Sustainable and equitable pension reform for emerging economies: An application to Indonesia

This study develops a general equilibrium overlapping generations model with heterogeneous households to examine pension reforms in an emerging economy with large informal employment, using Indonesia as our exemplar economy. We calibrate the model with detailed household-level data from the Indonesian Family Life Survey, along with macroeconomic and fiscal datasets, to capture the nation’s labour market structure, characterised by high informality. The study assesses the impacts of three key reforms, namely, raising formal workers’ pension access age, introducing a flat-rate social pension for informal labour and an overall reform combining the two. Although a social pension alone (set at 6.5% of per capita GDP) improves informal households’ welfare, it imposes a fiscal burden that reduces formal sector welfare. However, extending formal workforce participation alleviates fiscal pressure. This combined pension reform improves welfare and equity across both worker groups while remaining fiscally feasible. • We examine pension reform in emerging economies with a large informal labour force. • The stochastic overlapping generations model developed separates households by employment type. • Impacts of raising formal labour pension access age and social pensions for informal labour are studied. • Combined reform improves welfare, with a fiscal requirement of 1.5%–2% of GDP. • Model suits economies with similar informal labour markets and ageing populations.