Inequality in an OLG economy with intra-cohort heterogeneity and an obligatory pension system

While the inequalities of endowments are widely recognized as areas of policy intervention, the dispersion in preferences may also imply inequalities of outcomes. In this paper, we analyze the inequalities in an OLG model with obligatory pension systems. We model both policy relevant pension systems (a defined benefit system — DB — and a transition from a DB to a defined contribution system, DC). We introduce within cohort heterogeneity of endowments (individual productivities) and heterogeneity of preferences (preference for leisure and time preference). We introduce two policy instruments, which are widely used: a contribution cap and a minimum pension. In theory these instruments affect both the incentives to work and the incentives to save for the retirement with different strength and via different channels, but the actual effect attributable to these policy instruments cannot be judged in an environment with a single representative agent. We show four main results. First, longevity increases aggregate consumption inequalities substantially in both pension systems, whereas the effect of a pension system reform works to reinforce the consumption inequalities and reduce the wealth inequalities. Second, the contribution cap has negligible effect on inequalities, but the role for minimum pension benefit guarantee is more pronounced. Third, the reduction in inequalities due to minimum pension benefit guarantee is achieved with virtually no effect on capital accumulation. Finally, the minimum pension benefit guarantee addresses mostly the inequalities which stem from differentiated endowments and not those that stem from differentiated preferences.