Optimal Sharing of Labor Productivity Risks and Mix of Pay-As-You-Go and Savings

This paper addresses two related issues: the optimal intergenerational sharing of labor productivity risks, through a Pay-As-You-Go (PAYG) social security with contingent rates of benefits and contributions, and the optimal combination of PAYG and funded savings in a small open economy. It shows that partial contingency of the social security on the labor productivity is ex ante optimal, when the interest rate is above the expected growth rate of the economy, and when the government has a lifetime perspective of the risk exposure. In addition, the government may induce a higher saving rate, due to the expected lower PAYG return and the household's desire of smoothing consumption over time.