Inequality in an OLG economy with heterogeneous cohorts and pension systems

Abstract

We analyze the consumption and wealth inequality in an OLG model with mandatory pension systems. Our framework features within-cohort heterogeneity of endowments and heterogeneity of preferences. We allow for population aging and gradual decline in TFP growth. We show four main results. First, increasing longevity translates to substantial increases in aggregate consumption inequality and wealth inequality. Second, a pension system reform from a defined benefit to a defined contribution works to reinforce consumption inequality and reduce wealth inequality. Third, minimum pension benefits are able to partially counteract an increase in inequality introduced by the defined contribution system, at a fiscal cost. Fourth the minimum pension benefit guarantee mostly addresses the sources of inequality which stem from differentiated endowments rather than those which stem from heterogeneous preferences.

This is a preview of subscription content, log in to check access.

References

  1. Bassi, M.: An Egg Today and a Chicken Tomorrow: A Model of Social Security with Quasi-Hyperbolic Discounting, CSEF Working Papers 205. Centre for Studies in Economics and Finance (CSEF). University of Naples, Italy (2008)

  2. Benhabib, J., Bisin, A., Luo, M.: Wealth Distribution and Social Mobility in the US: a Quantitative Approach. NBER Working Papers 21721, National Bureau of Economic Research, Inc (2015)

  3. Börsch-Supan, A., Weiss, M.: Productivity and age: evidence from work teams at the assembly line. J. Econ. Ageing 7, 30–42 (2016)

    Article  Google Scholar 

  4. Bourguignon, F., Spadaro, A.: Microsimulation as a tool for evaluating redistribution policies. J. Econ. Inequal. 4(1), 77–106 (2006)

    Article  Google Scholar 

  5. Brzeziński, M.: Accounting for recent trends in absolute poverty in Poland: a decomposition analysis. Post-Communist Econ. 24(4), 465–475 (2012)

    Article  Google Scholar 

  6. Bucciol, A.: A note on social security welfare with self-control problems. Macroecon. Dyn. 15(4), 579–594 (2011)

    Article  Google Scholar 

  7. Buyse, T., Heylen, F., Van De Kerckhove, R.: Pension reform in an OLG model with heterogeneous abilities. J. Pension Econ. Financ. 16(2), 144–172 (2017)

    Article  Google Scholar 

  8. Castañeda, A., Díaz-Giménez, J., Ríos-Rull, J.-V.: Accounting for the U.S. earnings and wealth inequality. J. Polit. Econ. 111(4), 818–857 (2003)

    Article  Google Scholar 

  9. Cremer, H., Pestieau, P.: Myopia, redistribution and pensions. Eur. Econ. Rev. 55(2), 165–175 (2011)

    Article  Google Scholar 

  10. Davies, J.B., Sandström, S., Shorrocks, A., Wolff, E.N.: The level and distribution of global household wealth. Econ. J. 121(551), 223–254 (2011)

    Article  Google Scholar 

  11. De Nardi, M., Yang, F.: Wealth inequality, family background, and estate taxation. J. Monet. Econ. 77(C), 130–145 (2016)

    Article  Google Scholar 

  12. Deaton, A.: The Analysis of Household Surveys: A Microeconometric Approach to Development Policy. World Bank Publications, Washington, DC (1997)

    Google Scholar 

  13. Domeij, D., Klein, P.: Public pensions: to what extent do they account for swedish wealth inequality? Rev. Econ. Dyn. 5(3), 503–534 (2002)

    Article  Google Scholar 

  14. Fehr, H.: Computable stochastic equilibrium models and their use in pension- and ageing research. Economist 157(4), 359–416 (2009)

    Article  Google Scholar 

  15. Fehr, H., Kindermann, F.: Pension funding and individual accounts in economies with life-cyclers and Myopes. CESifo Econ. Stud. 56(3), 404–443 (2010)

    Article  Google Scholar 

  16. Fehr, H., Uhde, J.: Means-testing and economic efficiency in pension design. Econ. Model. 44(S1), 57–67 (2014)

    Article  Google Scholar 

  17. Fehr, H., Habermann, C., Kindermann, F.: Social security with rational and hyperbolic consumers. Rev. Econ. Dyn. 11(4), 884–903 (2008)

    Article  Google Scholar 

  18. Feldstein, M.: Would Privatizing Social Security Raise Economic Welfare? NBER Working Papers 5281. National Bureau of Economic Research, Inc (1995)

  19. Ferber, J.: Multi-agent Systems: an Introduction to Distributed Artificial Intelligence. Addison-Wesley, Reading (1999)

    Google Scholar 

  20. Fleurbaey, M., Maniquet, F.: Fair social orderings when agents have unequal production skills. Soc. Choice Welf. 24(1), 93–127 (2005)

    Article  Google Scholar 

  21. Fleurbaey, M., Maniquet, F.: Fair income tax. Rev. Econ. Stud. 73(1), 55–83 (2006)

    Article  Google Scholar 

  22. Gruber, J., Wise, D.A.: Social Security Programs and Retirement Around the World: Micro-Estimation. University of Chicago Press, Chicago (2004)

    Google Scholar 

  23. Hairault, J.-O., Langot, F.: Inequality and social security reforms. J. Econ. Dyn. Control 32(2), 386–410 (2008)

    Article  Google Scholar 

  24. Hénin, P.-Y., Weitzenblum, T.: Welfare effects of alternative pension reforms: Assessing the transition costs for French socio-occupational groups. J. Pension Econ. Financ. 4(3), 249–271 (2005)

    Article  Google Scholar 

  25. İmrohoroğlu, A., İmrohoroğlu, S., Joines, D.H.: Time-inconsistent preferences and social security. Q. J. Econ. 118(2), 745–784 (2003)

    Article  Google Scholar 

  26. Jabłonowski, J., Müller, C.: 3 sides of 1 coin—Long-term Fiscal Stability, Adequacy and Intergenerational Redistribution of the reformed Old-age Pension System in Poland, NBP Working Papers 145. Narodowy Bank Polski. Economic Research Department (2013)

  27. Jiménez-Martín, S.: The incentive effects of minimum pensions. IZA World of Labor, pp. 1–84 (2014)

  28. Kaganovich, M., Zilcha, I.: Pay-as-you-go or funded social security? A general equilibrium comparison. J. Econ. Dyn. Control 36(4), 455–467 (2012)

    Article  Google Scholar 

  29. Kanbur, R., Stiglitz, J.E.: Dynastic inequality, mobility and equality of opportunity. J. Econ. Inequal. 14(4), 419–434 (2016)

    Article  Google Scholar 

  30. Kindermann, F., Krueger, D.: High marginal tax rates on the top 1%? Lessons from a life cycle model with idiosyncratic income risk. NBER Working Papers 20601. National Bureau of Economic Research, Inc (2014)

  31. Kirman, A.: The economy as an evolving network. J. Evol. Econ. 7(4), 339–353 (1997)

    Article  Google Scholar 

  32. Krusell, P., Smith, A.A.: Income and wealth heterogeneity, portfolio choice, and equilibrium asset returns. Macroecon. Dyn. 1(2), 387–422 (1997)

    Article  Google Scholar 

  33. Krusell, P., Smith, A.A.: Income and wealth heterogeneity in the macroeconomy. J. Polit. Econ. 106(5), 867–896 (1998)

    Article  Google Scholar 

  34. Kumru, C.S., Thanopoulos, A.C.: Social security reform with self-control preferences. J. Public Econ. 95(7), 886–899 (2011)

    Article  Google Scholar 

  35. Lockwood, B.B., Weinzierl, M.: De Gustibus non est Taxandum: heterogeneity in preferences and optimal redistribution. J. Public Econ. 124(C), 74–80 (2015)

    Article  Google Scholar 

  36. McGrattan, E.R., Prescott, E.C.: On financing retirement with an aging population. NBER Working Papers 18760. National Bureau of Economic Research, Inc (2013)

  37. Nishiyama, S., Smetters, K.: Does social security privatization produce efficiency gains? Q. J. Econ. 122(4), 1677–1719 (2007)

    Article  Google Scholar 

  38. OECD: OECD Reviews of Pensions Systems: Ireland. Technical report, OECD Publishing (2014)

  39. Russell, S.J., Norvig, P.: Artificial Intelligence: A Modern Approach. Prentice Hall, Englewood Cliffs (1995)

    Google Scholar 

  40. Sinelnikov-Murylev, S., Radygin, A. (eds.): Russian Economy in 2016. Trends and Outlooks. (Issue 38). Gaidar Institute for Economic Policy, Moscow (2017)

  41. Song, Z.: The dynamics of inequality and social security in general equilibrium. Rev. Econ. Dyn. 14(4), 613–635 (2011)

    Article  Google Scholar 

  42. St-Amant, P.-A.B., Garon, J.-D.: Optimal redistributive pensions and the cost of self-control. Int. Tax Public Financ. 22(5), 723–740 (2015)

    Article  Google Scholar 

  43. Stigler, G.J., Becker, G.S.: De Gustibus Non Est Disputandum. Am. Econ. Rev. 67(2), 76–90 (1977)

    Google Scholar 

  44. Storesletten, K., Telmer, C.I., Yaron, A.: Consumption and risk sharing over the life cycle. J. Monet. Econ. 51(3), 609–633 (2004)

    Article  Google Scholar 

  45. Tesfatsion, L.: Agent-based computational economics: growing economies from the bottom up. Artif. Life 8(1), 55–82 (2002)

    Article  Google Scholar 

  46. van de Ven, J., Weale, M.: Modelling myopic responses to policy: an enhancement to the NIBAX model. DWP Working Paper 88 (2010)

  47. Wooldridge, M.: An Introduction to MultiAgent Systems. Wiley, New York (2009)

    Google Scholar 

  48. Wooldridge, M., Jennings, N.R.: Intelligent agents: theory and practice. Knowl. Eng. Rev. 10(2), 115–152 (1995)

    Article  Google Scholar 

Download references

Acknowledgments

The authors thank two anonymous referees for thorough and well-spirited comments. Earlier versions of this paper benefited greatly from cooperation with Marcin Waniek, who has co-authored an early working paper version of this paper and whose help and advice is gratefully acknowledged. Jan Jakub Woznica provided research assistance and Samuel Butterick provided wonderful editorial assistance. Marcin Bielecki gratefully acknowledges the support of National Science Centre grant no. UMO-2012/01/D/HS4/04039. Krzysztof Makarski and Joanna Tyrowicz gratefully acknolwedge the support of National Science Center grant no. UMO-2014/15/G/HS4/04638 All opinions expressed are those of the authors and have not been endorsed by NSC nor NBP. The remaining errors are ours.

Earlier versions of this paper have received extremely valuable comments from Fabian Kindermann, Patrick Puhani, Dirk Niepelt, Hans Fehr, Martyna Kobus, Nicoleta Ciurila, Damiaan Chen, Lukasz Drozd, Borys Grochulski and Jaromir Nosal as well as participants of NIESR, GRAPE, NBP and WSE. Insightful suggestions and remarks were also offered during ICMAIF 2015, NBP Macroeconomic Workshop 2015, World Congress of Comparative Economics 2015, WIEM 2015 and Netspar 2015, SED 2017, MoPaCT workshop (Helsinki, 2016), workshops in University of Mannheim (2016), Higher School of Economics in St Petersburg (2017).

Author information

Affiliations

Authors

Corresponding author

Correspondence to Joanna Tyrowicz.

Electronic supplementary material

Below is the link to the electronic supplementary material.

(PDF 1.87 MB)

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Tyrowicz, J., Makarski, K. & Bielecki, M. Inequality in an OLG economy with heterogeneous cohorts and pension systems. J Econ Inequal 16, 583–606 (2018). https://doi.org/10.1007/s10888-018-9391-0

Download citation

Keywords

  • Consumption
  • Wealth
  • Inequality
  • Longevity
  • Defined contribution
  • Defined benefit