The main role of the public pension is to provide money for living costs in later life. This function is similar to that of private savings. Moreover, private pensions are now available in the private pension market. Nevertheless, why is a public pension © Springer Science+Business Media Singapore 2017

T. Ihori, Principles of Public Finance, Springer Texts in Business and Economics, DOI 10.1007/978-981-10-2389-7_7

necessary and mandatory? There are four plausible reasons to justify the mandatory public pension system.

Income Redistribution

The argument here is that the public pension is necessary because it can redistribute income among generations and/or within generations. Intragenerational transfer means that pension contributions made by those who die earlier are transferred to those who live longer as pension benefits. This redistribution may be justified if life expectancy is uncertain and people are risk averse. However, such intragenerational redistribution can also be provided by private pensions. Thus, to some extent, this particular advantage is not unique to the public pension system.

It is true that a private pension is not perfect to deal with this problem because of asymmetric information. Life expectancy is hard to anticipate, but the consumer can understand her or his personal health condition more than the private pension company. Thus, those who are very healthy tend to purchase private pensions more than those who are not so healthy. Since a private pension company cannot identify who is more healthy or not, it could offer the same contract to all participants. Then, only very healthy people would join the program; consequently, the private pension company would not make a profit. In this context, the private market may not perform well with regard to the provision of a pension program. If asymmetric information causes a serious problem, a mandatory public pension is desirable in order to share the life expectancy risk among elderly people.

It is theoretically true that the asymmetric information problem exists and that the private market cannot handle this problem well. However, this difficulty may not be so serious quantitatively. Justifying the public pension simply because of the asymmetric information issue is a weak approach.

The unique role of the public pension is intergenerational redistribution, which has a function that private pensions do not have. Some argue that this function is desirable in order to provide help among generations. However, several problems should be noted.

First, how much should different generations help each other? Is it really possible to attain a desirable degree of redistribution in the pay-as-you-go system of an aging society?

As explained later, the rate of return on a public pension can differ significantly, depending upon the population size of each generation in the pay-as-you-go system. For example, in many developed countries, including Japan, the birth rate of each generation has changed considerably. After the Second World War, we experienced a rapid increase in population; then, the population began to decline. In this regard, the rate of return is volatile. It is not good to have volatile rates of return for a public pension. In particular, in an aging society that is experiencing depopulation, the rate of return may well be negative; hence, the pay-as-you-go system is inefficient.

The pay-as-you-go system involves the redistribution of money from the young to the old. If the old are poorer than the young, such redistribution between generations could be justified from the viewpoint of intergenerational equity.

However, in recent years it is not necessarily true that the old are poorer than the young.

For example, in Japan, during the high-growth era of the 1960s, the old were generally poor compared with the young because the workers experienced wage increases every year, while elderly people did not accumulate many assets. Consequently, at this time, age was a reliable indicator of people’s economic situation. Indeed, we may presuppose that elderly people were poor. However, age no longer provides reliable information about economic situations. Among old people, there are many who are rich and have significant assets, while others are poor and cannot afford to meet ordinary living costs. Further, there are many young people who cannot find good jobs and who earn relatively low incomes. Since elderly people are very heterogeneous with respect to economic and other conditions, it seems questionable to redistribute income uniformly based on age.

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