Pension Reforms and the Informal Sector: Modeling of Income Groups Behavior

Abstract

A 2018 article by the authors described a dynamic behavior model of the agents’ population belonging to different income groups in the transition from a pay-as-you-go to a mixed pension system. The model is based on the assumption that wealthier participants are characterized by a lower rate of income discounting, which effectively means an orientation toward a longer planning horizon. In this paper we propose and explore an advanced model. It significantly improves the approximation of trajectories observed in Argentina after the pension reform of 1993, which is largely similar to the failed Russian reform of 2002. The model shows that as income increases, the share of the corresponding income group who prefers keeping in the shadows should fall. This pattern is consistent with observations. The model helps to explain why pension reforms in many countries have resulted in an expansion of the shadow sector. The impact of the minimum pension, the rate of return on pension savings and the retirement age on the levels of participation of different income groups in the pension system is studied. Based on the results, we formulate recommendations for continuing the pension reform in Russia.