Pension Reform and Growth

Abstract

The authors 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 suggest 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.