MICRO/THEORY: Sustaining Social Security; Professor Tim Worrall (The University of Edinburgh)

We study the optimal design of a sustainable social security system in an economy facing demographic uncertainty, under the political constraint that no generation can veto the allocation at any date or state. A benevolent social planner, who maximizes the expected lifetime utility of all generations, must balance efficient intergenerational risk sharing with maintaining the incentives of the working-age agents to contribute and honoring the past promises made to retirees. This balance calls for a system that blends both defined-benefit and defined-contribution features together with adjustments in response to changes in longevity. Benefits are unrelated to past contributions when contribution rates are low but become linked to past contributions when contribution rates exceed a threshold in order to sustain participation of the current young. Public savings, such as public reserve funds, can buffer demographic shocks, reducing reliance on higher contributions and loosening the link between benefits and contributions.