Population aging and PAYG pensions in the OLG model
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Population aging and PAYG pensions in the OLG model Giam Pietro Cipriani
Received: 19 July 2012 / Accepted: 16 January 2013 © Springer-Verlag Berlin Heidelberg 2013
Abstract This paper shows the effects on a pay-as-you-go pension system of the demographic change in the standard overlapping generations model. Firstly, we consider a setting with exogenous fertility and then a model with endogenous fertility. In both cases, population aging due to increased longevity implies a reduction in pensions payouts. Keywords PAYG pensions · Fertility · Longevity JEL Classification J13 · H55
1 Introduction A number of papers have studied the effects of population aging on the pension system. In fact, the decline of the fertility rate and the increase in life expectancy have seriously undermined the solvency of the pay-as-you-go pension system in many developed countries that, because of aging, have had to substantially change their pension schemes. Theoretical models in the overlapping generations literature have studied the three main effects of a falling fertility: the intergenerational transfer effect, the capital dilution effect, and the child quality effect.
Responsible editor: Alessandro Cigno G. P. Cipriani (B) Department of Economics, University of Verona, Via dell’Artigliere 19, 37129 Verona, Italy e-mail: [email protected]
G.P. Cipriani
The first effect is the classical externality arising from the fact that a fall in the fertility rate decreases the future number of workers who will support all the pensioners, leading to a decentralized equilibrium with too few children. Examples include that of Cigno (2006, 2010), Ehrlich and Lui (1998), Nishimura and Zhang (1992), Rosati (1996), Wigger (1999), and more recently, Cremer et al. (2006) and Alders and Broer (2005). The second effect works in the opposite direction: a fall in the fertility rate increases the capital labor ratio, increasing output per capita and pension payouts. Among the relevant papers here are Michel and Pestieau (1993) and Cigno (1993). The third effect is due to the parental decision on investing in child education in a quality–quantity model: shifting child investment from quantity to quality, i.e., investing in children’s human capital, increases future wages and tax revenues for the pension system. A very recent paper in this literature is that of Cremer et al. (2011). Another recent paper with education, focusing on agent investment in their own human capital in a model with pay-as-you-go pensions is Cipriani and Makris (2012). The central issue in the various strands of the literature has been the study of the sustainability of a pay-as-you-go (PAYG) pension policy. However, a recent paper by Fanti and Gori (2012) shows that a falling birth rate does not necessarily cause a fall of pensions in the steady state of a standard overlapping generations (OLG) model with log utility and Cobb–Douglas production function. Their main policy implication is that no pension reforms may be necessary to face the fertility drop. In this paper, we ex
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