Effects of Social Security on National Saving

We have seen how demographic changes in the economy, combined with the pay-as-you-go form of Social Security, are leading to funding problems within the US system. The United States is not alone; many other countries also have pay-as-you-go systems and are facing similar demographic challenges. We have also examined some ways of resolving these financing problems. Yet we have not addressed another more basic question: why have a Social Security system at all? After all, our analysis suggests that people may adjust their private saving behavior in a way that undoes the effects of Social Security. What advantages and disadvantages of Social Security have we so far missed? The Uncertainties of Life A century or two ago, if you were unlucky enough to fall into serious poverty, there was very little in the way of government help, even in the richest countries. You were likely to end up in the poorhouse (sometimes called a workhouse or an almshouse), where you obtained the bare minimum of shelter and food in exchange for grueling work. For those who were old and poor, the poorhouse was a place to die an ignominious death:

Numerous as are the old men’s homes, old ladies’ homes, and homes for aged couples that are supported by private charity, they are yet, as every worker among the poor knows, too few to meet the demand. Our almshouses are also practically homes for the aged poor. Some almshouse inmates became paupers before they were aged, but many of them led independent and self-respecting lives, and even put by something for the future while physically able to earn wages. When wages ceased, savings, if any were made, were used up or else lost in unwise investments, and at the end almshouse relief and the pauper’s grave were preferred to exposure and starvation. [1]

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Social Security in the United States and other countries was set up largely to save old people from this fate. Carlo did not face any of the problems suggested by the quotation. In Carlo’s world there was no uncertainty: working and retirement income were known at the start of his working life, and his dates of retirement and death were also known with certainty. Carlo had no risk of using up all his savings before he died, or of losing his money in “unwise investments.” But Carlo’s world is not the world in which we live. In practice, individuals face enormous uncertainty both about their lifetime income and their consumption needs in retirement. The mere fact that we live in an uncertain world is not, in and of itself, a reason for the government to intervene. Private insurance markets might be available that allow individuals to purchase insurance to cover themselves against these kinds of risks.