Risk Aspects of Investment-Based Social Security Reform

Our current social security system operates on a pay-as-you-go basis; benefits are paid almost entirely out of current revenues. As the ratio of retirees to taxpayers increases, concern about the high costs of providing benefits in a pay-as-you-go system has led economists to explore other options. One involves "prefunding," in which a person's withholdings are invested in financial instruments, such as stocks and bonds, the eventual returns from which would fund his or her retirement. The risks such a system would introduce—such as the volatility in the market prices of investment assets—are the focus of this offering from the NBER. Exploring the issues involved in measuring risk and developing models to reflect the risks of various investment-based systems, economists evaluate the magnitude of the risks that both retirees and taxpayers would assume. The insights that emerge show that the risk is actually moderate relative to the improved return, as well as being balanced by the ability of an investment-based system to adapt to differences in individual preferences and conditions.

John Y. Campbell is the Otto Eckstein Professor of Applied Economics at Harvard University and a research associate of the National Bureau of Economic Research.

Martin Feldstein is the George F. Baker Professor of Economics at Harvard University and president and CEO of the National Bureau of Economic Research. He is the editor of many books, including Privatizing Social Security and International Capital Flows, also published by the University of Chicago Press.