Ageing and Pension Reform in a Small Open Economy: The Role of Savings Incentives

In this paper we analyse the effects of ageing in a small open economy with a representative government. More specific, we adress the question whether in case of ageing a transition from an unfunded to a more funded pension scheme is politically feasible. We show that the existence of a suitable subsidy on savings is crucial in this respect. Without a subsidy on savings, the economy is trapped at the preexisting level of saving and ageing leads to an increase of the PAYG tax. However, if a subsidy exists which is linked to the tax rate in a non-linear way a conversion from PAYG to funded pensions is politically feasible.