Pension design with a large informal labor market: evidence from Chile
Pension design in developing countries must take into account that both contributory and non-contributory pension schemes can affect incentives to work informally, with important fiscal consequences. The extent of this problem depends on the nature of the informal labor market: residual or competitive? Linked administrative and self-reported data from Chile on employment histories, earnings and savings are used to estimate a dynamic behavioral model in which a couple faces a labor market composed of a covered sector, that is subject to mandatory pension contributions, and an uncovered sector of self-employed and informal jobs. The estimated model is used to determine the extent of labor market segmentation, and whether mandatory pension contributions and minimum pension benefits could reduce the pension system's coverage rate and crowd out private savings. Then, an expanded safety net, recently implemented in Chile as a response to low pension coverage rates, is introduced into the model to quantify its effects on labor supply, savings and the government budget.
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