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Pension Reform, Informal Markets and Long-Term Income and Welfare

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  • Klaus Schmidt-Hebbel

Abstract

It is well known that a pay-as-you-go (PAYG) pension system lowers saving, income, and welfare of future cohorts in a one-sector economy because it entails a transfer to the first cohorts of PAYG pensioners. Is the opposite result possible in a two-sector (formal-informal production) economy? Yes, as shown by the simulations for a representative economy reported in this paper, based on the stady-state solution of a twosector two-period overlapping-generations model. A PAYG system can raise long-term saving, income, and welfare in a two-sector economy if the formal sector (forced to pay mandatory PAYG taxes) is more capital intensive than the non-taxed informal sector, causing higher wages and lower interest rates. Is this outcome empirically likely? No, as suggested by reviewing the stylized features of real world pension systems and formal-informal market structures. Therefore replacing PAYG by a fully-funded pension system is still more likely than not to raise long-term saving, income, and welfare levels.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 04.

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Date of creation: Mar 1997
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Handle: RePEc:chb:bcchwp:04

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Cited by:
  1. Laurence J. Kotlikoff & Kent Smetters & Jan Walliser, 2001. "Finding a Way Out of America's Demographic Dilemma," NBER Working Papers 8258, National Bureau of Economic Research, Inc.
  2. Sebastian Edwards & Alejandra Cox Edwards, 2000. "Economic Reforms and Labor Markets: Policy Issues and Lessons from Chile," NBER Working Papers 7646, National Bureau of Economic Research, Inc.
  3. Solange Berstein & Alejandro Micco, 2002. "Turnover and Regulation: The Chilean Pension Fund Industry," Working Papers Central Bank of Chile 180, Central Bank of Chile.

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