Pareto-improving Transition from Pay-as-you-go to Fully Funded Social Security under Uncertain Incomes

The possibility of a Pareto-improving transition from a pay-as-you-go to a fully funded pension system is discussed intensively in the literature. In this paper, the problem is analyzed within a standard overlapping generations model of a small open economy with stochastic wages. Applying the criterion of conditional Pareto-efficiency we derive a sufficient condition for the fully funded system to be preferred by all future generations and show that, in contrast to deterministic models with inelastic labour supply, a Pareto-improving abolition of the pay-as-you-go system is possible with probability one.