SFB 303 Discussion Paper No. A - 548

Author: Marquardt, Marko, and Wolfgang Peters
Title: Collective Madness
Abstract: This paper analyzes the influence of demographic changes on pay-as-you-go (PAYG) pension systems under majority voting. Ageing of the population, either through a decrease in the birth rate or through increasing life expectancy, leads to a lower internal rate of return of PAYG systems. Consequently, individuals prefer less PAYG pensions as population ages. However, empirical studies show that the extent of PAYG systems is increasing while the population is ageing, which seemingly contradicts the described individual rationale. We solve this puzzle by introducing majority voting on the extent of the PAYG pension system. Demographic change is shown to affect not only the individual's rationale, but also the composition of the electorate. In particular, the decisive voter may desire more intergenerational redistribution in a society with lower birth rates and higher longevity. This effect results in what we call collective madness: although each individual prefers a reduction of the PAYG system as the population ages, society as a whole pleads for its extension.
Keywords: Public Pension, Ageing, Majority Voting
JEL-Classification-Number: H55, D72, J18
Creation-Date: April 1997
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