Labor market search and optimal retirement policy

A popular and long-standing view is that social security is a means for young, unemployed people to "purchase" jobs from older workers. Can social security, by encouraging retirement and hence creating job vacancies for the young, improve the allocation of workers to jobs? Maybe, according to a standard model of labor market search, but public retirement programs currently pay the elderly substantially more than their jobs are worth. An important effect is that retirement reduces the value of other vacant jobs. Our results imply that recent reforms aimed at reducing retirement incentives are likely to improve labor market efficiency. I. INTRODUCTION The objective of this article is to formalize a popular argument about the economic rationale for social security and public pension programs in the United States and other countries. We construct a model in which there can be significant frictions slowing the process of matching workers with firms, and social security is a labor market policy designed to remove old workers from the labor market. In this sense, it can be said that social security is a means for young, unemployed individuals to "purchase" jobs from older, employed workers. President Franklin D. Roosevelt, in particular, in one of his fireside chats suggested that this would be an important goal for social security: The program for Social Security now pending before the Congress is a necessary part of the future unemployment policy of the Government. ... It proposes, by means of old-age pensions, to help those who have reached the age of retirement to give up their jobs and thus give to the younger generation greater opportunities for work and to give all a feeling of security as they look toward their old age. (Roosevelt 1938, 134-35) This position on social security continues to receive some support, at least enough to receive serious consideration in recent social security debates. In recent discussion about the retirement earnings test in Congress, many agreed with the following perspective: "Social Security, when it was created in 1935, sought to achieve two goals--moving older workers out of the workforce to make way for younger workers, and to partially replace lost income due to retirement" (Testimony of Honorable John J. Rhodes III in Social Security Retirement Test 1991). These debates are not unique to the United States. As is well known, European countries have recently devoted much attention to youth unemployment. As a result, public pension programs have become more generous and increasingly used to encourage labor force withdrawal among older workers. Although public pension programs have been used in many countries as age-targeted employment policies, there has been little work aimed at understanding their implications for the market at the aggregate level. In this article we begin to address whether policies aimed at discouraging work among the elderly, and thereby creating job vacancies for the young, can improve the allocation of workers to jobs in the labor market. In particular, the idea that continued employment by the old contributes to increased youth unemployment implies that the life cycle contributes to congestion problems in the labor market. Accordingly, an important aspect of a modeling approach aimed at addressing these issues should be a setting in which unemployment is an equilibrium phenomenon, and the labor market participation decisions of workers impose a negative externality on the pool of the unemployed. We introduce a simple model of labor market search along the lines of Mortensen (1982) and Pissarides (2000) extended to include retirement decisions and show how the optimality of induced retirement depends on the model's parameter values, some of which imply that the social value of retirement exceeds the private value while other parameter values imply that the private value exceeds the social value. …