Now that the debt crisis seems more or less under control, Europe’s next challenge is to put the economy back on track of robust, structural growth. Important to this task is to reconsider the European financial landscape, and to see how it can be better geared to supporting the long-term investment needs with sustained growth

van Ewijk, C.

English

International Migration, Integration and Social Cohesion online publications

UvA-DARE is a service provided by the library of the University of Amsterdam (https://dare.uva.nl)UvA-DARE (Digital Academic Repository)Funded pensions can strengthen European economic growthvan Ewijk, C.Publication date2014Document VersionFinal published versionPublished inPension BackgroundLink to publicationCitation for published version (APA):van Ewijk, C. (2014). Funded pensions can strengthen European economic growth. PensionBackground, 2014(2), 14-19. http://www.apg.nl/en/pdfs/apg-pensionbackground-may-2014_article-van-ewijk.pdfGeneral rightsIt is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s)and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an opencontent license (like Creative Commons).Disclaimer/Complaints regulationsIf you believe that digital publication of certain material infringes any of your rights or (privacy) interests, pleaselet the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the materialinaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letterto: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. Youwill be contacted as soon as possible.Download date:10 Mar 2023PEnsion background 1514T he European Commission envisages an important role for institutional investors, including pension funds. Their longer time horizons enable them ‘to behave in a patient, counter-cyclical manner, restraining ‘short-termism’ and reducing the need for maturity transformation.1 Recent research indicates that funded pensions tend to contribute to economic growth, indeed.2 Countries with stronger pension funding perform better in terms of economic growth than countries with less pension funding. Moreover, pension funds may contribute to more robust economies by the better diversification of risks. Having a strong private pension pillar makes citizens less vulnerable to political risks associated with domestic public finances. Also pension funds are better equipped to distribute risks over citizens than for example banks are. At the same time, pension systems face some serious challenges too. Economic growth is impossible without risk; pension contracts should be designed so as accommodate risks in an efficient and - socially - sustainable manner. Pension funding and economic growth Pension funding may contribute to economic growth in a number of ways. a.  First of all, more private retirement saving increases funds available for investment. In Europe this is especially relevant, as it is clear that bank credit will be constrained for a longer period, and will never return to its pre-crisis level. Higher capital requirements will reduce the pre- existing subsidy of implicit government guarantees and therefore lead to more natural levels of bank credit to  the private sector. now that the debt crisis seems more or less under control, Europe’s next challenge is to put the economy back on track of robust, structural growth. Important to this task is to reconsider the European financial landscape, and to see how it can be better geared to supporting the long-term investment needs with sustained growth.funded pensions Can strEngthEn EuroPEan EConoMiC growth1  European Commission, green Paper on long-tErM FinanCing oF thE EuroPEan EConoMY, Brussels, 25- 03- 2013.2  M. Bijlsma, C. van Ewijk, F haaijen (2014), Pension funding and economic growth, Discussion Paper, netspar. PEnsion background 1716EU members, some countries relying almost entirely on pay-as- you-go public pensions (first pillar) whereas others feature substantial funded private pensions (second pillar), see figure 2.3These differences have consequences for the financial  landscape. Figure 3 shows some key features for the financial structure for the group of countries (‘funded’) with strong private pension funding (>80% of GDP) and the group of countries (‘unfunded’) with small pension assets (<50% GDP); the Eastern European countries are taken as a separate group.4 Taken together, the ‘funded’ countries feature a stronger financial sector than the ‘unfunded’ countries; they have a larger stock market capitalization and also larger venture capital (VC) investment. This is as it was to be expected as funded counties have strong institutional investors and pension funds, while the ‘unfunded’ countries rely primarily on the public sector for old age provision. Interestingly, also the position of banks tends to be stronger in the ‘funded’ countries, both in total assets and in foreign assets. This could indicate that also banks benefit from the stronger supply of capital in ‘funded’ countries. This is in contrast with the ‘funding gap’ view5 according to which banks are worse off in funded countries, as their deposit base is weaker when households save through pension funds rather than through bank deposits. This makes banks more dependent on wholesale markets for their funding, driving up their funding cost and making them more susceptible to liquidity shocks. If this is true, then one could argue  that pension funding in this respect does not stabilize the economy, but may even be de-stabilizing for the banking sector. The facts do not support this argument, however. Figure 4 (next page) shows that total household deposits held at banks are somewhat smaller (% GDP) in funded countries, indeed. If taken relative to total bank credit to the private sector the difference is even larger, viz. 40 per cent for funded countries and almost 60 per cent for  b.  Secondly, pension funding may contribute to growth through its focus on long-term investment. Due to the long-term and illiquid character of liabilities, pension funds feature a longer time horizon for their investments too. For this same reason pension funds and insurance companies may be particularly suited for catering illiq-uid investments, e.g. mortgages.c.  Third, pension funds contribute to allocation of risk in the economy, thereby lowering the price of risk and thus promoting growth. Diverting risks from banks to pension funds reduces systematic risks in the financial system. Pension funds are better able to deal with macroeconomic risks than highly leveraged banks. Moreover, participants cannot withdraw their funds on short notice, so that pen-sion funds can adopt a truly long time horizon. One of the reasons why the recent euro zone crisis has become so serious was because much of the sovereign debt was in the hands of banks, leading to an unhealthy spiral of banking risk and sovereign risk. Non-European governments  typically obtain more funding from unleveraged lenders, which makes the financial system more stable.d.  Finally, a strong private pension pillar contributes to the stability of the economy as it makes citizens less reliant on public pension schemes. The current debt crises in southern European countries and Ireland illustrate the vulnerability of the public finances to domestic circum-stances. With funded private pensions, credit risks for citizens can be diversified. By holding an internationally diversified portfolio of assets, pensions and thus domestic consumption become less vulnerable for domestic shocks. This helps to stabilise the domestic economy and avoids vicious circles of deteriorating government finances and weakening consumer demand. impact on the financial landscape How the pension system affects the financial landscape can be made up from an international comparison of financial systems. There is a large variety of pension systems across Figure 2: Large variety in pension systems among EU members Figure 3: Financial structure in funded, unfunded and Eastern European countries1009080706050403020100Greece ItalyFinlandFranceGermanyPortugalSpainSwedenBelgiumIrelandDenmarkNetherlands UKprivate pensionspublic pensionsBank AssetsForeign Assets of BanksStock market capitalisationSize of Corporate Bond marketVC investment * 1000non-fundedfundedFunded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESPFinancial structure Funded vs non-funded% of GDP, unweighted, 2007-2011 period, averagedeastern_EU600%500%400%300%200%100%0%3  see also a.l. Bovenberg & C. van Ewijk, Private pensions for Europe, CPB Policy Brief 2011/07, the hague.4  this methodology follows M. Bijlsma & g. Zwart, 2013, the changing landscape of financial markets in Europe, the united states and Japan by Michiel Bijlsma and gijsbert t. J. Zwart, Brueghel working Paper 2013/02. Ferry haaijen (CPB) helpfully assisted with applying this framework to funded pensions. 5  lans Bovenberg, 2012, naar een duurzaam financieringsmodel voor hypotheken, nEa paper 47, netspar, tilburg. PEnsion background 1918to distinguish between bad luck and bad management in investment. Trust is the key factor here. Systems with indi-vidual accounts in terms of common financial instruments - such as individual or collective DC plans - are more trans-parent and robust in nature than more complicated hybrid DC/DB systems. On the other hand, these hybrid systems may contribute to better risk sharing as they also can deal with risks that are not traded in financial markets. In many countries there is a tendency to favour the simple and clear property rights of individual account systems. These systems are also better geared to introduce flexibility and individual choice, than the traditional DB type pensions. However, also DC systems require delicate communication on the pensions to be expected from the investments. The history of overselling of expected returns and miss-investments  in assets indicate that trust is a serious issue in DC plans  as well. How the virtue of transparency in systems with  individual accounts is weighed against the loss in risk  sharing capabilities, may differ between countries. ConclusionFunded pensions contribute to deeper capital markets and higher growth. This does not imply that funded pensions perform better in all states of the world. It is obvious funded pensions are more sensitive to shocks in financial markets than public pension schemes on PAYG basis. Recent experi-ence with the world-wide shock of the credit crisis have put funded pensions to a serious test. The important lesson for the future is that such deep common shocks require a highly robust design of the pension system. This is essential to maintain the social contract implied in collective pension systems. But this not specific to funded systems; it is true for the first pillar as well. Just as there have been important reforms in public pension schemes, for example by raising retirement age and linking it to life expectancy, also reform in funded pensions are called for. If properly (re-)designed and managed, funded pensions can play an important role in making economies more robust by better diversification of risks at the national level as a complement to public  pensions that take care of poverty alleviation and risk sharing on a national basis. Casper van Ewijk Professor at the University of Amsterdam, the Netherlands, and Director of Netspar, the Network for Studies on Pensions, Aging & Retirement unfunded countries. This should not be interpreted as an indication that deposits are constraining bank credit. On the contrary, the low ratio in ‘funded’ countries exactly points to the opposite: it is due to the fact that bank credit is substantially higher (% GDP) in countries with large pen-sion funding. Apparently, banks benefit more from deeper capital markets thanks to the ample supply of capital. This positive factor dominates the possible drawback of smaller supply of households’ deposits.requirements for pensions Pensions are necessary for providing income when old.  But pensions systems are also important for the allocation of macroeconomic risks in society. Risk taking is intrinsic to economic growth; risks cannot – and should not - be taken away but should be shared in an efficient manner. Pension systems obviously play a role here as pension saving constitutes the major source for financing investment in European economies. Pension systems should diversify risks. Optimal international and intergenerational risk sharing yields considerable welfare gains; it reduces the costs of risk, and thus helps to promote economic growth. According to Obstfeld halving the variance of macroeconomic risks through better risk sharing could increase growth from 1.7% to 2% and lead to a welfare gain of 37%.6With firms withdrawing as risk bearing sponsors, more risks will inevitable have to be put onto workers and pensioners. Funded pension systems can assist individuals to optimize saving and risk taking over the lifecycle. To some extent pensions systems can also share risks that cannot be shared through financial markets, e.g. systematic longevity risk, (wage) inflation risks and risk sharing with new generations. As people live longer, it becomes more important to benefit from the risk premium, also during the later phases of the life cycle. A good pension is a risk pension. Both for the individual and for the economy as a whole. This implies that unlike many traditional DC plans, pensions should not aim at seemingly ‘safe’ nominal pensions, but rather focus on real and variable annuities accepting risk in the portfolio also after retirement. Similarly for more DB oriented systems; these should be adjusted to trade risk in an efficient and transparent manner. Taking risk into pensions implies that high standards have to be set with regard to property rights of the individual participant. Risk is extremely difficult to communicate to citizens, also to the better informed. Risk in pensions gives rise to serious signal extraction problems, making it hard 6  M. obstfeld, 1994, risk taking, global diversification, and growth, american Economic review 84, 1310-29.Figure 4: Deposits and bank credit for three groups of countries: funded, non-funded, and eastern Europe.non-fundedfundedHousehold deposits (%GDP) Deposits/bank credit privatesectorFunded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESPFunding gap banksunweighted, 2007-2011 period, averagedeastern_EU80%70%60%50%40%30%20%10%0%

Funded pensions can strengthen European economic growth

UvA-DARE

UvA-DARE is a service provided by the library of the University of Amsterdam (https://dare.uva.nl)UvA-DARE (Digital Academic Repository)Funded pensions can strengthen European economic growthvan Ewijk, C.Publication date2014Document VersionFinal published versionPublished inPension BackgroundLink to publicationCitation for published version (APA):van Ewijk, C. (2014). Funded pensions can strengthen European economic growth. PensionBackground, 2014(2), 14-19. http://www.apg.nl/en/pdfs/apg-pensionbackground-may-2014_article-van-ewijk.pdfGeneral rightsIt is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s)and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an opencontent license (like Creative Commons).Disclaimer/Complaints regulationsIf you believe that digital publication of certain material infringes any of your rights or (privacy) interests, pleaselet the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the materialinaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letterto: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. Youwill be contacted as soon as possible.Download date:10 Nov 2022PEnsion background 1514T he European Commission envisages an important role for institutional investors, including pension funds. Their longer time horizons enable them ‘to behave in a patient, counter-cyclical manner, restraining ‘short-termism’ and reducing the need for maturity transformation.1 Recent research indicates that funded pensions tend to contribute to economic growth, indeed.2 Countries with stronger pension funding perform better in terms of economic growth than countries with less pension funding. Moreover, pension funds may contribute to more robust economies by the better diversification of risks. Having a strong private pension pillar makes citizens less vulnerable to political risks associated with domestic public finances. Also pension funds are better equipped to distribute risks over citizens than for example banks are. At the same time, pension systems face some serious challenges too. Economic growth is impossible without risk; pension contracts should be designed so as accommodate risks in an efficient and - socially - sustainable manner. Pension funding and economic growth Pension funding may contribute to economic growth in a number of ways. a.  First of all, more private retirement saving increases funds available for investment. In Europe this is especially relevant, as it is clear that bank credit will be constrained for a longer period, and will never return to its pre-crisis level. Higher capital requirements will reduce the pre- existing subsidy of implicit government guarantees and therefore lead to more natural levels of bank credit to  the private sector. now that the debt crisis seems more or less under control, Europe’s next challenge is to put the economy back on track of robust, structural growth. Important to this task is to reconsider the European financial landscape, and to see how it can be better geared to supporting the long-term investment needs with sustained growth.funded pensions Can strEngthEn EuroPEan EConoMiC growth1  European Commission, green Paper on long-tErM FinanCing oF thE EuroPEan EConoMY, Brussels, 25- 03- 2013.2  M. Bijlsma, C. van Ewijk, F haaijen (2014), Pension funding and economic growth, Discussion Paper, netspar. PEnsion background 1716EU members, some countries relying almost entirely on pay-as- you-go public pensions (first pillar) whereas others feature substantial funded private pensions (second pillar), see figure 2.3These differences have consequences for the financial  landscape. Figure 3 shows some key features for the financial structure for the group of countries (‘funded’) with strong private pension funding (>80% of GDP) and the group of countries (‘unfunded’) with small pension assets (<50% GDP); the Eastern European countries are taken as a separate group.4 Taken together, the ‘funded’ countries feature a stronger financial sector than the ‘unfunded’ countries; they have a larger stock market capitalization and also larger venture capital (VC) investment. This is as it was to be expected as funded counties have strong institutional investors and pension funds, while the ‘unfunded’ countries rely primarily on the public sector for old age provision. Interestingly, also the position of banks tends to be stronger in the ‘funded’ countries, both in total assets and in foreign assets. This could indicate that also banks benefit from the stronger supply of capital in ‘funded’ countries. This is in contrast with the ‘funding gap’ view5 according to which banks are worse off in funded countries, as their deposit base is weaker when households save through pension funds rather than through bank deposits. This makes banks more dependent on wholesale markets for their funding, driving up their funding cost and making them more susceptible to liquidity shocks. If this is true, then one could argue  that pension funding in this respect does not stabilize the economy, but may even be de-stabilizing for the banking sector. The facts do not support this argument, however. Figure 4 (next page) shows that total household deposits held at banks are somewhat smaller (% GDP) in funded countries, indeed. If taken relative to total bank credit to the private sector the difference is even larger, viz. 40 per cent for funded countries and almost 60 per cent for  b.  Secondly, pension funding may contribute to growth through its focus on long-term investment. Due to the long-term and illiquid character of liabilities, pension funds feature a longer time horizon for their investments too. For this same reason pension funds and insurance companies may be particularly suited for catering illiq-uid investments, e.g. mortgages.c.  Third, pension funds contribute to allocation of risk in the economy, thereby lowering the price of risk and thus promoting growth. Diverting risks from banks to pension funds reduces systematic risks in the financial system. Pension funds are better able to deal with macroeconomic risks than highly leveraged banks. Moreover, participants cannot withdraw their funds on short notice, so that pen-sion funds can adopt a truly long time horizon. One of the reasons why the recent euro zone crisis has become so serious was because much of the sovereign debt was in the hands of banks, leading to an unhealthy spiral of banking risk and sovereign risk. Non-European governments  typically obtain more funding from unleveraged lenders, which makes the financial system more stable.d.  Finally, a strong private pension pillar contributes to the stability of the economy as it makes citizens less reliant on public pension schemes. The current debt crises in southern European countries and Ireland illustrate the vulnerability of the public finances to domestic circum-stances. With funded private pensions, credit risks for citizens can be diversified. By holding an internationally diversified portfolio of assets, pensions and thus domestic consumption become less vulnerable for domestic shocks. This helps to stabilise the domestic economy and avoids vicious circles of deteriorating government finances and weakening consumer demand. impact on the financial landscape How the pension system affects the financial landscape can be made up from an international comparison of financial systems. There is a large variety of pension systems across Figure 2: Large variety in pension systems among EU members Figure 3: Financial structure in funded, unfunded and Eastern European countries1009080706050403020100Greece ItalyFinlandFranceGermanyPortugalSpainSwedenBelgiumIrelandDenmarkNetherlands UKprivate pensionspublic pensionsBank AssetsForeign Assets of BanksStock market capitalisationSize of Corporate Bond marketVC investment * 1000non-fundedfundedFunded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESPFinancial structure Funded vs non-funded% of GDP, unweighted, 2007-2011 period, averagedeastern_EU600%500%400%300%200%100%0%3  see also a.l. Bovenberg & C. van Ewijk, Private pensions for Europe, CPB Policy Brief 2011/07, the hague.4  this methodology follows M. Bijlsma & g. Zwart, 2013, the changing landscape of financial markets in Europe, the united states and Japan by Michiel Bijlsma and gijsbert t. J. Zwart, Brueghel working Paper 2013/02. Ferry haaijen (CPB) helpfully assisted with applying this framework to funded pensions. 5  lans Bovenberg, 2012, naar een duurzaam financieringsmodel voor hypotheken, nEa paper 47, netspar, tilburg. PEnsion background 1918to distinguish between bad luck and bad management in investment. Trust is the key factor here. Systems with indi-vidual accounts in terms of common financial instruments - such as individual or collective DC plans - are more trans-parent and robust in nature than more complicated hybrid DC/DB systems. On the other hand, these hybrid systems may contribute to better risk sharing as they also can deal with risks that are not traded in financial markets. In many countries there is a tendency to favour the simple and clear property rights of individual account systems. These systems are also better geared to introduce flexibility and individual choice, than the traditional DB type pensions. However, also DC systems require delicate communication on the pensions to be expected from the investments. The history of overselling of expected returns and miss-investments  in assets indicate that trust is a serious issue in DC plans  as well. How the virtue of transparency in systems with  individual accounts is weighed against the loss in risk  sharing capabilities, may differ between countries. ConclusionFunded pensions contribute to deeper capital markets and higher growth. This does not imply that funded pensions perform better in all states of the world. It is obvious funded pensions are more sensitive to shocks in financial markets than public pension schemes on PAYG basis. Recent experi-ence with the world-wide shock of the credit crisis have put funded pensions to a serious test. The important lesson for the future is that such deep common shocks require a highly robust design of the pension system. This is essential to maintain the social contract implied in collective pension systems. But this not specific to funded systems; it is true for the first pillar as well. Just as there have been important reforms in public pension schemes, for example by raising retirement age and linking it to life expectancy, also reform in funded pensions are called for. If properly (re-)designed and managed, funded pensions can play an important role in making economies more robust by better diversification of risks at the national level as a complement to public  pensions that take care of poverty alleviation and risk sharing on a national basis. Casper van Ewijk Professor at the University of Amsterdam, the Netherlands, and Director of Netspar, the Network for Studies on Pensions, Aging & Retirement unfunded countries. This should not be interpreted as an indication that deposits are constraining bank credit. On the contrary, the low ratio in ‘funded’ countries exactly points to the opposite: it is due to the fact that bank credit is substantially higher (% GDP) in countries with large pen-sion funding. Apparently, banks benefit more from deeper capital markets thanks to the ample supply of capital. This positive factor dominates the possible drawback of smaller supply of households’ deposits.requirements for pensions Pensions are necessary for providing income when old.  But pensions systems are also important for the allocation of macroeconomic risks in society. Risk taking is intrinsic to economic growth; risks cannot – and should not - be taken away but should be shared in an efficient manner. Pension systems obviously play a role here as pension saving constitutes the major source for financing investment in European economies. Pension systems should diversify risks. Optimal international and intergenerational risk sharing yields considerable welfare gains; it reduces the costs of risk, and thus helps to promote economic growth. According to Obstfeld halving the variance of macroeconomic risks through better risk sharing could increase growth from 1.7% to 2% and lead to a welfare gain of 37%.6With firms withdrawing as risk bearing sponsors, more risks will inevitable have to be put onto workers and pensioners. Funded pension systems can assist individuals to optimize saving and risk taking over the lifecycle. To some extent pensions systems can also share risks that cannot be shared through financial markets, e.g. systematic longevity risk, (wage) inflation risks and risk sharing with new generations. As people live longer, it becomes more important to benefit from the risk premium, also during the later phases of the life cycle. A good pension is a risk pension. Both for the individual and for the economy as a whole. This implies that unlike many traditional DC plans, pensions should not aim at seemingly ‘safe’ nominal pensions, but rather focus on real and variable annuities accepting risk in the portfolio also after retirement. Similarly for more DB oriented systems; these should be adjusted to trade risk in an efficient and transparent manner. Taking risk into pensions implies that high standards have to be set with regard to property rights of the individual participant. Risk is extremely difficult to communicate to citizens, also to the better informed. Risk in pensions gives rise to serious signal extraction problems, making it hard 6  M. obstfeld, 1994, risk taking, global diversification, and growth, american Economic review 84, 1310-29.Figure 4: Deposits and bank credit for three groups of countries: funded, non-funded, and eastern Europe.non-fundedfundedHousehold deposits (%GDP) Deposits/bank credit privatesectorFunded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESPFunding gap banksunweighted, 2007-2011 period, averagedeastern_EU80%70%60%50%40%30%20%10%0%

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Funded pensions can strengthen European economic growth
van Ewijk, C.
Published in:
Pension Background
Link to publication
Citation for published version (APA):
van Ewijk, C. (2014). Funded pensions can strengthen European economic growth. Pension Background,
2014(2), 14-19. http://www.apg.nl/en/pdfs/apg-pensionbackground-may-2014_article-van-ewijk.pdf
General rights
It is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s) and/or copyright holder(s),
other than for strictly personal, individual use, unless the work is under an open content license (like Creative Commons).
Disclaimer/Complaints regulations
If you believe that digital publication of certain material infringes any of your rights or (privacy) interests, please let the Library know, stating
your reasons. In case of a legitimate complaint, the Library will make the material inaccessible and/or remove it from the website. Please Ask
the Library: https://uba.uva.nl/en/contact, or a letter to: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam,
The Netherlands. You will be contacted as soon as possible.
Download date: 04 Feb 2021
PEnsion background 1514
T he European Commission envisages an important role for institutional investors, including pension funds. Their longer time horizons enable them ‘to behave in a patient, counter-cyclical manner, 
restraining ‘short-termism’ and reducing the need for 
maturity transformation.1 Recent research indicates that 
funded pensions tend to contribute to economic growth, 
indeed.2 Countries with stronger pension funding perform 
better in terms of economic growth than countries with less 
pension funding. Moreover, pension funds may contribute 
to more robust economies by the better diversification of 
risks. Having a strong private pension pillar makes citizens 
less vulnerable to political risks associated with domestic 
public finances. Also pension funds are better equipped to 
distribute risks over citizens than for example banks are. At 
the same time, pension systems face some serious challenges 
too. Economic growth is impossible without risk; pension 
contracts should be designed so as accommodate risks in an 
efficient and - socially - sustainable manner. 
Pension funding and economic growth 
Pension funding may contribute to economic growth in a 
number of ways. 
a.  First of all, more private retirement saving increases 
funds available for investment. In Europe this is especially 
relevant, as it is clear that bank credit will be constrained 
for a longer period, and will never return to its pre-crisis 
level. Higher capital requirements will reduce the pre- 
existing subsidy of implicit government guarantees and 
therefore lead to more natural levels of bank credit to  
the private sector. 
now that the debt crisis seems more or less under control, Europe’s next 
challenge is to put the economy back on track of robust, structural growth. 
Important to this task is to reconsider the European financial landscape, and to 
see how it can be better geared to supporting the long-term investment needs 
with sustained growth.
funded pensions Can 
strEngthEn EuroPEan 
EConoMiC growth
1  European Commission, green Paper on long-tErM FinanCing oF thE 
EuroPEan EConoMY, Brussels, 25- 03- 2013.
2  M. Bijlsma, C. van Ewijk, F haaijen (2014), Pension funding and 
economic growth, Discussion Paper, netspar. 
PEnsion background 1716
EU members, some countries relying almost entirely on 
pay-as- you-go public pensions (first pillar) whereas others 
feature substantial funded private pensions (second pillar), 
see figure 2.3
These differences have consequences for the financial  
landscape. Figure 3 shows some key features for the financial 
structure for the group of countries (‘funded’) with strong 
private pension funding (>80% of GDP) and the group of 
countries (‘unfunded’) with small pension assets (<50% GDP); 
the Eastern European countries are taken as a separate group.4 
Taken together, the ‘funded’ countries feature a stronger 
financial sector than the ‘unfunded’ countries; they have a 
larger stock market capitalization and also larger venture 
capital (VC) investment. This is as it was to be expected as 
funded counties have strong institutional investors and 
pension funds, while the ‘unfunded’ countries rely primarily 
on the public sector for old age provision. 
Interestingly, also the position of banks tends to be stronger 
in the ‘funded’ countries, both in total assets and in foreign 
assets. This could indicate that also banks benefit from the 
stronger supply of capital in ‘funded’ countries. This is in 
contrast with the ‘funding gap’ view5 according to which 
banks are worse off in funded countries, as their deposit 
base is weaker when households save through pension funds 
rather than through bank deposits. This makes banks more 
dependent on wholesale markets for their funding, driving 
up their funding cost and making them more susceptible 
to liquidity shocks. If this is true, then one could argue  
that pension funding in this respect does not stabilize the 
economy, but may even be de-stabilizing for the banking 
sector. The facts do not support this argument, however. 
Figure 4 (next page) shows that total household deposits 
held at banks are somewhat smaller (% GDP) in funded 
countries, indeed. If taken relative to total bank credit to 
the private sector the difference is even larger, viz. 40 per 
cent for funded countries and almost 60 per cent for 
 b.  Secondly, pension funding may contribute to growth 
through its focus on long-term investment. Due to the 
long-term and illiquid character of liabilities, pension 
funds feature a longer time horizon for their investments 
too. For this same reason pension funds and insurance 
companies may be particularly suited for catering illiq-
uid investments, e.g. mortgages.
c.  Third, pension funds contribute to allocation of risk in 
the economy, thereby lowering the price of risk and thus 
promoting growth. Diverting risks from banks to pension 
funds reduces systematic risks in the financial system. 
Pension funds are better able to deal with macroeconomic 
risks than highly leveraged banks. Moreover, participants 
cannot withdraw their funds on short notice, so that pen-
sion funds can adopt a truly long time horizon. One of the 
reasons why the recent euro zone crisis has become so 
serious was because much of the sovereign debt was in the 
hands of banks, leading to an unhealthy spiral of banking 
risk and sovereign risk. Non-European governments  
typically obtain more funding from unleveraged lenders, 
which makes the financial system more stable.
d.  Finally, a strong private pension pillar contributes to the 
stability of the economy as it makes citizens less reliant 
on public pension schemes. The current debt crises in 
southern European countries and Ireland illustrate the 
vulnerability of the public finances to domestic circum-
stances. With funded private pensions, credit risks for 
citizens can be diversified. By holding an internationally 
diversified portfolio of assets, pensions and thus domestic 
consumption become less vulnerable for domestic 
shocks. This helps to stabilise the domestic economy and 
avoids vicious circles of deteriorating government 
finances and weakening consumer demand. 
impact on the financial landscape 
How the pension system affects the financial landscape can 
be made up from an international comparison of financial 
systems. There is a large variety of pension systems across 
Figure 2: Large variety in pension systems among EU members Figure 3: Financial structure in funded, unfunded and Eastern European countries
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private pensions
public pensions
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 As
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 As
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 ca
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 10
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non-funded
funded
Funded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESP
Financial structure Funded vs non-funded
% of GDP, unweighted, 2007-2011 period, averaged
eastern_EU
600%
500%
400%
300%
200%
100%
0%
3  see also a.l. Bovenberg & C. van Ewijk, Private pensions for Europe, CPB 
Policy Brief 2011/07, the hague.
4  this methodology follows M. Bijlsma & g. Zwart, 2013, the changing 
landscape of financial markets in Europe, the united states and Japan by 
Michiel Bijlsma and gijsbert t. J. Zwart, Brueghel working Paper 
2013/02. Ferry haaijen (CPB) helpfully assisted with applying this 
framework to funded pensions. 
5  lans Bovenberg, 2012, naar een duurzaam financieringsmodel voor 
hypotheken, nEa paper 47, netspar, tilburg. 
PEnsion background 1918
to distinguish between bad luck and bad management in 
investment. Trust is the key factor here. Systems with indi-
vidual accounts in terms of common financial instruments 
- such as individual or collective DC plans - are more trans-
parent and robust in nature than more complicated hybrid 
DC/DB systems. On the other hand, these hybrid systems 
may contribute to better risk sharing as they also can deal 
with risks that are not traded in financial markets. In many 
countries there is a tendency to favour the simple and clear 
property rights of individual account systems. These systems 
are also better geared to introduce flexibility and individual 
choice, than the traditional DB type pensions. However, 
also DC systems require delicate communication on the 
pensions to be expected from the investments. The history 
of overselling of expected returns and miss-investments  
in assets indicate that trust is a serious issue in DC plans  
as well. How the virtue of transparency in systems with  
individual accounts is weighed against the loss in risk  
sharing capabilities, may differ between countries. 
Conclusion
Funded pensions contribute to deeper capital markets and 
higher growth. This does not imply that funded pensions 
perform better in all states of the world. It is obvious funded 
pensions are more sensitive to shocks in financial markets 
than public pension schemes on PAYG basis. Recent experi-
ence with the world-wide shock of the credit crisis have put 
funded pensions to a serious test. The important lesson for 
the future is that such deep common shocks require a highly 
robust design of the pension system. This is essential to 
maintain the social contract implied in collective pension 
systems. But this not specific to funded systems; it is true 
for the first pillar as well. Just as there have been important 
reforms in public pension schemes, for example by raising 
retirement age and linking it to life expectancy, also reform 
in funded pensions are called for. If properly (re-)designed 
and managed, funded pensions can play an important role 
in making economies more robust by better diversification 
of risks at the national level as a complement to public  
pensions that take care of poverty alleviation and risk sharing 
on a national basis. 
Casper van Ewijk 
Professor at the University of 
Amsterdam, the Netherlands, 
and Director of Netspar, the 
Network for Studies on 
Pensions, Aging & Retirement 
unfunded countries. This should not be interpreted as an 
indication that deposits are constraining bank credit. On 
the contrary, the low ratio in ‘funded’ countries exactly 
points to the opposite: it is due to the fact that bank credit 
is substantially higher (% GDP) in countries with large pen-
sion funding. Apparently, banks benefit more from deeper 
capital markets thanks to the ample supply of capital. This 
positive factor dominates the possible drawback of smaller 
supply of households’ deposits.
requirements for pensions 
Pensions are necessary for providing income when old.  
But pensions systems are also important for the allocation 
of macroeconomic risks in society. Risk taking is intrinsic 
to economic growth; risks cannot – and should not - be 
taken away but should be shared in an efficient manner. 
Pension systems obviously play a role here as pension saving 
constitutes the major source for financing investment in 
European economies. Pension systems should diversify 
risks. Optimal international and intergenerational risk 
sharing yields considerable welfare gains; it reduces the 
costs of risk, and thus helps to promote economic growth. 
According to Obstfeld halving the variance of macroeconomic 
risks through better risk sharing could increase growth 
from 1.7% to 2% and lead to a welfare gain of 37%.6
With firms withdrawing as risk bearing sponsors, more risks 
will inevitable have to be put onto workers and pensioners. 
Funded pension systems can assist individuals to optimize 
saving and risk taking over the lifecycle. To some extent 
pensions systems can also share risks that cannot be shared 
through financial markets, e.g. systematic longevity risk, 
(wage) inflation risks and risk sharing with new generations. 
As people live longer, it becomes more important to benefit 
from the risk premium, also during the later phases of the 
life cycle. A good pension is a risk pension. Both for the 
individual and for the economy as a whole. This implies 
that unlike many traditional DC plans, pensions should not 
aim at seemingly ‘safe’ nominal pensions, but rather focus 
on real and variable annuities accepting risk in the portfolio 
also after retirement. Similarly for more DB oriented systems; 
these should be adjusted to trade risk in an efficient and 
transparent manner. 
Taking risk into pensions implies that high standards have 
to be set with regard to property rights of the individual 
participant. Risk is extremely difficult to communicate to 
citizens, also to the better informed. Risk in pensions gives 
rise to serious signal extraction problems, making it hard 
6  M. obstfeld, 1994, risk taking, global diversification, and growth, 
american Economic review 84, 1310-29.
Figure 4: Deposits and bank credit for three groups of countries: funded, non-funded, and eastern Europe.
non-funded
funded
Household deposits (%GDP) Deposits/bank credit privatesector
Funded = CHE, DNK, FIN, ISL, NLD, UK. Non-Funded = AUT, BEL, FRA, DEU, GRC, IRE, ITA, NOR, PRT, ESP
Funding gap banks
unweighted, 2007-2011 period, averaged
eastern_EU
80%
70%
60%
50%
40%
30%
20%
10%
0%


Funded pensions can strengthen European economic growth

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