An Analysis of the Impact of Public Pension Spending on Economic Growth in the Affluent Democracies 1960-1988

Abstract

During the past two decades a number of studies have attempted to assess cross-nationally the impact of government spending on economic growth (Castles and Dowrick, 1988; Korpi, 1985; Marlow, 1986; McCallum and Blais, 1987; Saunders, 1985; Weede, 1986a, 1986b, 1991). Most of these studies have assessed the impact of government consumption spending or, more commonly, total social welfare spending. Few studies, however, have attempted to specifically assess the impact of the largest component of social welfare spending, public pension expenditures, on rates of economic growth. Determining the impact of pension spending on economic growth has potentially important social policy implications. An important factor in the future of the welfare state may well be whether its programs hinder or facilitate economic development. The coincidence of declining economic growth and rapidly rising social spending in the industrial democracies during the past two decades has led many to implicate this spending as a cause of economic difficulties. If expenditures on social programs are widely believed to be detrimental to economic growth, support for those programs may wane. As the largest component of social welfare spending, public pension programs may be an especially important factor in determining the direction of whatever effects government spending has on economic growth. This paper investigates the relationship between public pension expenditures and economic growth in the affluent democracies for the years 1960-1988. We measure the effects on economic growth of both aggregate pension expenditures and average per recipient benefit levels. Previous studies have shown that the size of a nation's population is a major factor in the size of its social welfare and public pension budget (Holzman, 1988; Pampel and Williamson, 1985, 1988; Williamson and Pampel, 1993). Nations with larger elderly populations will have larger public pension budgets even if their per recipient benefit levels are lower than those of other nations. To distinguish the effects of the total size of public pension programs from their generosity, attention must be paid to the per recipient benefit levels as well as aggregate spending levels. Theoretical and empirical analyses of the economic impacts of public pension programs focus largely, but not exclusively, on savings rates, labor supply, and income redistribution. Though there are likely economic growth consequences for income redistribution brought about by public pensions there is little published work in that area. Instead, attention to the redistributional impact of pension schemes primarily concerns the net effect of transfers on income levels of the aged and the intergenerational transfer of wealth.(1) In contrast to the work on redistribution, much of the work on the savings and labor supply impacts of public pension programs is directly related to economic growth, at least implicitly. Savings rates, as they translate into capital investment, and labor supply are primary components of economic growth. The economic growth concern of public pensions programs is how those programs alter savings and work incentive structures for both beneficiaries and taxpayers. Mainstream neo-classical theory is ambivalent about the impact of public pension expenditures on economic growth, primarily because microeconomic responses to the receipt of those benefits are varied (Aaron, 1982; Danziger, Haveman, and Plotnick, 1981). Some of the actual responses consumers and workers have to the prospect of guaranteed public pension benefits might be growth promoting, while others might be growth retarding. As a way of highlighting the difficulties encountered in trying to anticipate the economic impact of public pensions, Aaron presents three theoretical models of the savings and labor supply behavior of individuals. The central issue distinguishing these three models is their assumption of the time horizon on which individuals base their behaviour. …