Ex-ante methods to assess the impact of social insurance policies on labor supply with an application to Brazil

This paper solves and estimates a stochastic model of optimal inter-temporal behavior to assess how changes in the design of the unemployment benefits and pension systems in Brazil could affect savings rates, the share of time that individuals spend outside of the formal sector, and retirement decisions. Dynamics depend on five main parameters: preferences regarding consumption and leisure, preferences regarding formal versus informal work, attitudes towards risks, the rate of time preference, and the distribution of an exogenous shock that affects movements in and out of the social insurance system (given individual decisions). The yearly household survey is used to create a pseudo panel by age-cohorts and estimate the joint distribution of model parameters based on a generalized version of the Gibbs sampler. The model does a good job in replicating the distribution of the members of a given cohort across states (in or out of the social insurance / active or retired). Because the parameters are related to individual preferences or exogenous shocks, the joint distribution is unlikely to change when the social insurance system changes. Thus, the model is used to explore how alternative policy interventions could affect behaviors and through this channel, benefit levels and fiscal costs. The results from various simulations provide three main insights: (i) the Brazilian social insurance system today might generate unnecessary distortions (lower savings rates and less formal employment) that increase the costs of the system and can induce regressive redistribution; (ii) there are important interactions between the unemployment benefits and pension systems, which calls for joint policy analysis when considering reforms; and (iii) current distortions could be reduced by creating an actuarial link between contributions and benefits and then combining matching contributions and anti-poverty targeted transfers to cover individuals with limited or no savings capacity.