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What's gone wrong in the design of PAYG systems?

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  • Riccardo Magnani

    () (Centre d'Economie de l'Université de Paris Nord (CEPN))

Abstract

In order to face the population ageing problem, most countries with PAYG systems introduced pension reforms during the last twenty years. However, in many cases these reforms are considered as insufficient to guarantee the pension sustainability; in other cases, the pension sustainability is achieved through the introduction of drastic reforms and, thus, at the expense of a dramatic reduction in the well-being of current and future generations. The objective of this article is to show that the non-sustainability of PAYG systems and, consequently, the necessity to introduce drastic pension reforms, is explained by the fact that in countries with PAYG systems pensions have not been computed according to appropriate rules. In particular, we show that the sustainability of the pension system is guaranteed if (i) pension benefits are computed using actuarial principles, (ii) the implicit rate of return on contributions is the same for each retiree and equal to the average wage bill growth rate, and (iii) pension reserves are remunerated at a risk-free interest rate equal to the average wage bill growth rate. These conditions allow a PAYG system to face any demographic shock, such as an increase in life expectancy and a transitory increase in fertility rates (baby boom) followed by a transitory reduction in fertility rates (baby boost).

Suggested Citation

  • Riccardo Magnani, 2018. "What's gone wrong in the design of PAYG systems?," CEPN Working Papers 2018-13, Centre d'Economie de l'Université de Paris Nord.
  • Handle: RePEc:upn:wpaper:2018-13
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    References listed on IDEAS

    as
    1. Robalino, David A. & Bodor, András, 2009. "On the financial sustainability of earnings-related pension schemes with ‘pay-as-you-go’ financing and the role of government-indexed bonds," Journal of Pension Economics and Finance, Cambridge University Press, vol. 8(02), pages 153-187, April.
    2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467-467.
    3. Settergren, Ole & Mikula, Boguslaw D., 2005. "The rate of return of pay-as-you-go pension systems: a more exact consumption-loan model of interest," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(02), pages 115-138, July.
    4. Settergren, Ole & Mikula, Boguslaw D., 2005. "The Rate of Return of Pay-As-You-Go Pension Systems: A More Exact Consumption-Loan Model of Interest," Discussion Paper 249, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
    5. Barr, Nicholas, 2002. "Reforming pensions : myths, truths, and policy choices," LSE Research Online Documents on Economics 286, London School of Economics and Political Science, LSE Library.
    6. Auerbach, Alan J. & Lee, Ronald, 2011. "Welfare and generational equity in sustainable unfunded pension systems," Journal of Public Economics, Elsevier, vol. 95(1-2), pages 16-27, February.
    7. Heikki Oksanen, 2001. "Pension Reforms for Sustainability and Fairness," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 2(4), pages 12-18, October.
    8. Barr, Nicholas & Diamond, Peter, 2009. "Reforming pensions: principles, analytical errors and policy directions," LSE Research Online Documents on Economics 25099, London School of Economics and Political Science, LSE Library.
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    More about this item

    Keywords

    Pension economics; Pension finance; Population ageing;

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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