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Dynamic inefficiency arises from overaccu-mulation, which, in turn, is a result of the fact that the current young generation needs to save for old age.. Once again, the effect of the savin

Introduction to Modern Economic Growth previous generations, and it is possible to rearrange accumulation decisions and consumption plans in such a way that these pecuniary externalities can be exploited

A complementary intuition for dynamic inefficiency, which will be particularly useful in the next section, is as follows Dynamic inefficiency arises from overaccu-mulation, which, in turn, is a result of the fact that the current young generation needs to save for old age However, the more they save, the lower is the rate of return to capital and this may encourage them to save even more Once again, the effect of the savings by the current generation on the future rate of return to capital is a pecuniary externality on the next generation We may reason that this pecuniary externality should not lead to Pareto suboptimal allocations, as in the equilibria of standard competitive economies with a finite number of commodities and households But this reasoning is no longer correct when there are an infinite number of commodities and an infinite number of households This second intuition also suggests that if, somehow, alternative ways of providing consumption to indi-viduals in old age were introduced, the overaccumulation problem could be solved

or at least ameliorated This is the topic of the next section

9.5 Role of Social Security in Capital Accumulation

We now briefly discuss how Social Security can be introduced as a way of deal-ing with overaccumulation in the overlappdeal-ing-generations model We first consider

a fully-funded system, in which the young make contributions to the Social Secu-rity system and their contributions are paid back to them in their old age The alternative is an unfunded system or a pay-as-you-go Social Security system, where transfers from the young directly go to the current old We will see that, as is typically presumed, pay-as-you-go (unfunded) Social Security discourages aggregate savings However, when there is dynamic inefficiency, discouraging savings may lead

to a Pareto improvement

9.5.1 Fully Funded Social Security In a fully funded Social Security sys-tem, the government at date t raises some amount d (t) from the young, for example,

by compulsory contributions to their Social Security accounts These funds are in-vested in the only productive asset of the economy, the capital stock, and pays the

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