Presidential Address: Pension Policy and the Financial System

Research Retrieved: October 2018
Retrieve the paper from the Harvard Business School & NBER.

Summarizing Paragraph

Past research has found different ways in which those who have access to employer-related retirement plans, such as 401(k)s, may be motivated to enroll. However, the labor market is increasingly made up of freelancers, who, for example, work for Uber or Amazon’s Mechanical Turk and are responsible for their own retirement plans. However, savings rates remain low, especially at the lower end of the income spectrum. The authors conducted a field study in collaboration with 8,391 new users of the financial technology platform Acorns. The study provides evidence that framing savings in smaller fractions (for example $5 per day rather than $150 per month) increases consumer enrollments in savings plans. Further, framing deposits in smaller fractions eliminated the participation gap between high and low income consumers.


Around the world there is a wide heterogeneity in the development of the financial system. Countries around the world have made vastly different choices about how to fund their pension systems. Some countries have decided to finance retirement incomes largely by taxing current workers, in so-called pay-as-you-go (PAYGO) pension systems. Others have promoted private pension savings to fund pension benefits. The paper examines the effect of these two different pension policies on the structure of financial systems in 23 countries part of the Organization for Economic Cooperation and Development (OECD). The author provides theoretical and empirical evidence supporting the hypothesis that policies that promote pension savings also promote the development of the financial system.

Key Findings

  • Capital markets, defined as stock market capitalization over country’s GDP, are smaller in countries with more PAYGO oriented pension systems.
  • The corporate sector in countries with more PAYGO oriented pension system is more dependent on bank financing and has a higher insider ownership. Moreover, firms are smaller in these countries.
  • The household debt to GDP ratio is lower in countries with more PAYGO oriented pension systems. Also, the loan-to-value (LTV) ratio of households is lower in these countries.
  • Households financial assets are lower in more PAYGO oriented counties. This fact, combined with lower levels of LTV ratio, implies that housing equity represents a higher share of the net worth of households in PAYGO oriented countries compared to countries with privately-funded pension systems.
  • Household credit is a smaller share of banks’ assets in more PAYGO oriented countries. Whereas corporate credit is a sizable share on banks’ assets in these countries.

Practical Relevance

The author provides evidence supporting the hypothesis that pension policy affects the structure of the financial system. The author also highlights that the effect of the pension system on the financial system comes on top of the effect exercised by the legal framework or by general faith in financial markets of each country. Therefore, a pension system can affect the risk in an economy through indirect effects on the financial system. A potential mechanism could operate through the mortgage market. Moreover, the findings of this paper are important in the debate on the costs and benefits or a market-based versus a bank-based financial system. In fact, the pension-funding model pushes financial systems towards one or the other.