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Coping with demographic change: macroeconomic performance and welfare inequality effects of public pension reform

Published online by Cambridge University Press:  18 May 2022

Willem Devriendt ,
Freddy Heylen  and
Arthur Jacobs
Willem Devriendt
Affiliation:
Department of Economics, Ghent University, Sint-Pietersplein 6, 9000 Ghent, Belgium
Freddy Heylen*
Affiliation:
Department of Economics, Ghent University, Sint-Pietersplein 6, 9000 Ghent, Belgium
Arthur Jacobs
Affiliation:
Department of Economics, Ghent University, Tweekerkenstraat 2, 9000 Ghent, Belgium
*
*Corresponding author. Email: [email protected]
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Abstract

This paper evaluates alternative reforms of the public pension system in an overlapping generations model for an open economy facing demographic change. We make progress compared to existing literature on pension reform by modelling individuals with heterogeneous innate ability and endogenous human capital, and by putting (the reduction of) welfare inequality effects of reform at the centre. Frequently adopted reforms such as an increase of the normal retirement age or a decrease of the pension benefit can guarantee financial sustainability, but they fail when the objective is also to avoid intergenerational or intragenerational welfare inequality. Our results prefer a reform which combines an increase of the retirement age with an intelligent linkage between the pension benefit and earlier labour earnings. First, this design conditions pension benefits on past individual labour income, with a high weight on labour income earned when older and a low weight on labour income earned when young. Second, this linkage is complemented by a strong rise in the benefit replacement rate for low ability individuals (and a reduction for high ability individuals).

Keywords

Demographic changeheterogeneous abilitiesinequalityoverlapping generationspension reformC68E24J11J26H55
Type
Article
Information
Journal of Pension Economics & Finance , Volume 22 , Issue 3 , July 2023 , pp. 425 - 449
Copyright
Copyright © The Author(s), 2022. Published by Cambridge University Press

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