PAYG Pension System Research Articles

Sharing Demographic Risk—Who Is Afraid of the Baby Bust?

We model the reaction of a PAYG pension system to demographic shocks. We compare the ex ante first best and second best solution of a Ramsey planner with full commitment to the outcome under simple third best rules. The model is calibrated to the German economy. We find that the German system comes relatively close to the second-best solution, and that the recent baby-boom/baby-bust cycle leads to welfare losses of about 5 percent of lifetime consumption for some cohorts. We argue that it is crucial for all our results to correctly model the labor market distortions arising from the pension system. (JEL D91, E62, H55, J11)

Extending the Aaron Condition for Alternative Pay-as-You-Go Pension Systems

at or earnings related. Here, four alternative PAYG pension systems are considered. It is shown that each system generates its own Aaron condition. In addition, the standard Aaron condition assumes that the wage rate and labor participation rate does not vary across individuals and that the rate of population growth is constant and exogenous. These assumptions are also relaxed. Using US data covering the period 1933-2001, I then show that the results of comparisons between PAYG and funded systems depend critically on exactly which variety of PAYG system is being compared, and that PAYG systems are becoming less attractive over time as fertility rates decline. (JEL H55, J13, J14)

How Does Ageing Affect the Welfare State?

In a political economy environment, aging has opposite economic and political effects on the size of the welfare state. On one side, it tends to decrease the profitability of a welfare state that features a PAYG pension system, thus inducing individuals to prefer a smaller system; on the other side the pivotal (median) voter becomes older (or poorer) and hence more willing to support a larger system. The overall effect is thus ambiguous. We show that specific features of the welfare system, such as its composition and the redistributive design of social security may change the magnitude of the economic effect and thus of the overall impact of aging on the size of the welfare state.

The Optimal Legal Retirement Age in an OLG Model with Endogenous Labour Supply

The long run welfare implications of the legal retirement age are studied in a perfect foresight overlapping-generations model where agents live for two periods. Agents’ lifetime is divided between working life and retirement by a legal retirement age controlled by the government whereas agents, besides savings, control the intensive margin or yearly labour supply. The legal retirement age is utilized to dampen distortionary effects of payroll taxes and public pension annuities and promote capital accumulation. We show that a social optimal legal retirement age exists and how it depends on whether payroll taxes or benefit annuities ensures budget balance of the PAYG pension system.

Social Security Systems, Human Capital, and Growth in a Small Open Economy

We consider a small open economy in which the level of public education funding is determined by popular vote. We show that growth can be enhanced by the introduction of pay-as-you-go pensions even if the growth rate of aggregate wages falls short of the interest rate. The reason is that the PAYG system allows future retirees to partially internalize positive externalities of public education due to the positive effect of higher future labor productivity on their pension benefits. The majority support for education funding will be especially strong when the PAYG benefit formula is flat, i.e. progressively redistributive. This means that if a flat benefit PAYG pension system is in place then the economy will achieve the highest growth rate relative to the alternative pension system designs. We argue furthermore that while such PAYG pension system may be opposed by the majority of working individuals due to inferior returns to their pension contributions relative to a funded scheme, it is likely to be politically sustained by the coalition of retirees and lower income workers.

Sharing Demographic Risk: Who is Afraid of the Baby Bust?

We model the optimal reaction of a public PAYG pension system to demographic shocks. We compare the ex-ante first best and second best solution of a Ramsey planner with full commitment to the outcome under simple third best rules that mimic the pension systems observed in the real world. The model, in particular the pension system, is calibrated to the German economy. The objective of the social planner is calibrated such that the size of the German pension system was optimal under the economic and demographic conditions of the 1960s. We find that the German system comes relatively close to the second-best solution, especially when labor market distortions are correctly modelled. Furthermore, the German system and a constant contribution rate lead to a lower variability of lifetime utility than does the second best policy. The recent baby-boom/baby-bust cycle leads to welfare losses of about 5% of lifetime consumption for some cohorts. We argue that it is crucial for these results to model correctly the labor market distortions arising from the pension system.

Sharing Demographic Risk - Who is Afraid of the Baby Bust?

We model the optimal reaction of a public PAYG pension system to demographic shocks. We compare the ex-ante first best and second best solution of a Ramsey planner with full commitment to the outcome under simple third best rules that mimic the pension systems observed in the real world. The model, in particular the pension system, is calibrated to the German economy. The objective of the social planner is calibrated such that the size of the German pension system was optimal under the economic and demographic conditions of the 1960s. We find that the German system comes relatively close to the second-best solution, especially when labor market distortions are correctly modelled. Furthermore, the German system and a constant contribution rate lead to a lower variability of lifetime utility than does the second best policy. The recent baby-boom/baby-bust cycle leads to welfare losses of about 5% of lifetime consumption for some cohorts. We argue that it is crucial for these results to model correctly the labor market distortions arising from the pension system.

Education, Demographics, and the Economy

This paper deals with two issues concerning the effects of population aging on education decisions in the presence of a PAYG pension system: We first analyze the effects of an aging population per se on individual skill choices and continuous education and the production structure. Second, we study the implications of postponed retirement, which is often proposed as a measure to cope with the economic challenges of increased longevity. Our study uses a dynamic general equilibrium framework with overlapping generations and probabilistic aging. The model allows for capital-skill complementarity in the production of final output. As a response to population aging, in a small open economy with a fixed interest rate, our first simulation shows that GDP is depressed due to an adverse effect on skill choice and labor supply. We then introduce postponed retirement as a potentially dampening policy measure due to its encouragement of human capital formation. However, since there is less private saving in this scenario, the overall effect on GDP is even worse than in the pure aging scenario.

Education, demographics, and the economy

AbstractThis paper deals with two issues concerning the effects of population aging on education decisions in the presence of a PAYG pension system: We first analyze the effects of an aging population per se on individual skill choices and continuous education and the production structure. Second, we study the implications of postponed retirement, which is often proposed as a measure to cope with the economic challenges of increased longevity. Our study uses a dynamic general equilibrium framework with overlapping generations and probabilistic aging. The model allows for capital–skill complementarity in the production of final output.As a response to population aging, in a small open economy with a fixed interest rate, our first simulation shows that GDP is depressed due to an adverse effect on skill choice and labor supply. We then introduce postponed retirement as a potentially dampening policy measure due to its encouragement of human capital formation. However, since there is less private saving in this scenario, the overall effect on GDP is even worse than in the pure aging scenario.

A Bird in the Land is Worth Two Abroad

AbstractIncreased migration possibilities of graduates can lead to brain drain. It isshown that surplus-maximizing governments react to this threat by lowering thequality of the regular university degree and enlarging the student body. Thispolicy keeps more human capital in the country and avoids fiscal externalitiesof public subsidies to higher education. Therefore, the implementation of thebachelor’s degree in many European countries could be interpreted as a rationalresponse to increased international integration.JEL Classification: F15, H73, I28Keywords: brain drain, education quality, bachelor’s degree, educational subsi-dies 1 Introduction The education that an individual has attained can influence her migration possibilitiesduring her whole life. This is obvious for the case of language abilities, which areacquired most easily when young. But also the subject studied seems to play a majorrole. Some fields of study, like medicine or economics, can be applied anywhere inthe world, while other ones, like law, stick more to the country where they have beentaught. Starting from this observation, a growing literature analyzes how globalizationchanges the composition of the higher education offered because the new pattern ofmobility can be strategically exploited by governments.Thum and Ubelmesser (2003) present a model in which a gerontocratic majority faces¨the classical holdup problem with respect to the human-capital investment of the younggeneration. The promise of a low contribution rate for the PAYG pension system inthe future is not credible as long as the young are in the minority and have no exit

PAYG pension systems with capital mobility

This paper studies the design of an optimal pension scheme in an OLG and open economy model. The pension scheme provides a flat rate benefit and is based on the PAYG principle. It thus combines inter- and intra-generational redistribution. In this setting a number of symmetric economies are connected by an open and perfect capital market. When this number is very large, we have the small open economy case; when it is reduced to one, we have the case of autarky or perfect coordination. As the number of countries increases, there is more intragenerational redistribution, but less capital accumulation.

How does ageing affect the welfare state?

Ageing has opposite economic and political effects on the size of the welfare state. On one side, it tends to decrease the profitability of a welfare state that features a PAYG pension system, thus inducing individuals to prefer a smaller system; on the other side, the pivotal (median) voter becomes older (or poorer) and hence more willing to support a larger system. The overall effect is thus ambiguous. We show that specific features of the welfare system, such as its composition and the redistributive design of social security, may change the magnitude of the economic effect and thus of the overall impact of ageing on the size of the welfare state.

La mise en place d'un fonds de réserve des retraites améliore-t-elle le bien être ?

Nous analysons les effets de la mise en place d’un fonds de réserve pour les retraites par répartition avant que ne survienne un vieillissement consistant en un allongement de la durée de vie. Nous nous plaçons soit en économie ouverte avec parfaite mobilité du capital, soit en économie fermée avec capital, salaire et taux d’intérêt endogènes. Nous montrons que, en l’absence d’imperfection, le bien être est accru dans tous les cas, que la générosité du régime de retraite soit maintenue ou que la pression fiscale reste stable, sauf s’il y a altruisme intergénérationnel.

Can social security be welfare improving when there is demographic uncertainty?

This paper studies the welfare implications of a PAYG pension system in an overlapping generations (OLG) model with demographic uncertainty and incomplete markets. In the absence of public pensions, small cohorts tend to be favoured by the changes in relative prices implied by demographic shocks. PAYG defined-benefit systems can help to share the financial risks created by this type of demographic uncertainty across generations. Our careful quantitative analysis test this possibility with unfavourable results: the overall welfare impact of the public pensions is negative, due to the prominence of the crowding-out effect over the insurance effect.

Longevity and Pay-as-You-Go Pensions

This paper aims at investigating whether or not a utilitarian social planner should subsidize longevity-enhancing expenditures in an economy with a PAYG pension system. For that purpose, a simple two-period OLG model is developed, in which the length of the second period of life can be raised by private health spendings. Focussing on the steady-state, it is shown that the sign of the optimal subsidy on health expenditures tends to be negative when the replacement ratio is sufficiently large. Moreover, the optimal health subsidy is also shown to depend significantly on the longevity production process and on the production technology.

Pension Reform in Greece: ‘Reform by Instalments’ – A Blocked Process

The dominant characteristic of the process of pension reform in Greece is policy immobility: key measures rationalising the public PAYG pension system have been characterised as ‘extremely urgent’ for the last half-century and remain so today. This policy immobility – or ‘reform by instalments’ – is explained on the basis of key structural features of the Greek pension system, chief amongst which is fragmentation. These features allow short-termism of political actors to thwart reform efforts and to rely on external stimuli to initiate progress. Experience since the mid-1990s, despite some early promise, has largely confirmed traditional patterns.

On the optimality of PAYG pension systems in an endogenous fertility setting

In order to help in designing an accurate pension reform, we determine the resource allocation in an endogenous fertility model that generates an endogenous demographic transition by means of distinguishing between female and male labor. We analyze the problem of the optimal solution and characterize the decentralization of the first best. We show that a pension policy linking pension benefits to the number of children acts as a corrective tax system able to restore both the optimal capital stock and the optimal rate of population growth as a single instrument. We also show that neither a Beveridgean pension scheme nor a Bismarckian one can decentralize the first best.

On the Optimality of PAYG Pension Systems in an Endogenous Fertility Setting

In order to help in designing an accurate pension reform, we determine the resource allocation in an endogenous fertility model that generates an endogenous demographic transition by means of distinguishing between female and male labor. We analyze the problem of the optimal solution and characterize the decentralization of the first best. We show that a pension policy linking pension benefits to the number of children acts as a corrective tax system able to restore both the optimal capital stock and the optimal rate of population growth as a single instrument. We also show that neither a Beveridgean pension scheme nor a Bismarckian one can decentralize the first best. pay-as-you-go pension system, golden rule

Funding a PAYG pension system: the case of Italy

AbstractItaly is characterised by a mature pay‐as‐you‐go social security system and by particularly adverse population projections. Given these trends, the social security contribution rate is expected to increase above its current high level. This hinders the development of employer‐provided pension funds and introduces a significant wedge between labour cost and earnings that discourages both labour demand and labour supply. Any proposal to reduce payroll taxes and to reform the system in the direction of partial funding has to cope with the state of Italian public finances. Italy has to comply with the Stability and Growth Pact that imposes constraints on budget deficit and debt trends. Using micro data from the Bank of Italy's Survey of Household Income and Wealth and official population projections, we estimate future employment trends under different demographic and macroeconomic scenarios and compute the cost of the transition. We show that it would be substantially reduced if positive effects on employment were induced by the payroll tax reduction.

Implizite Einkommensteuer als Messlatte für die aktuellen Rentenreformvorschläge

Abstract The rate of return in a PAYG pension system is typically lower than in a funded system. This lower rate of return generates a loss for the contributors which basically acts like an implicit income tax. In this paper, we argue that the implicit income tax is an excellent measure with which to evaluate the upcoming pension crisis in Germany and that it is also much better suited than other measures (such as the contribution rate, the pension level or the rate of return) to understand the impact of various reform scenarios. We also calculate the development of the implicit tax for prominent reform proposals in Germany.