Old Age Consumption and Pension Policy in a Two-Tier Developing Economy∗

In a number of developing countries, an important part of the economy is informal both in terms of production and of social protection. In this paper we consider introducing a universal pension system in the formal sector. It is shown to have two main effects: first, it makes the formal sector more attractive to migration and second, it affects capital accumulation in a way which depends on the type of social security introduced, PAYG or funded, and its induced effect on private saving. Classification JEL: H55, J61 ∗Part of this research was completed while the second author was visiting the African Department of the IMF. We are extremely grateful to David de la Croix for his comments on an earlier version of this paper. †CREPP, Université de Liège and CORE, Université Catholique de Louvain. ‡CREPP, Université de Liège, CORE, CEPR and Delta. Corresponding author. Address: CORE, University of Louvain, 34 Voie du Roman Pays, 1348 Louvain-la-Neuve, Belgium. Fax: (32)-10-474301,