Aging, Pension Reform and the Current Account

Declining fertility and increasing life expectancy put pressure on the financing of social security in developed countries. Economists and policy makers have considered options to address this financing challenge, most of which contain reforms of the pension system. No pension reform appears unambiguously superior: reforms typically fare good in some dimensions, but not all. Because of trade-offs, evaluation criteria play a major role in the selection of the preferred policy reform. Typically, analysts consider financial sustainability of the system, evolution of output per capita and minimum income in old age. In this paper we add one criterion, current account imbalances. Using an overlapping-generations model calibrated for Austria with a multi-pillar pension system and an aging population, we compare pension reforms with pay-as-you-go financing and capital-funded financing. In contrast to a number of previous studies, the capital-funded pillar in our model contains both a tax component and insurance against the longevity risk, both realistic. Neglecting current accounts, we find that increases in retirement age with the current pay-as-you-go pension system achieve a good balance between output maintenance, pension finance sustainability and old-age anti-poverty, consistent with previous studies. Such arrangements however increase the dependence on net foreign assets, as the need to save for consumption after retirement is reduced. Adding a capital-funded pillar to the pension system helps achieve (and in some cases improve on) the same goals without increasing the dependence on net foreign assets, over the long run. Savings placed in the pension funds are indeed available for domestic investment. As in previous studies, there are however transitional costs.