A Note on Social Security Welfare with Self-Control Problems

We develop an overlapping-generation model for a closed economy with uncertainty on labor income and mortality risk to show that unfunded social security programs may increase welfare in economies where agents are affected by self-control problems à la Gul and Pesendorfer (2001, Econometrica 69, 1403). We depart from the existing literature by setting the agent’s preference parameters to match target levels of macro-variables observed in the real US economy. In our approach, economies with tempted and non-tempted agents are undistinguishable in terms of aggregate consumption, labor and saving behavior when social security provides a replacement rate of 40% (as in the US). This situation makes agents bear costly self-control problems over more years. Our simulations inform that social security improves welfare with degrees of temptation equal to 11% or higher. A social security program with a replacement rate of 40% finds support for degrees of temptation not lower than 15%.