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The Simple Economics of Funded and Unfunded Pension Systems

David Blake and J. Michael Orszag


Most state pension schemes are financed on a pay-as-you-go (PAYG)
basis, which means that taxes on the young are used to pay for the
pensions of the retired generation. With private pensions, however,
a fund of assets is built up and invested. Some countries such as Chile
and Australia have moved to a mandatory funded pension system and
the Conservatives in the U.K. have proposed to do the same with their
Basic Pension Plus
proposal. Other countries such as the U.S. and
Sweden have built up a funded reserve to help ease the payment of
pensions when the 'baby boom' generation retires. This article reviews
the economic theories of funded and unfunded pension systems and
examines the advantages and disadvantages of each type of system;
these theories help to explain the current interest in funded systems as
well as the difficulties associated with the transition towards them.

ISSN 1367-580x.