Fostering Within-Family Human-Capital Investment: An Intragenerational Insurance Perspective of Social Security

We propose an extended pay-as-you-go social security system that conditions pension benefits on the aggregate wage sum and on the wage of one's children. The latter increases parents' incentives to provide their children with good within-family education. However, since wages depend stochastically on parents' unobservable investment in their children's human capital, some insurance against the productivity risk of one's children is provided, because retirement income still depends on aggregate wages. We analyze the effects of such a social security system on the endogenous distribution of human capital and compare it with real-world systems, which typically do not condition benefits on the wages of one's children. Our approach suggests a novel role for a well-designed social security system: it can foster human-capital accumulation and act as an intragenerational insurance against productivity risk.human-capital formation, social security, intragenerational insurance, heterogeneous households