Intergenerational redistribution in a small open economy with endogenous fertility.

Abstract

The literature comparing fully funded (FF) and pay-as-you-go (PAYG) financed public pension systems in small, open economies stresses the importance of the Aaron condition as an empirical measure to decide which system can be expected to lead to a higher long-run welfare. A country with a PAYG system has a higher level of utility than a country with a FF system if the growth rate of total wage income exceeds the interest rate. Endogenizing population growth makes one determinant of the growth rate of wage incomes endogenous. The author demonstrates why the Aaron condition ceases to be a good indicator in this case. For PAYG-financed pension systems, claims can be calculated according to individual contributions or the number of children in a family. Analysis determined that for both structural determinants there is no interior solution of the problem of intergenerational utility maximization. Pure systems are therefore always welfare maximizing. Moreover, children-related pension claims induce a fiscal externality which tends to be positive. The determination of the optimal contribution rate shows that the Aaron condition is generally a misleading indicator for the comparison of FF and PAYG-financed pension systems.