On the role of social security systems in a non-unitary discounting model

Abstract

A sustainable welfare system is an issue of considerable concern in an era of low population growth. To address this problem, we develop a two-period overlapping generations model in which agents discount their future utility from consumption and leisure at different rates. Using this model, we demonstrate how time inconsistency emerges and investigate the welfare effects of social security systems. We show that when agents discount utility from consumption more than that from leisure, introducing a positive social security policy can achieve Pareto improvement even when the interest rate is higher than the population growth rate. Importantly, a social security system not only mitigates welfare loss because of dynamic inefficiency by allowing for intergenerational income transfers but also alleviates it because of the presence of time-inconsistent behavior by serving as a commitment device.