Pension Reform and Growth

Abstract

Replacing a pay-as-you-go pension system with a fully funded scheme could eliminate the incentives (under the pay-as-you-go system) to informalize production and employment. Simulations of an endogenous-growth model suggest that long-term growth could increase substantially by such a reform. Econometric evidence suggests that pension reform in Chile in 1981 may be a factor in the increase in Chile`s private savings since 1980.

Corsetti and Schmidt-Hebbel review the qualitative macroeconomic and welfare implications of replacing a pay-as-you-go pension system with a fully funded scheme.

They summarize the typically small effects found in the simulations literature, based on exogenous-growth one-sector models. Much larger, and sustained, effects are obtained in the framework of an overlapping-generations model with endogenous growth and formal-informal production sectors - the model presented in this paper.

Model simulations using the overlapping-generations model suggest that replacing a pay-as-you-go system with a fully funded system could substantially raise long-term growth rates by eliminating the incentives (under the pay-as-you-go system) to informalize production and employment.

A final look at Chile's reform experience suggests that a structural transformation toward formalization is taking place and that both private savings and growth have been rising substantially since 1980.

Econometric evidence suggests that Chile`s pension reform, in 1981, could be contributing toward Chile`s large increase in private savings.

This paper - a product of the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the department to understand macroeconomic and financial aspects of pension systems.