Demographic change is a growing concern for both developed and developing countries. Increasing longevity and reduced fertility threaten the sustainability of traditional pay-as-you-go pension systems. The pension contributions from the working population will not be sufficient to support the elderly. In response, countries are increasingly shifting their pension systems toward partial or full funding. In addition to the main purpose of coping with demographic pressures and unsustainable fiscal positions, other motivations for countries to reform their pension systems often include the hope that funded pensions will contribute to economic development by promoting national savings and capital market development.
In this study, we seek to determine the impacts of pension funds on the development of capital markets. This paper reaches further than previous studies by separating countries according to their level of financial development to account for potential heterogeneity in the results, by using new estimation techniques that have been shown to produce less bias, and by basing results on a larger panel dataset, both in terms of the number of countries and the number of time periods.
The introduction of funded pension systems allows pension funds to accumulate assets that can be invested in financial markets. Even in the case that pension savings crowd out other household savings such that the total savings in the economy do not increase, the accumulation of pension fund assets is expected to potentially promote depth and liquidity in the capital markets because of the different investment behavior between households and pension funds.
With accumulating assets and the longer-term nature of their liabilities, pension funds have incentives to invest more in illiquid and long-term assets that yield higher returns, and thus provide a long-term supply of funds to the capital markets (Davis, 1995). As well, Catalan, Impavido, and Musalem (2000) argue that with their stake in illiquid pension funds, households will increase their liquidity by holding deposits in the banking sector, open end mutual funds, and traded securities, at the expense of other illiquid assets such as real estate or non-traded financial instruments. Such behavior will also stimulate financial market development.
Download
The Role of Pension Funds in Capital Market Development
