Labor Market Search and Optimal Retirement Policy

with Joydeep Bhattacharya and Robert R. Reed III

Abstract

A popular view about social security, dating back to its early days of inception, is that it is a means for young, unemployed workers to “purchase” jobs from old, employed workers. The question we ask is: Can social security, by encouraging retirement and hence creating job vacancies for the young, improve the allocation of workers to jobs in the labor market? Using a standard model of labor market search, we establish that the equilibrium with no policy-induced retirement can be efficient. Even under worst-case parameterizations of our model, we find that public retirement programs pay the elderly substantially more than labor market search theory implies that their jobs are worth. An important effect, ignored by the popular view, is that the creation of a vacant job by a retirement reduces the value of other vacant jobs.

Hard and electronic copies of the paper are circulated as:

NBER Working Paper No. 8591, November 2001.