Pension funding and human capital

In this paper we analyze the consequences of pension funding in a general equilibrium model of both formal schooling decisions and on-the-job human capital formation à laHeckman, Lochner and Taber (1998). Our focus lies on the distortive and redistributive effects of a Bismarckian pension system as well as the macroeconomic and welfare consequences of its abolition.We find that a Bismackian PAYG style pension system like the German one strongly enhances on-the-job human capital formation and redistributes from the lower to the higher skilled, a resultthat, to the best of our knowledge, is new to the literature. Our reform simulations indicate that in a small open economy setting pension funding reduces the amount of human capital formedvia on-the-job training by about 50 percent on average. In a closed economy setup however, the annual interest rate decreases by 2.6 percentage points which in turn boosts human capital accumulation.In the long run, we report a strong welfare gain of about 6.5 percent of initial resources.However, this gain comes along with short run losses up to nearly 5 percent for the middle aged generations, who still have to pay contributions in order to finance existing pension claims. Overall,pension funding comes at efficiency costs of about 2.2 percent in a closed economy setting.