The Effect of Government Provided Insurance on Household Self-insurance
A lot of research has been devoted to studying the means through which households can smooth consumption in response to adverse effects, such as through own saving or borrowing, labor supply of family members or borrowing from relatives and friends. For brevity, we refer to these means as self-insurance or private risk-sharing. The ability of households to absorb shocks to their income and wealth has substantial implications for their welfare. At the same time, the extent of private risk-sharing should be an important determinant for policy interventions. For example, a reform from a progressive to a proportional tax system is judged based on the gains from reduced distortions net of the losses from lower redistribution. But the size of the latter margin depends on how much smoothing households can do on their own, through self-insurance. More generally, the value of government provided insurance is highly dependent on the extent of self-insurance that prevails in the economy and it could be severely overstated if one fails to account for the crowding-out effect it might have on private risk-sharing. Motivated by the above, in this project we aim to understand the extent to which the social insurance system that prevails in a country affects households’ incentives for private risk-sharing. Specifically, we ask: How large is the crowding out effect that government provided social insurance has on household self-insurance?