Pension design with a large informal labor market: Evidence from Chile REVISE AND RESUBMIT AT THE INTERNATIONAL ECONOMIC REVIEW

This paper investigates empirically the fiscal and welfare trade-offs involved in designing a pension system when workers can avoid participation by working informally. A dynamic behavioral model captures a household’s labor supply, formal/informal sector choice and saving decisions under the rules of Chile’s canonical privatized pension system. The parameters governing household preferences and earnings opportunities in the formal and the informal sector are jointly estimated using a longitudinal survey linked with administrative data from the pension system’s regulatory agency. The parameter estimates imply that formal jobs rationing is limited and that mandatory pension contributions play an sizeable role in encouraging informality. Our policy experiments show ∗Assistant Professor, Department of Economics, University of North Carolina at Chapel Hill ([email protected]) †I thank Petra Todd, Ken Wolpin, Dirk Krueger, Olivia Mitchell and the participants at the Penn Macro Club and the Empirical Micro Lunch for their helpful comments. I gratefully acknowledge financial support from the TRIO (PARC/Boettner/NICHD) Pilot Project Competition and from the Center for Retirement Research at Boston College. Formerly circulated under the title “Dynamic labor supply and saving incentives in privatized pension systems: evidence from Chile”