Age-Specific Employment Policies

Many countries around the world are experiencing a significant shift in demographic patterns towards an older population. The age composition of the labor force has also changed dramatically, often accompanied by sharp reductions in the labor force participation rates of older workers. These phenomena in concert pose numerous challenges for the design of public pension programs and labor market policies in general. While governments have traditionally encouraged early retirement by the elderly to free up jobs for the young, such policies now impose an unprecedented tax burden on the current younger generations of working individuals. This has prompted many governments to instead adopt policies that promote old-age labor force participation. The primary goal of this paper is to draw some qualititative insights about these different policy responses within the context of a dynamic general equilibrium model. In order to address the role of the lifecycle for the allocation of workers to jobs, we develop a model of the labor market characterized by search and matching frictions and embed it into an overlapping-generations framework. We explicitly introduce agetargeted labor market policies and endogenize labor force participation across all age groups. Our analysis reveals that the age composition of the labor force may cause an inefficient allocation of workers to jobs in the labor market thereby creating an efficiency-enhancing role for publicly-induced retirement. Interestingly, we also find that public pension programs may improve labor market welfare by “redistributing bargaining power” over the lifecycle. Our work suggests that recent policy initiatives aimed at reducing the work disincentives currently embedded in many public pension programs may further the income redistribution motive of social security, encourage labor market participation among the elderly, and increase total employment. In this vein, we find that complete elimination of the earnings test may improve labor market welfare. ∗We thank Casey Mulligan for his encouragement and for many helpful discussions. We have also benefited from comments by John Duffy, Aarti Singh, Chris Waller, Dave Wildasin, Randy Wright, and seminar participants at the University of Kentucky, the Midwest Macro Meetings at Nashville, and the Federal Reserve Bank of Cleveland Central Bank Institute Summer Program on Monetary Economics (August 2002). We also thank Zhuo Chen and Moohoun Song for research assistance. †Corresponding author: Robert R. Reed III, Department of Economics, Gatton College of Business and Economics, University of Kentucky, Lexington, KY 40506; Phone: (859) 257-5975; Fax: (859) 323-1920; email: [email protected]