Do funded pension systems protect against aging? A theoretical analysis

Abstract

Since the 1980s, the concomitance of several unfavorable developments has highlighted the difficulties of pay-as-you-go pension schemes in ensuring their financial balance. Public pension systems have entered a crisis in several countries.

Some believe that the only way out of this impasse is to break free from the “pay-as-you-go trap” by setting up funded pension plans. The main argument put forward is that, unlike the old public pay-as-you-go system, a funded pension, based on individual savings, is immune to the problem of population aging.

However, in this paper, we will try to show that, contrary to what is often argued, capitalization is not a system intrinsically protected against the consequences of demographic aging. With a generation smaller than the one that preceded it, it will be very difficult to finance pensions, whether by pay-as-you-go or funded. We must not lose sight of the fact that, fundamentally, pensions are nothing more than a drain on the work of those in active employment at the time the pensions are received. This basic reality may be barely visible in the case of a system based on individual savings, but it is nonetheless true.

JEL Classification: H55

Paper type: Theoretical Research