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Sustainable and Equitable Pension Reform for Emerging Economies: An Application to Indonesia


George Kudrna, John Piggott and Phitawat Poonpolkul

Abstract: This paper develops a general equilibrium overlapping generation model with heterogenous households to study pension reforms in emerging economies with large informal employment and rapid population ageing. Using Indonesia, a country in which 80% of the labour force works in the informal sector, and which confronts a 5-fold increase in the 65+ share of the population this century, as our exemplar economy, we assess, both separately and in combination, the impact of increasing the pension access age for formal labour and introducing a flat-rate social pension for informal labour. Households are differentiated by skill and employment type, and confront idiosyncratic labour income and survival shocks. The micro/household behaviours are calibrated with Indonesian Family Life Survey (IFLS) data, along with recent World Bank macro and fiscal data to target some macro moments. The benchmark model assumes tax and pension policy settings applicable solely to formal labour. We show that in a model incorporating population ageing, the combined reforms would significantly improve aggregate welfare for both groups: flexibility in late life work in the formal sector benefits those workers, while informal workers benefit from the social pension, set at 6.5% of per capita GDP. The incremental revenue requirement, taking account of both the reduced formal pension outlays and the cost of the social pension, is calculated to be about 1.5% of GDP.

Keywords: Population Ageing, Informal Labour, Retirement Policies, Social Security, Redistribution, Life Cycle, Stochastic General Equilibrium.

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