The PAYG system and the optimal redistribution instrument in an overlapping generation model

Abstract Using a two‐period overlapping generation (OLG) model, this article seeks to identify the optimal redistribution policy instrument in terms of aggregate welfare when agents differ according to their labour condition. We use five policy specifications: (i) early redistribution to the young informal generation; (ii) late redistribution to the informal old generation; (iii) a mix between early and late redistribution; (iv) redistribution from the current formal young generation to the current formal old one; and (v) a non‐redistribution scenario. With inelastic labour supply, we show that transferring to the young performs better as a redistribution policy. This result is robust across different parameter values.