Privatizing Social Security: the Role of Imperfect Substitution between Less and More Experienced Workers

Abstract In this paper we use a large overlapping generations model with individuals that differ across age and productivity to assess the effect of privatizing a pay-as-you-go social security system in two model economies. The first one is the standard model pioneered by Auerbach and Kotlikoff (1987) characterized by the perfect substitutability in production of individuals with different experience levels. In the second one, individuals with different experience in the labor market are imperfect substitutes in production (Kremer and Thomson (1998)). The findings indicate that although in both economies the aggregate effects of removing social security are qualitatively similar, the standard model economy underestimates both the welfare losses of the individuals living at the period of the pension reform and the increase in pre-tax income inequality associated with such policy change.