The relation between demography and economics with special reference to the role of mandatory funded and unfunded old-age pensions

  • Bernard van Praag Bernard van Praag
  • Peter Hop Peter Hop

In this paper we consider the influence of the demography on the dynamic equilibrium of an economy. More precisely, we focus on mandatory pensions, as in most Western countries except USA and Switzerland the role of ‘the third pension-pillar’, based on voluntary savings, is relatively minor. Our first main result is that the interest rate in a two-pillar system (PAYG and mandatory pensions) is increasing with the birth rate. This finding would give a theoretical underpinning for the actual conjecture that real long-term interest rates over the world tend to fall in line with falling birth rates. The second result is that the mix between mandatory funded and unfunded systems may be seen as an endogenous result of the system. If the birth rate is rising, the role of the un-funded system declines or even vanishes, while inversely with falling birth rate the role of the unfunded system appears to grow. A third important result is that average utility or welfare increases with increasing birth rates, while at the same time inequality be-tween workers and retired, measured by the benefit ratio, appears to reduce. A final es-sential result is that a pension system built on a funded and an unfunded component does better in terms of average welfare than a system which consists of a funded system only, except for very low birth rates where a mandatory funded system only yields higher average welfare.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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