Can Pay‐as‐You‐Go Pensions Raise the Capital Stock?

Abstract

We reconsider pay‐as‐you‐go (PAYG) pension policy in a version of the Diamond overlapping generations model with an imperfectly competitive financial sector and with a low rate of tax on its profits. PAYG then has two effects on capital: the well‐known negative crowding‐out effect in displacing savings and a positive effect in reducing a second form of crowding‐out caused by the displacement of ‘productive savings’ in capital by ‘non‐productive savings’ in financial sector equity. These two countervailing effects may generate a hump‐shaped steady‐state relationship between the PAYG contribution rate and the capital stock.