Ebook: The Evolution of Public Pension Schemes

1. 1 An introduction to the problem This book deals with the development of public pension schemes. The operation of public pension schemes has drawn a great deal of attention recently due to ageing of the population which has become apparent since the 19 70s. This would probably have been less of a problem if these schemes had been financed by a Capital Reserve (abbreviated from now on as CR) system. As is well-known, in a pure CR-system individuals (or generations) save for their own retirement. The (average) rate of return on the premiums paid in this system equals the real rate of interest and, in principle, changes in the rate of population growth do not affect the premium rate or the benefit rate of the system. Most public pension schemes, however, are financed by a Pay-As-You-Go (abbreviated from now on as PAYG) system. In this system current pension payments are financed by current premium payments. In contrast to the CR-system intergenerational transfers occur in this system. If the number of retired people increases relative to the number of workers the premium rate will increase under PAYG. In itself this increase does not have to imply any concern for the premium paying population. What counts is whether the rate of return under a PAYG-system will fall (too far) below the rate of return the CR-system is offering.

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The purpose of this book is to describe and to give a theoretical explanation of the developments of Pay-As-You-Go (PAYG)-financed public pension schemes in democracies from a positive point of view. The book especially tries to grasp the determinants for changes in PAYG-systems. It is shown that if confidence in the continuation of an operative public pension scheme is growing, the conversion from a Capital-Reserve to the PAYG system - which has occurred in the history of most schemes - can be explained out of the self-interest of the generations alive. On the other hand, if a PAYG-system has been operating for a long enough period, then the operation of the system can be explained from altruism just as well. The analysis gives insights into the determinants of the future evolution of PAYG-systems. If the current financial crisis perseveres, the PAYG-scheme will not necessarily be maintained indefinitely. This statement holds even if future young generations are altruistic towards the old and even if the old are in the majority in a representative democracy.