Impact of PAYG pensions on country welfare through capital accumulation

This study employs a two-country overlapping generations (OLG) model to examine how the pay-as-you-go (PAYG) pension system affects national welfare through changes in capital accumulation. In a closed economy, increase in per capita pension reduces individual savings, and the decrease in capital weakens welfare under dynamic efficiency. However, when a two-country model with capital mobility is considered, the increase in pension plan in a country may increase the welfare of the capital-exporting country. Employing a two-country model in which capital accumulates and moves between two countries, we present the marginal effect of pension plans on countries’ welfare for the steady-state generations and initial and transitional generations. We demonstrate that a paradoxical result occurs when the increase in pension plans in a country improves the country’s welfare because a higher interest rate improves the capital-exporting country’s intertemporal terms of trade. However, we show that the marginal change in a country’s PAYG pension plan cannot simultaneously improve both countries’ welfare in the steady state.