The Demography of an Equitable and Stable Intergenerational Transfer System

By De Santis, Gustavo | Population, November 1, 2003 | Go to article overview

The Demography of an Equitable and Stable Intergenerational Transfer System


De Santis, Gustavo, Population


'"Would you tell me please which way I ought to go from here?' Alice asked. 'That depends a good deal on where you want to get to' said the Cat. ? don't care much where...' said Alice. 'Then it doesn't matter which way you go' said the Cat. '... so long as I get somewhere' Alice added as an explanation."

(Lewis Carroll, Alice's Adventures in Wonderland)

Forms of economic support for the elderly have always existed. In pre-industrial times, this was primarily a private matter. Under many forms, and frequently with limited success, caring for the aged was the responsibility of families and households (see Bengtsson and Fridlizius, 1994; Reher, 1998). With the industrial revolution and the urbanisation process that ensued, proximity and therefore also solidarity between family members declined, and alternative systems of a collective nature developed gradually for the economic protection of the elderly (Conrad, 1991; Ritter, 1991). These arrangements were originally fully funded but in most cases, at least in Europe, and for a variety of reasons*1), turned later to Pay-As-You-Go (or PAYG). The difference is that, with funding, individuals are forced to save when they are adults and working, and deplete their own capital progressively in their old age when their labour income shrinks or disappears; with PAYG, current pensions are paid out of current contributions taken from younger cohorts, and there is no accumulation of capital(2).

In recent times, PAYG pension systems have experienced serious financial difficulties that most observers tend to impute to their basic intrinsic weakness: with no collateral (i.e. savings), there is no guarantee that sufficient resources will actually be available to pay the promised future pensions. The survival of the system depends on whether the relevant variables (labour force participation and productivity, number of retirees, etc.) will evolve at least as favourably as the designers of the system imagined. Unfortunately, system designers are policy makers. They tend to be shortsighted because they know they will not be in charge forever, and because they seek the support of voters who are possibly even more short-sighted than they are(3). All this conspires to bias the system towards excessively generous promises that may prove impossible to keep, as the recent history of most PAYG systems and their frequent adjustments suggests(4). The difficulty of foreseeing the future availability of resources, and the related tendency to promise too much, are among the reasons why several economists prefer funding to PAYG. Its role, according to some of them, should be sharply reduced, possibly to a mere safety net for those who are both elderly and poor (see Disney, 1996, 2000; Feldstein and Ranguelova, 2000). International financial institutions strongly support this view (World Bank, 1994, 1997) or, according to some observers, impose it on recalcitrant but economically weak countries (Müller, Ryll and Wagener, 1999).

In these pages I will not discuss all the reasons that may motivate this preference for funding. They are basically economic, and involve, for instance, the stimulus to capital accumulation and, hence, economic growth, or the assumed optimal balance between the public and the private sphere in the annuity market. Instead, I will try to show that most of the alleged shortcomings (Ponzi scheme(5), intrinsic instability, extreme variability of internal rates of return, discouraging effects on the labour market, etc.) are not characteristic of PAYG per se, and, in particular, that they do not affect the ES version that I will present below.

I. Simplifications, assumptions and "philosophy"

To simplify matters, I will keep this exposition at a very high level of abstraction, assuming that there is only one all-encompassing intergenerational transfer system, that all workers are subject to the same rules regardless of their sex, industry, birth cohort, etc. and that management costs are negligible. …

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