Intergenerational Risk Sharing, Pensions, and Endogenous Labour Supply in General Equilibrium*

Abstract

We show that a two‐tier pension system, with a pay‐as‐you‐go first tier and a fully funded, defined wage‐indexed second tier, can provide for optimal intergenerational risk‐sharing without distorting the labour supply, thereby achieving the first best. Other arrangements with a fully‐funded second tier fail to achieve the first best.

Intergenerational Risk Sharing and Endogenous Labour Supply within Funded Pension Schemes

“…Most of these studies assume exogenous labour supply and focus only on equity risk (Teulings and de Vries 2006;Gollier 2008;Cui et al 2011), thereby overstating the risk-sharing gains. Beetsma et al (2013) do allow for wage risk, equity risk and endogenous labour by exploring whether the combination of a PAYG pillar and a funded pillar with defined benefits can provide for optimal risk sharing. They do not include endogenous labour supply, however.…”

Procyclicality of Pension Fund Regulation and Behaviour

“…Moreover, it creates a channel through which inancial market shocks affect the labour market. Beetsma et al (2013) already emphasize that non-lumpsum contributions in a model with endogenous labour supply restricts the risk sharing potential via a pension system. Most studies on intergenerational risk sharing neglected the effect of the rules for pension fund restoration on the real economy.…”

Pension Fund Restoration Policy in General Equilibrium

“…Furthermore, mandatory participation ensures that the pension fund does not collapse in case of underfunding or overfunding. As highlighted by Beetsma et al (2013), newly born workers would not want to participate in case the pension fund is underfunded as they would have to help restore funding adequacy. Additionally, van Bommel and Penalva (2012) highlight that older agents have an incentive to block newly born workers from participating in case the pension fund is overfunded so as to capture the funding surplus for themselves.…”

“…Beetsma and Bovenberg (2009) argue that Defined Benefit pension funds improve welfare compared to Defined Contribution pension funds through enhanced intergenerational risk sharing, but do not consider the distortionary effect of Defined Benefit pension funds on labour supply. Beetsma et al (2013) highlight that, in the absence of a suitably arranged Pay-As-You-Go pension pillar, a Defined Benefit pension fund cannot implement the social optimum because of induced labour supply distortions. Bonenkamp andWesterhout (2014) andDraper et al (2017) find for Defined Benefit pension funds that the welfare gain from intergenerational risk sharing dominates the cost of labour supply distortions.…”