Political sustainability of unfunded pensions in an endogenous growth model

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Description/Abstract

Cooley and Soares (1999) show that a pay-as-you-go pension system can be an outcome of a political equilibrium and rather relatively large size of it can be introduced. This note assumes endogenous growth model rather than the exogenous one, which establishes a link between savings rate and economic growth. Since the introduction of the pay-as-you-go system lowers the savings rate, it has an adverse effect on growth rate and hence on future pensions. When this additional incentive is taken into account, then the level of pay-as-you-go system chosen in political equilibrium is much lower than in exogenous growth model of Cooley and Soares. Still their qualitative conclusion holds, at least some level of pay-as-you-go system will be introduced in equilibrium.