Pensions, Economic Growth and Welfare in Advanced Economies

In this chapter, we analyse the effects of PAYG and funded pension systems on welfare. The debate on the choice between alternative systems focuses on their effects on savings, capital accumulation, labour supply, economic growth and inequality and the potential benefits of mixed systems in which a PAYG system with notional accounts is complemented by a funded pensions system. The main findings are as follows. Firstly, the redistribution of income among individuals makes the PAYG system an important part of any mixed system. Secondly, the design of the pension system should efficiently balance incentives and distortions with equality and insurance against individual idiosyncratic risks. Thirdly, funded systems generate positive effects on the savings rate, capital accumulation, productivity and the labour supply. These effects must be taken into account when PAYG systems are improved with notional accounts. Fourthly, in practice, income distribution among older people does not clearly depend on the relative importance of PAYG over funded pensions systems, suggesting that other factors are even more important. Fifthly, there are significant differences between advanced economies in their social preferences regarding the combination of replacement rates in PAYG systems and contributions to funded systems. Lastly, there is no guarantee that, regardless of social preferences, imposing a target of pension expenditure on GDP maximises social welfare.