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The authors acknowledge support from the Italian National Interest Project‘Crisis Lab’ (MIUR, PNR 2011–2013).
1 Introduction
Several OECD countries are currently facing a remarkable ageing process, which is driven by increases in life expectancy and declines in fertility rates (OECD, 2014, 2015). The observed increases in the median age of the population, which is projected to continue raising over the years ahead, have resulted in an increase in the demographic old-age dependency ratio.1 According to OECD (2015), the demographic old-age dependency ratio, equal to 14 in 1950, reached the value of 28 in 2015, and it is projected to nearly double in 2075, reaching the value of 55.
The increase in the demographic old-age dependency ratio should be seriously taken into account by governments that are financing public pensions via a pay-as-you-go (PAYG) system. In a PAYG system, those who are currently occupied finance the pensions of same-period retirees, based on the promise that they will receive a similar treatment by future cohorts of workers. Due to this mechanism, a decline in population growth may jeopardize the financial viability of the system itself, since it reduces the likelihood that the promise can be maintained in the future.2 In the short term, OECD countries providing PAYG-financed public pensions will suffer from the retirement of the Baby Boom generation, a cohort much larger than the ones that followed in the workforce.3
According to World Bank (2005), traditional strategies adopted in order to make public pension promises more affordable within a PAYG system, i.e., adjustments in the pension eligibility age, in indexation arrangements, and in benefits’ accrual rates, have often been unsatisfactory.
In search for sustainability, some countries (e.g., Italy and Sweden) have introduced the so-called notional defined contribution (NDC) scheme. By maintaining PAYG, the NDC plan provides benefits that bear an actuarial relationship to individual lifetime contributions.4 Nevertheless, due to demographic changes, the introduction of NDC can only partially ease PAYG system's sustainability tensions.
Therefore, in a context of falling fertility and rising longevity, one should seriously consider not merely an amendment of the system, but its replacement with a different and more sustainable one.
The most credited solution to the solvency problem originated by the PAYG system in an ageing economy is...