Public pension reform with ill-informed individuals

Abstract

Several studies find that most individuals do not understand how public pension systems function. The present paper explores how this pension illiteracy affects the outcomes of public pension reform in terms of income inequality and total labor supply. For this purpose, I introduce an overlapping generations model with endogenous savings, labor supply, and retirement. Calibrating the model to an average OECD economy, I find that a reform that increases the earnings-dependence of pension systems can reduce both lifetime inequality and labor market participation if individuals fail to account for the contribution–benefit formula in their economic decision-making. These results contrast with the conventional equity–efficiency trade-off predicted by a model populated only with rational individuals.