to some market failure. Efficiency explanations of social security include the “SS as welfare for the elderly”, the “retirement increases productivity to optimally manage human capital externalities”, “optimal retirement insurance”, “labor market congestion,” the “prodigal father problem”, the “misguided Keynesian”, the “optimal longevity insurance”, the “government economizing transaction costs”, and the “return on human capital investment” theory. Finally we analyze three “narrative” theories of social security: the “chain letter theory”, the “monopoly capitalism theory”, and the “Sub-but-Nearly-Optimal policy response to private pensions theory”. The political and efficiency explanations are compared with the international and historical facts and used to derive implications for replacing the typical pay-as-you-go system with a forced savings plan. Most of the explanations suggest that forced savings does not increase welfare. In fact, it may decrease it.