Pension reform in an OLG model with heterogeneous abilities

Abstract

We study the effects of pension reform in a four-period OLG model for an open economy where hours worked by three active generations, education of the young, the retirement decision of older workers, and aggregate growth, are all endogenous. Within each generation we distinguish individuals with high, medium or low ability to build human capital. This extension allows to investigate also the effects of pension reform on the income and welfare levels of different ability groups. Particular attention goes to the income at old-age and the welfare level of low-ability individuals. Our simulation results prefer an intelligent pay-as-you-go pension system above a fully-funded private system. When it comes to promoting employment, human capital, growth, and aggregate welfare, positive effects in a pay-as-you-go system are the strongest when it includes a tight link between individual labor income (and contributions) and the pension, and when it attaches a high weight to labor income earned as an older worker to compute the pension assessment base. Such a regime does, however, imply welfare losses for the current low-ability generations, and rising inequality in welfare. Complementing or replacing this 'intelligent' pay-as-you-go system by basic and/or minimum pension components is negative for aggregate welfare, employment and growth. Better is to maintain the tight link between individual labor income and the pension also for low-ability individuals, but to strongly raise their replacement rate.

Inequality in an OLG economy with heterogeneous cohorts and pension systems

“…Our results could be related to recent findings by Buyse et al (2017) who examine the impact of pension system schemes on macroeconomic and welfare effects in an economy with endogenous human capital accumulation and individuals differing ex ante with respect to their human capital accumulation ability. In their setup, labor supply of lowest ability individuals drops sharply in DB with minimum pensions relative to pure DB system, whereas we argue that the labor supply disincentives are small relative to other effects observed in the economy subsequent the introduction of the minimum pensions.…”

“…In their setup, labor supply of lowest ability individuals drops sharply in DB with minimum pensions relative to pure DB system, whereas we argue that the labor supply disincentives are small relative to other effects observed in the economy subsequent the introduction of the minimum pensions. However, Buyse et al (2017) analyze minimum pensions in DB system, whereas we do it in a DC system. In our specification in a DB system a minimum pension guarantee would affect only a small fraction of the entire population, as the Polish DB system was very generous in terms of high replacement rates.…”

“…Moreover, there appear to be substantial differences in calibration: where our utility function implies Frisch elasticity of about 1, their specification implies a negative Frisch elasticity equal to -1/2. Finally, in their setup, agents optimize labor supply and investment in human capital, which is a different optimization problem than the one Buyse et al (2017) put forward. 19…”

Cross‐Country Differences in Unemployment: Fiscal Policy, Unions, and Household Preferences in General Equilibrium

“…Following Buyse et al . (), we calibrate the share parameter in aggregate effective labour, η H , to match the relative wage of young workers without a tertiary degree versus young workers with tertiary degree in the US. This relative wage is 0.53 .…”

Differential mortality, aging and social security: delaying the retirement age when educational spillovers matter

“…Regarding the initial equilibrium, consider rising longevity (in t = 0) so that H = 1 and L = 33:5 36 , i.e. with an unchanged mortality di¤erential corresponding to 2:5 years 13 . Such a scenario corresponds to a rise of the demographic dependancy ratio from 36% to 66%, i.e.…”