Growth and Social Security: The Role of Human Capital

This paper studies the growth and efficiency effects of pay-as-you-go financed social security when human capital is the engine of growth. Employing a variant of the Lucas (1988) model with overlapping generations, it is shown that a properly designed unfunded social security system leads to higher output growth than a fully funded one. Furthermore, the economy with unfunded social security is efficient while the other one is not. These results stand in sharp contrast to those that obtain in models where economic growth is driven by physical capital accumulation.