Project Showcase

With Torben Andersen and Joydeep Bhattacharya

 In the real world, public pay-as-you-go pension (PAYG) schemes are popular and co-exist with private, retirement saving schemes. This is true even in dynamically efficient economies where such pensions offer a lower return. The classic Aaron-Samuelson result argues that, in theory, this is impossible. Later work has shown that it may be possible if agents, left on their own, undersave due to myopia or time inconsistency. In that case, if the government is paternalistic, a welfare rationale for PAYG pensions arises but only if voluntary retirement saving is fully crowded out because of a binding borrowing constraint. This paper generalizes the Aaron-Samuelson discussion to the reference-dependent utility setup of K˝oszegi and Rabin (2009) where undersaving happens naturally. No borrowing constraint is imposed. In this case, it is possible to offer a non-paternalistic, welfare rationale for return dominated, PAYG pensions to coexist with private retirement saving.

With Eungsik Kim

 The Chinese pension system has seen radical reform over the past three decades. In the years ahead, demographic and budgetary pressures are projected to strain both the pension system and informal family support for retirees. Such stresses will likely precipitate further reform, but the scale and timing of such reform remain uncertain. This paper studies the welfare effects of future pension-reform risk in a standard, multi-cohort, overlapping-generations economy characterized by an intergenerational human capital externality and endogenous within-family intergenerational transfers. In the model economy, future pension risk generates a precautionary investment motive: self-interested parents self protect by investing in their children's education, rationally expecting these altruistic children to support them financially, and indirectly, provide insurance against pension reform risk. This investment in human capital fuels the human capital externality and generates welfare gains since the market, ignoring the externality, was under providing education, to begin with. The analytical framework is calibrated to the Chinese economy, and a stylized, uncertain policy reform is studied. Preliminary results indicate that the welfare gain to future generations from the human capital externality may dominate the welfare losses arising from the policy uncertainty; the generation of retirees before the reform may, however, be hurt. The big takeaway is that limited doses of policy uncertainty may sometimes have unintended but desirable consequences.