New Rural Old-Age Pension Program, Liquidity Constraints and Human Capital Investment

The new rural old-age pension program is a mixed one. It can relax liquidity constraints through pension income, and strengthen liquidity constraints through pension fee at the same time. Its impact on liquidity constraints and hence on human capital investment is uncertain. This paper constructs a basic two-period household model to analyze human capital investment with or without liquidity constraints. When there are not liquidity constraints, the pension program has no impact on human capital investment. And when there are liquidity constraints, the impact of the new pension program depends on comparison between decreasing return of human capital investment and cross derivative of pension income on the first-period consumption and pension fee. Under perfect credit constraints, households will not participate in the program if return to investment in human capital is high enough. This leads to the vicious reversal financial subsidies to those relatively well-off households, which have no credit constraints and are willing to participate. One way to overcome this effect is to allow for late pension payments for poor rural households, but with an interest rate higher than market interest rate.