Public pension policy and the equity–efficiency trade-off∗

Abstract

This paper illustrates that the equity–efficiency trade-off between a redistributive, Beveridgean, pension system and an earnings-based, Bismarckian, scheme can collapse when accounting for labor supply effects on the extensive margins. I introduce a general equilibrium overlapping generations model with endogenous savings, human capital formation, and labor supply. The model is calibrated to an average OECD economy. The results suggest that allocating funds towards a Bismarckian pension system always reduces earnings inequality – and, in some cases, lifetime inequality – when compared with a Beveridgean scheme. However, the Bismarckian scheme crowds out more human capital in the economy following a higher steady-state interest rate.