THE CASE FOR PAY‐AS‐YOU‐GO PENSIONS IN A SERVICE ECONOMY
| Published date | 01 May 2007 |
| Author | Bas Van Groezen,Harrie A. A. Verbon,Lex Meijdam |
| Date | 01 May 2007 |
| DOI | http://doi.org/10.1111/j.1467-9485.2007.00409.x |
THE CASE FOR PAY-AS-YOU-GO
PENSIONS IN A SERVICE ECONOMY
Bas van Groezen
n
, Lex Meijdam
nn
and Harrie A. A. Verbon
nn
Abstract
The elderly consume more labour-intensive services than young individuals. This
makes them vulnerable to rising costs of services due to higher wages, which can be
caused by increased capital accumulation. This paper shows that in a model with a
service sector, the golden-rule capital stock is lower and dynamic inefficiency is
more likely to occur than in the conventional one-sector model. This implies that in
many cases, a positive Pay-As-You-Go tax maximises long-run welfare in a service
economy. Calculations based on data from the United Kingdom and the
Netherlands show that the long-run optimal degree of funding coincides with the
current situation in these countries.
I Intro ductio n
The prospective age wave that many countries are confronted with has put
pension reform high on the political agenda. As most countries mainly rely on
public Pay-As-You-Go (PAYG) schemes, one of the most prominent reform
options involves the move to a more funded pension system (see e.g. Economic
Policy Committee,2002, for Europe). In the United States a shift to a fullyfunded
system of individual mandatory accounts is even advocated (see e.g. Feldstein,
1996). The central argument for such a pension reform is that decreasing the
PAYG-scheme stimulates savings, which implies a higher capital stock. As the
reward for capital is on average higher than the rate of population and wage
growth, which can be considered the implicit return of an unfunded scheme, such
a policy will increase lifetime income of the current youngand future generations,
and thus entails substantial welfare gains as long as the interest rate exceeds the
rate of economic growth (see e.g. Lindbeck and Persson, 2003).
1
As is well known, switching to a more funded scheme also involves short-run
transition costs, so that this policy cannot be enacted in a Pareto-improving way
n
Utrecht University
nn
Tilburg University
1
Other arguments in favour of a shift to a more funded scheme are the reduction of the
distortionary effects of PAYG-taxes on labour supply (see e.g. Feldstein, 2005) and the
stimulation of economic growth if capital accumulation involves positive externalities (see e.g.
Gya
´rfa
´s and Marquardt, 2001).
Scottish Journal of Political Economy, Vol. 54, No. 2, May 2007
r2007 The Authors
Journal compilation r2007 Scottish Economic Society. Published by Blackwell Publishing Ltd,
9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main St, Malden, MA, 02148, USA
151
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