Pension Coverage and Mandatory Contributions in Chile

by Clement Joubert, University of Pennsylvania

This project studies the link between mandatory pension contributions and pension overage in Chile. Twenty-seven years after switching from a public pay-as-you-go system to a fully-funded privately-managed pension system, Chilean lawmakers are concerned that only 58 percent of the labor force made contributions in 2000. I consider the hypothesis that the contribution rate affects incentives for workers to turn to self-employment or to the informal sector. To formalize this effect, I develop a dynamic model of the joint Husband and Wife labor and saving decisions. Households face a dual labor market with a covered and an uncovered sector. The covered sector corresponds to salary jobs in which workers must contribute a share of their wage to an individual tax-deferred pension account. The uncovered sector encompasses self-employment and informal work. Pension contributions effectively impose a lower bound on the saving rate, and reduce the disposable income available for consumption-smoothing. This can lower the relative value of covered sector jobs, especially for younger and cash-strapped households, and affect pension coverage negatively. I will structurally estimate the model with a representative sample of Chilean married couples using linked administrative and self-reported panel data on accepted wages, labor sector choices and savings. The data will identify the two labor sectors’ wage offer equations and the preference parameters. I will apply the Simulated Method of Moments to select parameter values that best help match observed data. The estimated model will be used to simulate the labor decision responses to counter factual contribution rates. I will also quantify the gains of allowing rates to depend on age. Finally I will determine the optimal contribution design given different Government objective functions.

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