Risk sharing properties and labor supply disincentives of pay-as-you-go pension systems

The thesis consists of three essays discussing the benefits and distortions implied by pay-as-you-go (PAYG) pension systems. The first essay analyses how PAYG pension benefits should be related to a person’s lifetime earnings or her pension contributions such as to maximize utility at birth (ex-ante utility). This involves a trade-off between insurance against earnings shocks, labor supply distortions and capital accumulation in the economy. Using a model calibrated for the US economy, I find that a system under which there is no relation between pension benefits and life-time earnings (a flat benefit system) brings a higher utility than a system under which pension benefits reflect life-time earnings (a defined benefit system). The second essay shows how the interaction between unemployment shocks and PAYG pensions leads to earlier retirement of a worker. Using micro data I find that a person’s re-employment wage after an unemployment spell is lower the older the person is and the more time she spends outside employment. Using a theoretical model, I show that lower re-employment wages following an unemployment spell lead to earlier retirement among workers but only when a PAYG pension system is in place in the economy. Cross-country data confirms that in countries with higher long-term unemployment or a higher PAYG pension system, the labor market participation of older workers is lower. The third essay shows through a theoretical model that PAYG pension systems can be used to share both financial and demographic shocks between young and old agents.