Public Pension Reform and the Equity-Efficiency Trade-off

Alternative structures of public pension programs have distinct implications for the trade-offs that determine economic behavior over the life cycle. This paper studies these implications in terms of labor supply and economic inequality to characterize the equity–efficiency trade-off between a redistributive (Beveridgean) and an earnings-based (Bismarckian) benefit formula. The economy is modeled as a continuous-time overlapping generations model with endogenous labor supply, savings, and human capital formation. Individuals differ in ability, and they are free to choose how much to work at each period in time and when to enter and exit the labor market. Numerical simulations provide the qualitative insights that a redistributive pension system introduces opposite effects on the incentives to retire for high- and low-skilled individuals, which leads to an increased earnings inequality. This effect can, in turn, dominate the reduced pension inequality such that lifetime and population-wide income inequality increases. Ultimately, it appears that the equity–efficiency trade-off is difficult to characterize when accounting for endogenous labor supply on both the intensive and extensive margins.