The Move from DB to DC

Now consider that in period 3, the system is changed from DB to DC, as happened in the 2004 reform in Japan. Then, from period 3, the pension benefit is endogenously determined, while the pension contribution is fixed. Each generation’s net benefit is given in Table 7.5.

Alternatively, we have

This situation changes the net benefits of all the generations except generation

1. Generation 2 gains because it now receives a benefit of 20 from generation 3 and pays 10. Generation 3 loses because it now receives only 5 when old and pays 10. Generation 4 pays 10 and receives 5. The net loss of generation 4 is now —5, which

Table 7.4 Net payoff for each generation in relation to the pay-as-you-go (defined benefit) system

Generation

1

2

3

4

5

Net return

10

0

5

— 10

— 10

Table 7.5 The transition to a defined system in period 3

Generation

1

2

3

4

5

Net return

10

10

—5

—5

0

is smaller than in the DB system. This is because the size of the total contribution is smaller in the DC system since the population is declining and the per capita contribution is fixed.

This numerical example suggests that a change to the DC system is beneficial to the young and to future generations 4 and 5; however, they still suffer negative net benefits. As long as the pay-as-you-go system is maintained, the young and future generations lose out in an aging society with a declining population.

The 2004 pension reform in Japan has qualitatively the same policy implication because it may be regarded as a gradual change from the DB system to the DC system. Thus, it is beneficial to the young and future generations to some extent, but it cannot fully solve the problem of intergenerational inequity. See the advanced study of this chapter for a simulation analysis of pension reforms in Japan.

 
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