Should we Revive PAYG? On the Optimal Pension System in View of Current Economic Trends

By Ed Westerhout, Lex Mijdam, Eduard Ponds and Jan Bonenkamp

http://d.repec.org/n?u=RePEc:tiu:tiucen:63418f60-e248-4dc9-aac8-ffefd6da93a4&r=dge

In many countries, both pay-as-you-go (PAYG) and funding are used to finance pensions, although the balance between the two principles differs a lot between countries. Over the last decades, many countries made a gradual transition to more funding. In this paper, we develop an analytical framework that includes three models of pension design, allowing us to study the role of efficiency aspects, redistributional aspects and political-economy aspects. We subsequently analyze the impact of several trends (a permanent decline in the rate of return on financial markets, a decline in the average rate of economic growth, decreased output volatility and increased capital market volatility) on the optimal balance between PAYG and funding. We argue that it may be optimal to revise the gradual transition to more funding and to revive PAYG.

This paper is a really nice overview of the literature on pension system along with an interesting analysis that shows that optimal policy design changes as fundamentals change.