An intergenerational welfare analysis in a small open economy model between social security systems

This study investigates the long-term macroeconomic and welfare impacts of transitioning from a Pay-As-You-Go to a fully funded pension system, specifically within the Ecuadorian economic context. The study is motivated by financial and demographic challenges that threaten the sustainability of the current pension structure. Understanding the effects of such a transition is essential for informed implementation. The research has two primary objectives: first, to simulate this reform under various economic shocks, particularly changes in oil income and interest rates given that variability in oil revenues directly affects the economy as oil is Ecuador’s main source of income; and second, to evaluate how the timing of the changes influences welfare outcomes across generations. The analysis is based on a transition from a Pay-As-You-Go system to a Fully Funded system, allowing for a more flexible response to demographic and fiscal pressures. To achieve this, a calibrated Overlapping Generations model is employed, integrated with a Small Open Economy framework and tailored to Ecuadorian data. This model allows for simulation of the pension reform under different macroeconomic conditions and transition scenarios. Findings suggest that while a fully funded system may increase welfare in the new steady-state equilibrium relative to a PAYG system reflecting the right timing for replacing the social security system under a general equilibrium model positive economic shocks can produce large welfare gains. However, welfare outcomes during the transition period remain highly sensitive to shocks, which in some scenarios can cause net losses for certain generations. The impact varies depending on the type of shock and the timing of reform implementation. These results highlight the importance of timing and economic context when designing pension policy. A poorly timed reform could reduce expected benefits, even if long-term outcomes appear favorable.