This paper analyses the e¤ects of reducing unfunded social security and population
ageing on economic growth and welfare, both for a small open economy
and for a closed economy. The economy consists of a service sector and a
commodity sector. Productivity growth only occurs in the latter sector and is
assumed to depend positively on its size. It is shown that if old agents mainly
demand labour intensive services, a decrease of the pay-as-you-go (PAYG) pension
scheme reduces long-run growth and thus welfare in a small open economy,
whereas current generations are better o¤. However, reducing social security
raises productivity growth in a closed economy, both in the short and long run.
Furthermore, ageing will lead to a lower long-run rate of economic growth
in a small open economy, whereas in the short run, the e¤ects depend on the
type of ageing and the size of the PAYG-scheme. In a closed economy, the
e¤ects of ageing depend on the substitutability of labour and capital
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