Public Pension Reform

The Aging Population in Japan

Japan now faces a serious problem because of longer life expectancy and lower fertility in an aging society. Using a simple theoretical framework of two-period overlapping generations, this section illustrates the potential conflicts among generations resulting from the 2004 pension reform in an aging Japan. The reform may be regarded as a gradual change from a defined-benefit (DB) system to a defined-contribution (DC) system. With regard to the pension system in Japan, see the case study of this chapter, Appendix A.

The budget constraint in the pay-as-you-go system is given as

where Lt is the number of people in generation t, bt is the per capita contribution when young in period t, and 0t is the per capita benefit when old in period t. In the DC system, bt = b, while in the DB system 0t = 0t = в. Here, b and в are exogenously given as fixed levels of contribution and benefit respectively.

The net benefit of generation t is defined as

where, for simplicity, the discount rate is assumed to be zero.

Considering the above budget constraint, in the DB system the net benefit of generation t is written as

In the DC system, we have

As the time path of population size, let us assume that, from time 1 to time 6,

Namely, L = 1 is the initial equilibrium level of population and L = 0.5 is the new equilibrium level of population. During the move from L = 1 to L = 0.5, the population temporarily rises. Generation 3 is a baby boom generation and, beginning with time period 5, population growth is negative. This may well reflect Japan’s actual and future demographic changes after the Second World War.

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